The Decline and Comeback of SPACs
Following on from Ryan Psik’s article explaining what Special Purpose Acquisition Companies are, this article will explore why SPACs have experienced a decline and comeback in the span of the last two decades. With firms from Wheels Up to 23&Me choosing to go public via SPAC, they are currently enjoying their time in the spotlight with a rapid increase in number since last year. In 2020 there were 248 SPAC Initial Public Offerings (IPOs) worth US$83bn; in 2019 there were 59 worth US$14bn – it is clear to see their massive jump in popularity (1). Rather unsurprisingly, 2020 was also the year of the largest SPAC so far, with Bill Ackman’s Pershing Square Tontine Holdings raising US$4bn (2).
As previously covered, SPACs are not a new phenomenon; in 1993 the investment bank GKN securities helped shape some of the first blank-cheque companies. They regained popularity in 2003 and pre-financial crisis, 2006 was a particularly successful year with 66 SPAC IPOs (1).
However the financial crisis put an end to the boom and this was a result of various factors, for example, greater market regulation; more importantly, the success of SPACs requires that there is a supply of private businesses who are willing to go public – this condition was not fulfilled during the recession leading to SPACs not being able to find companies before their deadlines and thus having to liquidate (3).
For example, Britain’s Chardan led its 2008 China Acquisition Corporation aiming to acquire a Chinese company – they were not able to find a suitable company within the time so changed suite in order to look for targets in a very different market (foreclosures in Florida). However, there were problems related to the due diligence requirements and the continuing failure led to it trading at around 14% below its IPO prices in January 2009 (4) and eventually, it led to its bankruptcy. Furthermore, during the financial crisis, many SPACs had to liquidate as a result of failing to find willing private companies.
The consequence of this was that there was only one SPAC IPO in 2009, a number which gradually increased in the following years – however the sudden increase in 2020 both in terms of the IPO count and total gross proceeds really stands out. This begs the question, what has stimulated this sudden comeback?
McKinsey reckons the most significant reason is the emergence of “leaders with an operational edge”(5). They say that what has changed, beginning in 2015, is that SPACs have transformed through three key differences:
- “More closes, fewer liquidations”
- “Increased size”
- “More well-known participants”
These summarise how SPACs have become more organised and have built a stronger reputation in recent years, creating a positive feedback cycle through a stronger reputation attracting bigger names. Many high-profile companies and investors are now involved, with leading private equity firms such as Apollo creating SPACs like Apollo Strategic Growth Capital (NYSE:APSG) (6) and individuals such as Narayan Ramachandran (Former Head of Morgan Stanley India) leading them (7). This provides greater security as investors have the comfort in knowing that those leading the SPACs are leaders in their field with strong direction and expert knowledge; this is further reflected in the reduction in the proportion of SPACs needing to then liquidate.
This helps reinforce the reasons why SPACs can be a more ideal channel of raising funds as opposed to traditional IPOs. As covered in Psik’s article, IPOs have additional costs of high bank fees and share underpricing, as underwriters tend to set initial prices lower than their potential in order to guarantee investor demand – this leads to the company raising less money than it possibly could have.
SPACs have also been used to promote diversity and encourage gender equality in the workforce. Perella Weinberg Partners have established a SPAC focussed on investing in businesses that are owned by and run by women (8) – as well as using a SPAC to go public themselves. This is a unique and particularly innovative way of actively encouraging greater diversity, a move that may be followed by other firms.
However, some, such as Goldman Sachs’ David Solomon, have warned that the recent boom is unsustainable (9) and said the process and the incentives involved are “still evolving”, highlighting that there is a big difference between firms choosing to go public via SPAC and firms who are going public in this manner as they are not able to finance other alternatives. Others argue that it is similar to private equity but simply a less secure investment with lower returns; whilst the SPAC promoters take a similar 20% of the equity for finding the target companies, private equity firms often have a more structured and expert process at analysing potential picks. Moreover, private equity firms balance investments across a diverse portfolio over various different companies rather than a riskier select few (10).
This worry is further backed through mediocre performances of investor-led SPACs a year after merging. SPACs led by operators did indeed outperform the market index, but the outcomes for investor-led SPACs are less promising. A year after merging, investor-led SPACs average share price falls to almost 70% of their original share-price (5). The success of operators may be that they are usually industry-specific (the industry chosen to complement the expertise of the operator) leading to a narrower, more successful search. However, this just further backs the argument that if the new model of SPACs is adopted we can see more prosperous results with less danger of decline when there is an economic downturn.
It will be intriguing to follow the trends surrounding SPACs to see if Solomon is indeed correct or if this new ‘highly-organised’ SPAC will become even more common, displacing the traditional manner. The COVID-19 pandemic has been a significant disruptor; it’s role in accelerating the use of SPACs has so far been through providing a transaction with lower risk for the company going public in a time of uncertainty.