What seems like today’s hottest path to a public listing comes with a lot of baggage. The basic premise of a Special Purpose Acquisition Company (Spac) is that a sponsor raises money in a public offering with the expectation that it will identify a target company for a merger or an acquisition within a specified period of time.
As of the market close on 16 October, there have been 143 Spac transactions this year, according to SPACInsider, an online database. There were 13 in all of 2016.
Many believe the meteoric rise in an asset class that basically involves handing over money in something of a blind-faith investment speaks more to the current frothy investing environment than the value proposition of a Spac itself.
With interest rates close to zero – and expected to remain that way for the next few years – investors are increasingly making large bets to get big returns. And with both holding periods and attention spans getting shorter, the Spac is the ultimate form of immediate gratification. It enables investors to play a new trend – sports betting or automated house flipping, for example – as soon as it catches fire in the market without waiting for a young company to first demonstrate a breakout year.
But it isn’t all about fools rushing in. A lesser known feature of today’s Spacs is that investors can opt out, redeeming their shares plus interest around a shareholder vote on a proposed target. Investors in normal public companies finalising a deal would love the ability to jump ship relatively unscathed before what could be a disastrous deal.
Not that this year has been a good one to bail out: the annualised rate of return across all Spacs in 2020 so far is 35%, according to SPACInsider, significantly higher than the S&P 500’s 9% return year to date.
Companies like Spacs because they allow them to bypass a lengthy review process and a prolonged investor roadshow. Even better, they can solidify a valuation and an outcome before a deal is announced to the public market. That certainty will always be attractive, even in less turbulent times, says Carlos Alvarez, who leads Spac-related banking at UBS.
Real estate technology company Opendoor went public via a Spac merger last month, citing speed to market and the ability to capitalise on healthy housing trends amid Covid-19 as deciding factors, according to a person familiar with the matter. Shares of venture capitalist Chamath Palihapitiya’s Social Capital Hedosophia Holdings are up more than 75% since the Spac announced Opendoor as its target.
Of course, in a hot market, there is a significant opportunity cost of tying capital up for a lengthy period of time. And most Spac sponsors are highly motivated to pull the trigger since they traditionally have been paid based on any deal they execute, not just a winning one. Their rewards are far better when ordinary investors do well, too, of course. But investors have done poorly when hanging on. Renaissance Capital says that as of late September only 31.1% of the 313 Spacs since 2015 had positive returns, sharply lagging traditional IPOs over that period. Their performance is often worse after a merger has closed.
Some of those risks are changing, though. Whereas Spac investors used to have to vote against a deal in order to redeem their shares, the right to redeem shares is now independent of a shareholder vote, giving investors more freedom and enabling more deals to go through.
Moreover, sponsors are moving away from guaranteed fees, opting for warrants exercisable based on performance. And banks such as Goldman Sachs now underwrite Spac deals. Spacs also fill a vacuum: thanks in part to the growth in private equity, there are fewer public companies today than 20 years ago.
Spacs are seeing a golden era that will fade as speculative appetite does, but they are unlikely to fade away entirely – they are too useful to everyone involved.
Source: Private Equity News
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