Bursts of Color - SPAC Yellow Flags
If you track the financial news, you know that SPACs ("Special Purpose Acquisition Vehicles") are hot. According to SPAC TRACK, there are currently 352 active SPACs with a total of $108 billion dollars in cash. Axios noted 12 new SPAC filings on Monday alone. This pace is frenetic, so last week my partner Rob posted SPAC - Red Alert. I've pulled out a few choice quotes along with my own commentary below.
What is a SPAC?
Per Rob:
A SPAC is a financial instrument that can help a private company go public that takes less than a month to set up.
The cash sitting in the SPAC becomes the money raised “during the IPO." Typically, SPACs have two years to purchase a target company, otherwise the investors get their money back, less some expenses. As an example, a $500 million SPAC merges with a private company and values the private company at $1.5 billion, resulting in a $2 billion post-money valuation of the combined entity.
What is There to Worry About?
Most companies with strong management teams and solid prospects will either go public the old-fashioned way or through a direct listing. Those that can’t stand on their own will choose the SPAC path and thus a lower quality company will be acquired. A ton of money will be chasing subpar companies…and you know how that will end.
Recent results are illuminating. A Stanford & NYU Study of the 2019-20 cohort showed that, while median 12-month returns were +32% for the SPAC Sponsors (you know... the big names who create them), post-merger investors lost 34.9% in the same period.
Why Aren't We Hearing More About This?
A lot of people are making money from this trend while it's on the way up. Bankers, lawyers and sponsors all get paid just to create the new SPACs. Next up are the investors who own equity in the target companies. As one of them told me last week:
We're very concerned about the SPAC market longer term. But we're staying quiet because, in the short term, it's a fantastic way for us to get liquidity on second rate assets.
I don't think the SPAC is inherently bad or good... rather, it's just a financial instrument, like the CDO of 2008 fame. In some situations it will be a good choice for the target company and its investors. However, anytime the financial community goes wild for a new product like this, it does give me pause to ask: who will be left without a chair when the music stops?