SINGAPORE (REUTERS, NYTIMES, BLOOMBERG) – Special purpose acquisition companies (Spacs) are emerging as a popular initial public offering alternative for firms, providing start-ups with a path to going public with less regulatory scrutiny.
A measure of the popularity of Spacs, also known as “blank cheque” companies, can be gauged from the fact that global blank-cheque deal volumes – or mergers through Spacs – surged to a record US$170 billion (S$227.3 billion) by March 9 this year, already outstripping last year’s total of US$157 billion, Refinitiv data showed.
Here’s what you need to know about Spacs:
1. What is a Spac?
Like “leveraged buyout” and “collateralised debt obligation”, Spac is an arcane Wall Street term that has stumbled into the mainstream lexicon.
A Spac is a shell company that raises funds to acquire a private company with the purpose of taking it public, allowing such targets to sidestep a traditional initial public offering (IPO).
They have gained in popularity in recent months, with investors increasingly looking to growth stocks for higher returns, and as the Covid-19 pandemic disrupted the traditional IPO process.
In essence, a Spac is a way to do an IPO without all the time, expense and regulatory oversight traditionally required.
For companies looking for funding, Spacs have the virtue of being able to raise capital faster than a traditional IPO – a Spac transaction can be completed in six weeks, versus about six months for an IPO. The sponsors of a Spac typically have two years to identify acquisitions or must return their investors’ money.
Spacs have been around in their current form since the 1990s, and for years were viewed as a scam-prone backwater of the finance world, but they have caught fire during the pandemic.
The Singapore Exchange has launched a public consultation exercise with financial industry players to assess the appetite for Spacs. It had done this in 2010, but at that time, the reaction was lukewarm.
2. Why are they popular?
The popularity of Spacs is tied to cases where investors have made handsome gains following Spac acquisitions in the US, such as the space exploration company Virgin Galactic, the online sports betting firm DraftKings and the real estate digital platform Opendoor.
The popularity of Spacs has seen celebrities, athletes and even former politicians like former US House Speaker Paul Ryan jump on the bandwagon. Other notable investors that launched Spacs included serial entrepreneur and billionaire Richard Branson and former BuzzFeed chairman Ken Lerer.
This has attracted other everyday investors keen to cash in on Spacs.
Given that Spacs are shell companies that do not make anything or own any assets, the founders themselves are often the main draw, with investors in essence making a bet that their stature and connections will be enough to close a deal with a hot start-up and eventually take it public.
In addition, according to the US Securities and Exchange Commission (SEC): “Certain market participants believe that, through a Spac transaction, a private company can become a publicly traded company with more certainty as to pricing and control over deal terms as compared with traditional initial public offerings, or IPOs.”
3. Why are they controversial?
The SEC has warned investors: “Unlike an operating company that becomes public through a traditional IPO, however, a Spac is a shell company when it becomes public. This means that it does not have an underlying operating business and does not have assets other than cash and limited investments, including the proceeds from the IPO.”
Studies show that the majority of Spac acquisitions have not delivered positive returns for retail investors, especially those who do not, or cannot, redeem their shares in Spacs. Spac founders, by contrast, have almost always made huge gains.
All but one of the 15 Spacs that started trading in the week ended March 25 closed below their IPO price of US$10 per unit on their first day of trading, according to financial markets platform Dealogic and market data. Many other deals are also trading below their IPO prices.
Investors are, in effect, subsidising the sponsors of the Spac, who get to own 20 per cent of the target company. This means about 20 per cent of investor funds goes to the sponsor. The stock price of the company bought by the sponsors would have to do extremely well for investors to make money, but the sponsors stand to benefit even if the stock price disappoints, because they paid virtually nothing for their stake.
Spac deals also involve less rigorous due diligence of companies than regular IPOs. The risk here may be compounded by the two-year time limit that sponsors have to identify a target and complete a merger.
The deadline could result in sponsors finding a low-quality target company – just to get a deal done – and/or overpaying for the target they identify. The greater the number of Spacs relative to targets, the higher the chances of low-quality targets being chosen.
The risks for target companies include the possibility of their merger with Spacs being rejected by Spac shareholders, as well as the risk of high redemptions of Spac shares, which would reduce the amount of funds the Spac would be left with to pay for the company.
Although Spacs usually try to mitigate this risk by raising extra funding from institutional investors, there is still some risk.
The SEC has also issued an investor alert about the dangers of investing in Spacs based on celebrities associated with them.
“Celebrity involvement in a Spac does not mean that the investment in a particular Spac or Spacs generally is appropriate for all investors,” the SEC said.
“Celebrities, like anyone else, can be lured into participating in a risky investment or may be better able to sustain the risk of loss. It is never a good idea to invest in a Spac just because someone famous sponsors or invests in it or says it is a good investment,” it added.
4. What are some of the big-ticket Spac deals so far?
Singapore-based Grab is set to nab the record for the biggest deal in the Spac world and list on United States exchanges through a reverse merger with Altimeter Growth in a deal valued at nearly US$40 billion (S$53.5 billion). The blank cheque deal drew institutional backing from heavyweights like T. Rowe Price Group and Singapore investment company Temasek.
Prior to this deal, the largest Spac deal was announced in February between Lucid Motors and Churchill Capital IV, and was valued at US$24 billion. The third-largest deal was inked by billionaire Alec Gores’ Spac with United Wholesale Mortgage Group, and was valued at US$16 billion.
As at Monday, the biggest companies to emerge from Spacs based on market capitalisation were DraftKings at about US$23 billion, Opendoor Technologies at US$11 billion, and Paysafe at around US$9 billion.
Overall, the size of Spac mergers appears to be on the rise, with the average value of deals in the first quarter of 2021 pegged at US$2.3 billion, compared with US$900 million in the corresponding quarter of 2020 and US$800 million in the first quarter of 2019.
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