SPACs (Special Purpose Acquisition Company) are companies created and listed on an exchange with the purpose of buying a growth company later. SPACs were derived as an easy way for companies to go public and avoid a long and sometimes difficult quotation process. SPACs are not new, but they have become very popular over the last couple of years. The abundant market liquidity and the return of a pro-risk environment, after the worst of the COVID crisis, have contributed to the growth of the market and to the rising euphoria that has benefitted SPACs.
After a record year in 2020, in Q1 2021 the IPOs of almost 300 SPACs raised nearly $100 billion surpassing the overall amount recorded in 2020 and now represents over two thirds of the total value of IPOs in the US market. Amid great market euphoria and spectacular growth, the SPACs phenomenon has attracted many investors. Some sponsors have also involved celebrities1 in deals and their presence has further driven appetite among retail investors, who are not always capable of understanding the structure, costs and risks associated with SPACs.
Most recently, SPACs have made the news headlines as their extraordinary growth has come under pressure. The fact that some SPAC mergers announced didn’t come out as expected has put pressure on their performance, with the IPO SPAC index in bear territory (with losses above 20% since their peak), despite a positive YTD performance for the overall market.
The SPACs phenomenon is now reaching a tipping point. The already mentioned resetting of market performance comes at a time of greater scrutiny from the Securities and Exchange Commission (SEC) that has already started to issue some warnings for investors and is questioning some SPAC practices. The SEC intervention is further freezing new IPOs and giving time to the overall SPAC business to reassess the way forward.
So far, SPACs have most benefitted sponsors and investors with a short-term horizon (arbitragers) and investment banks that earn fees in the IPO and merger process. The excess market euphoria, in fact, has driven price appreciation in advance of mergers, while post mergers performance has been more disappointing therefore hurting long-term investors. The Q1 2021 trend suggests that some excesses are being cleaned up and investors are becoming more cautious and selective. This is leading to rising divergences: SPACs with excessive pre-merger performance driven by rumours are correcting, while the most successful SPAC mergers are delivering positive performances.
In our view, this tendency will further strengthen over the next few months as more than 400 SPACs look for target companies to merge and investors start to be more nervous, looking for performance as with rising yields, bond market alternatives become more appealing (compared with parking money in a SPAC and waiting for a deal).
We believe cautiousness should remain at the forefront for the time being, as the market goes through this phase of maturation, in particular among retail investors. From a long-term investor’s perspective, while we recognise some benefits of SPACs for allowing a faster entrance to the market and a wider spectrum of companies that can go public, we believe that the current structure of SPACs favours more short-term speculative trades. It is less favourable for fundamental investors who look at business models, growth perspectives and at a company’s ESG (Environmental, Social and Governance) profile to build an investment case.
At the end of this transition process, we believe that SPACs will be more specialised and will provide higher visibility on sectors of target companies and better financial disclosure. All these improvements will make the SPAC market more resilient and mature and potentially more appealing for long-term investors.
This is the end of SPAC excess and the evolution towards a more mature and specialised market. In this transition process, divergences in fortune of SPACs will further intensify.