Exactly two years ago, just three months into the Covid-19 pandemic and the subsequent lockdowns, I wrote in this column about Why Wall Street is gaga over blank-cheque spacs — or special purpose acquisition companies.
The tale about yet another controversial financial instrument was clearly a sign of times. Money had become too cheap as major central banks had cut interest rates to near zero, capital was abundant and investors were chasing growth in every nook and corner of the market.
At that point, you might recall the market had still not recovered fully from the 34% plunge in early 2020. The milestone of the market barometer touching pre-pandemic levels was still several weeks away. With the lockdowns in force, investment bankers who help list private companies on global exchanges or help raise money for cash-strapped companies, could not use conventional methods to raise funds.
There were other factors at play. Companies taking the traditional initial public offering (IPO) route had long fretted about huge investment banking fees — typically 2% to 7% of the gross proceeds — as well as leaving money on the table just to get the listing done on time. Packaged as a cheap, safe and quick route to tap funds for expansion, spacs looked like an investment vehicle whose time had come.
Two years on, the tumultuous spac era is drawing to a close: 21 companies have cancelled spac mergers this year alone representing over US$20 billion ($27 billion) of dumped deal value. Last week, business magazine publisher Forbes abruptly cancelled its US$630 million merger with Hong Kong-based spac Magnum Opus Acquisition which included a US$200 million investment from controversial cryptocurrency exchange Binance, owned by China-born, Canadian entrepreneur Changpeng Zhao.
Within hours of Forbes pulling away from its merger, live sports and concerts ticketing platform SeatGeek announced that it was rescinding its own US$1.35 billion merger agreement with Redball Acquisition, a spac sponsored by private equity investor Gerry Cardinale and prominent baseball franchise Oakland Athletics’s executive Billy Beane “due to unfavourable market conditions.” Four weeks ago, Wall Street investment bank Goldman Sachs announced that it was shrinking its spac business amid regulatory crackdown and market turmoil.
See also: Hong Kong's first de-spac listing still leaves sector in limbo
Clock is ticking
Research firm Audit Analytics recently noted that 25 firms that merged spacs over the last two years or so have issued so-called going-concern warnings, clear evidence that there is “substantial doubt” about their ability to stay afloat for the next 12 months. Among them are several electric vehicle (EV) related firms including EV makers like Nikola Corp, Lordstown Motors, EV charging firms and EV battery makers, which were among the most aggressive spacs in late 2020 and early 2021.
Now, the clock is ticking away for more than half of the blank-cheque investment vehicles which raised funds through IPOs in 2020 and 2021 but have yet to find a partner. Over the next 18 months or so, most, if not all, of the spacs still looking for a suitable merger partner will be forced to decide whether they would be better off returning the funds to their investors or agree to a shotgun marriage with a desperate partner. According to some estimates, up to US$120 billion in funds could be returned back to investors when the lights are finally turned off at the spac party.
See also: Singapore-based Synagistics begins trading as Hong Kong’s first de-spac
Are you still with me or did I lose you at an acronym like spacs? For those who have been hiding under a rock for the past two years or too busy streaming Netflix, Apple+ or Disney+ shows to pay attention to Wall Street shenanigans, here is a quick low-down: Basically, a spac is a promise. Investors like you and me, give promoters of a spac a ton of money.
In return, spac promoters promise to put our cash to good use within a specified period of time, usually two years, to buy an existing private company and list it on an exchange — New York Stock Exchange, tech-heavy Nasdaq, London or even Singapore.
Here is how it works: spac promoters put together a board with well-known people, raise money from blank cheque listings, then look around for a target firm that they can buy. To lure IPO investors, they offer money-back guarantee on their initial US$10 per unit investment, including shares and warrants plus interest.
There is one small catch, though. The sponsors often take nearly 20% of the IPO units for a nominal fee. Most spacs have been in the US$200 million to US$400 million range, though there have been some super-sized ones like billionaire activist investor Bill Ackman’s US$4 billion vehicle Pershing Square Tontine Holdings, which has just four weeks to find a partner.
Once the deal is done, they have a growth company, cash that can be used to fuel growth and a promoter — celebrities like tennis star Serena Williams, basketball stars Shaquille O’Neal and Steph Curry, baseball star Alex (A-Rod) Rodriguez, pop star Ciara, former Goldman Sachs number two and ex-President Donald Trump’s economic adviser Gary Cohn, billionaire hedge fund investor Ackman or a private-equity firm like Apollo Global Management — willing to pump up interest and play pied piper to millions of investors.
A key component of the merger is PIPE (which stands for or private investment in public equity) — a fundraising round that happens at the same time of the spac merger to help sweeten the deal for the company being acquired. It gives the target firm more capital in addition to the money the blank cheque firm originally raised in its own IPO.
Since January 2020, US$257.6 billion has been raised by 928 spacs in the US. That is more than the money raised through conventional IPOs in the same period. If you add in PIPE investments, spacs have raised more money through secondary offerings than US listed companies have raised through rights issues.
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Of the 928 SPAC IPOs, less than 300 have resulted in mergers so far, though 120 of the announced mergers including Digital World Acquisition Corp’s US$875 million controversial merger with former President Trump’s social media company Trump Media & Technology Group — which runs the “Truth Social” app, a competitor to microblogging platform Twitter — are still awaiting regulatory approval.
No spac listing imminent
Industry consulting firm SPACInsider notes that 248 spacs raised US$83.4 billion in 2020, up from just US$13.6 billion raised by 59 spacs in 2019, the year before the pandemic began. The average amount raised by spac IPOs was US$336.2 million. Last year, 613 spacs raised US$162.5 billion. In the first five months of this year, 67 spacs have raised US$11.6 billion with average IPO size falling to US$174 million.
No spac has been listed so far in June and no listing is imminent in the next couple of weeks. There has been just one spac filing over the past fortnight but it is unclear when or if that spac will be allowed to list. Usually there is a burst of IPO activity in the six weeks between Memorial Day in late May and America’s Independence Day on July 4. This year though, it looks like there will be hardly much capital raising through traditional IPOs or indeed through spacs.
My column on spacs two years ago noted that Wall Street pundits argue that a boom in controversial investment vehicles like spacs is normally seen close to a market top. Indeed, many saw the spac boom as the ultimate sign that investors had more money than they knew what to do with.
I noted that market bubbles burst not just because retail investors keep pushing up stock prices through indiscriminate buying but because investment bankers dramatically boost supply of new paper through IPOs and secondary issuance to soak in anticipated demand, which ultimately drowns investors.
It looks like regulators and lawmakers are finally waking up and now want to regulate spacs. Outspoken US Senator Elizabeth Warren last week released a scathing 26 page report titled The SPAC Hack: How SPACs Tilt the Playing Field and Enrich Wall Street Insiders. As Warren writes, spacs and their sponsors are “abusing loopholes and gaps in current securities law.” Her report also called for laws that would codify rules proposed three months ago by the US Securities and Exchange Commission (SEC) and make major players in spacs liable for any wrongdoing.
The SEC has in recent weeks introduced new rules for spacs that mark one of the broadest attempts to date at cracking down on blank check companies. Its proposed rules would amend safe harbour rules and leave spacs open to investor lawsuits for excessively rosy financial forecasts.
Like the SEC, Warren is focused on “levelling the playing field” between spacs and traditional IPOs. Her report was critical of three things: For example, spac sponsors pay a fraction of market value for a 20% share in the company, ensuring huge profits for themselves regardless of deal quality. Warren noted how sponsors often put up only tens of thousands of dollars but receive “nearly hundreds of million in stock.”
She specifically called out major spac creators like Sri Lanka-born billionaire investor Chamath Palihapitaya, former Citigroup investment banking honcho Michael Klein and Texan billionaire restaurant owner Tilman Fertittta for their “self-dealing, self-enriching deals that ultimately crushed retail investors.”
Sponsor incentives do not align with retail investors, leading to low-quality deals that harm investors, she adds. Serial spac creator Palihapitaya, for example, put in just US$20,386 as sponsor of a spac called Social Capital Hedosophia Holdings but received US$169.12 million in shares of the target firm Clover Health Investments. The firm’s stock has since fallen to just US$2.55. Retail investors have lost nearly 75% of money. Though Chamath has lost money too, his initial US$20,386 investment is now worth a whopping US$43 million.
Similarly, Chamath paid US$16,667 for sponsor shares in Richard Branson’s Virgin Galactic Holdings which merged with his original Social Capital Hedosophia Holdings. While Virgin Galactic shares are down nearly 88% from their peak, Chamath — who was chairman of the firm cashed out over a year ago — pocketed over US$100 million in profits. Chamath invested US$18,650 on fintech firm SoFi Technologies and received US$170.5 million worth of shares.
In her report, Warren notes: “From 2019 to 2021, spac sponsors received average returns of 958 percent, even as companies taken public by spacs consistently underperformed the market and retail investors took losses.”
Warren also does not like the huge hidden costs of blank cheque firms, as spac transaction fees way outstrip those of traditional IPOs. She also criticised “information gaps’’, noting that the claims made in spac disclosures can be misleading because the requirements surrounding them are lax. “Sponsors take advantage of the flaws in spac rules to benefit themselves in multiples steps of the process: Paying advisory fees to companies they are associated with, participating in PIPEs and private investment rounds despite their clear insider knowledge, and even choosing their own companies as acquisition targets,” Warren notes.
Stocks of two-thirds of the merged spacs are down 50% or more since the merger. In Southeast Asia, a prime example of the bumpy ride of spac stocks is the ride hailing firm Grab Holdings, which teamed up with Altimeter Growth last December in a US$40 billion spac merger, now has a value of US$11.7 billion after a recent rebound of its shares. It is too early to write an epitaph of spacs. They have been around since the 1980s in some form or the other. Wall Street is good at squeezing the last drop of juice from all sorts of funky investment vehicles and it is likely that spacs would be no different than any other.
But their time is up. There was a time and place for spacs during the low interest rate environment when risk-taking was de rigueur. Now, regulators need to tighten the rules around spacs and investors should focus elsewhere.
Assif Shameen is a technology and business writer based in North America
