No need to be quite jealous just yet – this ride is no Lamborghini or limousine.
Good times don’t last forever may be the implicit message lurking around the corner of the celebration.
That is, for the investment banks that have been binging on the equity issuance boom via SPACs.
Otherwise known as blank-cheque companies, these special purpose acquisition companies (SPACs) have become the new black for banks. There is much money to be made on both sides throughout this process of acquiring privately held companies in order to take them public – all made possible by these listed vehicles.
SPACs raise capital through initial public offerings (IPOs) to acquire existing companies within a two-year window. The goal is to ultimately get on one of the major stock exchanges (e.g., NYSE). If the deal fails to complete timely, the investors’ funds must be returned and the SPAC faces liquidation, as they have no existing commercial operations or alternative purpose.
Whether or not you’re familiar with personal investing, you can probably (reasonably) expect to do a bit of research on the company before dumping all your birthday and dog-walking money into its security. With SPACs, it’s effectively the opposite: there is no research to be done, since most IPO investors have no clue what company they will end up investing in. This precisely explains the phrase “blank cheque companies.”
So who is crazy enough to pile money into a random, unnamed company that may or may not survive the IPO process?
Evidently, the big banks, of which the underwriters largely consist. After securing these major underwriters and institutional investors, the market is open to the public.
Many of the companies trying to go public are private equity portfolio companies, which are held by private equity funds for a period of time and do not tend to negotiate attractive deals by themselves. If a SPAC comes along, however, sale prices can boost by 20% on top of the original. Company owners oftentimes enjoy a somewhat expedited IPO process as it is shepherded along beside a seasoned partner.
This year’s SPAC cohort includes returning members Deutsche Bank, Credit Suisse, Goldman Sachs – along with senior executives seeking short term opportunities, to list a few.
219 SPACs raised $73 billion domestically YTD – $6 billion more than traditional IPOs.
Nearly 60 new SPACs jointly raised about $17 billion thus far this year, dwarfing 2019’s $13.6 billion record that had been a fourfold increase from 2016. That’s over $1 billion for each day the market was open.
Virgin Galactic Holdings Inc. (NYSE:SPCE) sold a 49% stake of 72 million shares to venture capitalist Chamath Palihapitiya’s SPAC Social Capital Hedosophia Holdings for $720 million before going public in 2019.
Or even better, you could simply start your own SPAC, and perhaps you’ll be rewarded with $4 billion preacquisition as did Pershing Square Capital Management founder Bill Ackman, who sponsored Pershing Square Tontine Holdings (NYSE:PSTH).
And if you don’t find a 32% trading premium* over the typical $10 SPAC price particularly alluring, consider the fact that the SPAC in question, SVF Investment Corp of SoftBank, hasn’t even proposed an acquisition to investors yet. In simpler terms, investors are just sitting on a pile of pure hope.
Competition may be a little rough if you ever dreamed of becoming a professional fundraiser.
*As of Friday, January 22, 2021 market close.
GOOD TIMES DON’T LAST FOREVER
During a quarter-end earnings call on Tuesday at Goldman Sachs, David Solomon warned of the imminent downfall of the boom.
“There will be something that will in some way, shape or form bring the activity levels down over a period of time,” Solomon said.
Solomon’s realization and warning may be the uninvited guest at the SPAC party, but someone needs to pull the brakes before investors accelerate into a brick wall.
Though not an initial SPAC IPO underwriter, Goldman is trailing in third after Credit Suisse Group AC and Citigroup Inc. as of last year with its $7.7 billion figure of funds raised.
WHAT’S NOT TO LIKE?
Investors are able to essentially get a cash refund if they decide that they don’t like the eventual acquisition proposal. However, they risk losing money on shares purchased at a premium to the underlying cash value, which increasingly seems to be the case given the overcrowded SPAC market. Stocks trading at a premium are priced higher than what they are worth in essence.
Warrants can further benefit investors if the takeover deal pans out successfully. But if the deal does not even complete, then even warrants would render absolutely worthless.
While no one is really concerned about making too much off of ridiculous sticker prices, given that this happens, there are a number of factors affirming Solomon’s point of unsustainability. Competition is a common one, albeit surfacing in a variety of forms.
Rising interest rates may deter the SPAC boom since the low opportunity cost associated no longer holds.
An overcrowded SPAC market also increases the likelihood of some bad deals hiding in the mix. Some companies, such as software SPAC Thoma Bravo Advantage (NYSE:$TBA), did not even bother to attach warrants to its 90 million shares, which sold at $10 per share for a grand total of $900 million as of its IPO.
Or it may be the case that a company is taken public before it is ready. Battery maker QuantumScape Corp. (NASDAQ:QS) valued at $50 billion before its shares plummeted 62.8% as reality hit: the company’s own road map points to its EBITDA breaking even in 2026, 2027 for sales surges, and no free cash inflow until 2028. And if that isn’t enough, a class action lawsuit was just filed on Friday on behalf of QuantumScape investors on the basis of misleading statements and failure to disclose essential product information.
No wonder Solomon is sounding the siren before the SPAC celebration spins further out of control.
Probably better to be a temporary party pooper than permanently thrown out of the game altogether.