Why Wall Street is gaga over blank-cheque SPACs

Basically, a SPAC is a promise. You give the promoters a tonne of money so that they will put it to use within a specified period of time — usually 18 months to two years — to buy an existing unlisted company. Promoters put together a board with well-known people, then look around for a target company that they can buy. Once the deal is done, you have a formidable board, a growth company, cash that can be used to fuel growth and a promoter — a billionaire investor, hedge fund or private-equity firm, willing to light up the rocket fuel and send it skywards.

The money sits in the SPAC account until a promoter, such as billionaire activist investor Bill Ackman, stumbles on a company that he wants to acquire. If they cannot find a suitable company after two years, investors get all their cash back, adjusted for minimal costs and accumulated interest. Ackman recently raised US$4 billion for Pershing Square Tontine Holdings, the biggest blank-cheque listing in history. There are few private companies worth at least US$4 billion that can have a merger of equals with Ackman’s SPAC. Yet, Ackman boasts an incredible track record. A decade ago, he listed a SPAC — Justice Holdings — on the London Stock Exchange that acquired Burger King Worldwide only to later merge with Canadian coffee chain Tim Hortons. Restaurant Brands is now owned by Brazilian private equity group 3G and Warren Buffett’s Berkshire Hathaway. If you had taken a ride with Ackman on that SPAC, you would have more than doubled your money.

What is driving the boom in SPACs? Part of it is the massive liquidity in the aftermath of global central banks’ quantitative easing and huge fiscal stimulus in the US, Europe, China, Japan and other economies following the Covid-19 pandemic. Money is really cheap, capital is abundant and investors are chasing growth in every nook and corner of the market. There are other factors at play. Companies taking the normal initial public offering (IPO) route often fret about huge investment banking fees — typically 2% to 7% of gross proceeds — as well as leaving money on the table just to get the listing done on time. “You need to look at the surge in SPAC listings as part of a larger trend, with more companies looking at alternatives to traditional IPOs,” says Marvin. She notes that, over the last two years, tech firms such as music streaming giant Spotify and productivity software firm Slack Technologies had taken the direct listing route rather than the traditional IPO.

Over the past year, the success of blank-cheque firms’ reverse takeovers such as that of Virgin Galactic Holdings, Sir Richard Branson’s firm that is developing commercial spacecraft and aims to provide suborbital spaceflights to space tourists, has forced investors to look at SPACs. Virgin Galactic listed last year through a reverse merger with a SPAC controlled by billionaire tech investor Chamath Palihapitiya, which sent its stock surging more than fourfold before correcting. More recently, hydrogen fuel-cell electric cabover semi-truck firm Nikola, another SPAC takeover, saw its stock surge 550% in a few weeks even though it will not start making anything until 2022. Sports betting firm DraftKings, which listed following a reverse SPAC takeover in April, has seen its stock surge more than 250% despite the fact that there have been no sports to bet on during the Covid-19 lockdown.

“The SPAC listings during the pandemic have a lot to do with providing more stability and certainty to both companies and IPO investors in a volatile time in the public markets,” says Cameron Stanfill, analyst for PitchBook in Seattle. “Since traditional IPOs of operating companies have been relatively scarce, SPAC sponsors and new entrants have taken it as an opportunity to raise the capital themselves and take a company public later,” he told The Edge Singapore.

South Sea bubble

To be sure, the concept of blank-cheque or SPAC-like firms is nothing new. The earliest blank-cheque companies were formed in the 18th century, during one of the most speculative periods in market history, when the concept of stock exchanges and tradable shares was still new. The South Sea bubble in 1720 centred on the slave trade with Spanish America, with British investors betting that it would soon be legalised. Around the same time, another bubble was developing in France, where Compagnie d’Occident had obtained rights to develop the vast French territories along the Mississippi River and export African slaves. Investors handed over money — selling their homes, land, worldly possessions — to these firms to explore and bring back gold or other resources from America. Eventually, the bubble burst, as the firms had no revenues when they solicited investors’ funds and the slave trade remained illegal.

Modern-day blank-cheque firms, or SPACs, have been around since the 1980s. Investors get excited about them, only for the firms to fade away and then a decade later witness their return in some other form. The current crop of SPACs, are targeting distressed companies that need cash as well as tech unicorns that want to monetise their assets quickly. “There are private-equity firms aiming to attract companies that need cash, but tech is also a big target,” says Marvin. “Before 2010, unicorns went public much earlier in their life cycle. Now, many unicorns wait 10 years before listing because they can get all the cash they need from venture capitalists (VCs) at fairly high valuations. So, why go public?”

By remaining private, unicorns do not have to deal with the regulatory burden. Still, Marvin notes, “during Covid, there was a serious liquidity issue and private markets dried up a bit”. Eventually, these companies need to go public and their choices are either a traditional IPO, direct listing or listing through a SPAC takeover, she says. “The fact is listing through a SPAC is much faster.” Moreover, there were a number of successful deals such as Draftkings that helped open the floodgates for SPACs. “Investors became comfortable with SPACs. So, suddenly, we started to see more of them,” she adds.

Is Ackman’s US$4 billion SPAC an aberration or is there a growing appetite for mega SPACs? “Pershing Square’s SPAC is one of the few examples of a tech-focused SPAC, but it is unique and unprecedented in other ways,” says Pitchbook’s Stanfill. Given its size, Ackman’s vehicle will have only a small number of potential targets and the investment by the related hedge fund provides a more straightforward alignment of incentives relative to other SPACs, he notes. “SPACs of this size will be more of an outlier, but as companies continue to mature and achieve massive valuations in the private markets, it may be possible for other high-profile investors to follow” Ackman’s lead in doing mega SPACs.

For two decades now, large institutional investors have been paying 2% annual management fees and 20% profits to hedge funds and private-equity firms. In his new SPAC, Ackman is charging no management fee and only 6.2% incentive fee that is paid only after investors have made a return of at least 20% on their initial investment. In effect, Ackman is telling investors he does not want fees and is only after massive capital gains. He is luring investors by telling them that their interests are aligned and they will get as much of the upside if they ride with him.

Tech firms take SPAC route

Will tech firms, particularly unicorns — private firms with a valuation of at least US$1 billion — be an outsized beneficiary of SPACs? “From the looks of the SPACs being raised, the capital should be fairly spread out across sectors, with only a handful of firms directly targeting technology businesses,” says Stanfill. The scalability of SPACs is also a hindrance to this method’s becoming a common route to the public market for private companies, as each SPAC represents an opportunity for only one deal, he notes.

So, why are tech firms chasing the SPAC route? For one thing, the process of pricing an IPO is months of back and forth wrangling between institutional investors and investment bankers and, even then, companies are forced to leave money on the table, which helps give IPO investors the first-day pop. Moreover, IPOs as a group have been the best-performing segment of the market in recent years. Renaissance IPO ETF, which tracks recent IPOs, is up 46% this year and up more than 113% from its March lows. Since IPOs have done so well, investors have been more willing to partake in SPACs.

Detractors say companies acquired by blankcheque firms in a reverse takeover are able to avoid strict scrutiny that a firm filing for IPO might go through. SPACInsider’s Marvin disagrees. “Governances is not an issue,” she says. “Due diligence is similar to a traditional IPO. Instead of a prospectus, you put together a proxy for the [US Securities and Exchange Commission], which still needs to review everything. It’s not like dodgy companies are getting SPACs to take them over,” she says. Companies are not getting better valuations by taking the SPAC route to listing. “SPAC shareholders still have to approve the deal. There is still price discovery. If investors don’t like the deal, the shares won’t trade above the listing price and the deal will be repriced,” she says.

Some Wall Street pundits argue that a boom in SPACs is normally seen close to a market top. Indeed, they see it as the ultimate sign that investors have more money than they know what to do with. Market bubbles often burst not just because new buyers keep pushing up stock prices but because investment bankers dramatically boost supply of new paper through IPOs and secondary issuance to soak in anticipated demand, which drowns investors.

What’s next? A new exchange-traded fund (ETF) that will let investors participate in the current SPAC craze. The Defiance Next-Gen SPAC IPO ETF, which is expected to list soon, will be the first instrument tracking the popular blank-cheque offerings. The ETF will invest in SPACs when they are taking over a target company as well as actual blank SPACs looking for target firms. “Things will probably calm down a bit from where we are now, but I believe SPACs as an asset class will continue to grow,” says Marvin. SPACs, like direct listings, are unlikely to replace IPOs anytime soon. They will just be an alternative way for firms to list.

Assif Shameen is a technology and business writer based in North America.