Special purpose acquisition companies (Spacs) are truly having their moment. By early August, the number of Spac IPOs so far in 2020 had overtaken the total number for the whole of last year.
Amid the volatility caused by Covid-19, Spac listings offer a way to go public without the risk and complexity of a traditional IPO. Meanwhile, investors have been drawn to the seemingly low-risk model of Spac vehicles, where the money is held in a trust account until an acquisition takes place.
‘Market participants have been more actively seeking alternative investments and Spacs provide an inherent appeal as a security with principal-protected downside and equity upside,’ says Chris Tyson, managing director and head of Spac advisory services and M&A at MZ Group.
In a Spac listing, a shell company raises money on the public markets and then has a limited time – often two years – to find a private company to merge with. The private company is then taken public through the merger.
Such listings used to be viewed with skepticism – given the lack of transparency and scrutiny compared with a typical IPO process – but in recent years have become increasingly popular with established market players.
In the year to August 5, the US market saw 62 Spac IPOs raising $25.2 bn, compared with 59 IPOs raising $13.6 bn across the whole of 2019, according to Spac Research, a data and news provider.
But there aren’t just more Spac listings – they have also grown in magnitude. The average size of a Spac IPO in 2020 so far is $407 mn, compared with $230.5 mn last year.
In July, Bill Ackman and Pershing Square raised $4 bn in the largest Spac IPO on record. In the prospectus, the Spac says it is looking for what it refers to as ‘mature unicorns’ – high-quality growth companies that have achieved significant scale while remaining private.
Underlining the booming interest in this type of investment vehicle, Defiance ETFs has filed with the SEC to launch a new fund: the Defiance NextGen Spac IPO ETF, which would trade under the ticker SPAK.
Companies to go public via the Spac process over the last year include electric carmaker Nikola, fantasy sports company DraftKings and Richard Branson’s space tourism venture Virgin Galactic.
Martin Steinbach, EY EMEIA IPO leader, told IR Magazine last month that the Spac boom highlights a trend toward derisking strategies for companies going public. ‘In the US, we see Spac activity moving up,’ he said. ‘It’s a transaction technique used in volatile markets where you can’t predict on a short-term basis the right IPO timing.’
Tyson says the boom in retail investment during the Covid-19 outbreak – online stock brokers have reported several million new accounts being opened in the US alone – has changed the trading dynamics of Spac vehicles.
‘There has been much attention recently on retail traders’ impact on the broader market. This is also being felt in the Spac space due to increased attention paid by retail investors who have flooded in on the back end,’ he says.
‘It’s a rather desirable outcome for any sponsor to move shares into the hands of retail holders. Under almost any circumstances, they are less likely to exercise redemption rights than institutional holders.’
Tyson notes that retail investors are helping to push Spac valuations higher than usual. ‘Under normal circumstances, Spac deals trade at a risk-arb-type discount to the eventual cash in trust value,’ he says.
‘But anecdotal evidence has strongly suggested that retail investors are responsible for bidding Spacs above trust value following an acquisition announcement, including those that haven’t even disclosed transaction terms or the name of an acquisition target.’
While Spacs are performing well after initially raising capital, they often struggle to beat the market once a merger has taken place, according to research from Goldman Sachs.
The bank analyzed 56 Spac transactions over the last two years and finds that once the merger is complete, the new public company tends to lag the performance of the S&P 500 and Russell 2000 – although there are wide variations in returns.
‘The performance distribution is extremely wide, with the 75th percentile Spac outperforming the S&P 500 by 22 percentage points while the 25th percentile transaction lagged by 69 percentage points,’ state the Goldman analysts.
Speaking on IR Magazine’s Ticker podcast in May, Phil Denning, a partner at ICR, said companies need an ‘aggressive’ IR strategy as they move out of the Spac structure.
‘We say this is IR on some kind of stimulants,’ he said. ‘You really need to get out there and aggressively engage with the shareholders. The difference is, during a traditional IPO, you have the bookbuilding process, so those people are buying and know what they are investing in.’
In a de-Spac process, explained Denning, the company is inheriting a shareholder base from the listed shell company. ‘Some of them are going to continue to be shareholders in the newly formed public company, and some are going to choose to sell,’ he said. ‘You need to now build a shareholder base [of] the more traditional, fundamental investors that understand your industry [and] your business.’