SPAC Straight Talk – what will follow the boom?

SPACS are booming, popping, peaking, accelerating. Whatever words you choose, the figures tell the story. In the decade 2009-2019 a total of 226 SPACs IPO-ed to the value of $47bn; in 2020 alone 223 SPACs were formed, raising $80bn. As of March 2, 2021, 204 SPACs had already come to market this year, 12 of which IPO-ed just that day!  Defiance’s SPAC ETF (SPAK) reflects this growth with its over 19% return since inception.

Goldman Sachs’ equity strategy team put out a report on March 1, which suggested that SPACs could generate more than $700 bn in acquisition activity over the next two years. This would come from around $103 bn of SPAC capital seeking target mergers, together with the associated PIPE (private investment in public equity) investments that tend to accompany SPAC deals. Sachs’ team noted that such activity on average trebled the buying power of the SPAC in the 2010s, in 2020 it magnified it by 6 times and so far in 2021 private investments have boosted SPAC deals by up to seven times their value.1

As of February 28, 2021, Defiance SPAC ETF has returned 19.03% (Total Return) / 19.02% (Market Price) since inception date 09/30/2020.

The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than their original cost and current performance may be lower or higher than the performance quoted. Performance current to the most recent month-end can be obtained by calling 833.333.9383. Short term performance, in particular, is not a good indication of the fund’s future performance, and an investment should not be made based solely on returns. Market price is the price at which shares in the ETF can be bought or sold on the exchanges during trading hours, while the net asset value (NAV) represents the value of each share’s portion of the fund’s underlying assets and cash at the end of the trading day. The fund’s expense ratio is 0.45%

A graph showing the capital seeking target and SPAC IPO capital associated with mergers

Indeed SPACs are even overtaking the traditional IPO method of becoming a public company, as increasingly star-studded SPAC sponsors like Richard Branson, Jay-Z and Shaquille O’Neal, join seasoned deal-makers like Chamath Palihapitya and Bill Ackman to push their wares to retail and institutional investors alike. Well not quite, but that is for later, along with a discussion about what is driving these changes and what they might mean for the M&A market moving forward. For now, let’s do a quick review of the SPAC basics and the interests behind the headlines.

SPACs are Special Purpose Acquisition Companies, formed by sponsors with no operations other than to take another company public. The SPAC IPOs, and sells shares to raise money for the potential merger. The shares usually sell for $10 each and allow even the smallest retail investor to access an M&A market that was once closed to all but the most senior investment banks or high-worth individuals. The target companies benefit from a much less risky route to public status. They sign a deal with the SPAC sponsor for a fixed amount, often with an accompanying PIPE element, and then announce it publicly. 

In contrast, in the traditional IPO process, the company must announce the deal before negotiating its size or price or whether there is enough demand. The opening share price is ultimately decided by the investment bank that is performing the IPO. It is a cumbersome, slow process, that holds both the potential for embarrassment and the inability to respond quickly to changing trends and emerging opportunities. So SPAC deals minimize risk and open opportunities for the target companies, and in turn pass on some of the risk to the sponsors. This explains the “promote”, the discount that SPAC sponsors get on the stock price of the future company, and the warrants (permissions) to buy further stock at a fixed price at a later date.

There is logic behind the “promote,” but the extent to which SPAC sponsors benefit from a deal, even if the stock price falls post-merger, and even at the expense of other investors by diluting their share, has prompted some criticism. In a similar vein, Michael Klausner of Stanford Law School and Michael Ohlrogge of New York University School of Law recently published a study on role of hedge funds in the SPAC boom. They highlight the conflicting interests when hedge funds provide considerable early capital to get the SPAC off the ground, with no intention of holding shares beyond their “pop” in value after a deal is announced. This can leave retail and institutional investors who look to hold the SPAC in the long term, losing out.2

Such critiques, combined with the acceleration in SPAC formation, has led some to predict the innate inequality of the SPAC market and its ultimate doomsday. What these criticisms overlook, however, is the market forces at play, which have propelled the SPAC market so far and which are now pushing its adjustment.

Indeed, the very transparency of a SPAC deal empowers potential investors to do their homework and make informed choices. Details about share dilution are available before a merger, allowing shareholders the possibility to vote against it or sell their shares. This puts pressure on SPAC sponsors to temper their promote. This is already evident, for example Klausner and Ohlrogge’s study found that the promote has fallen from an average of 20% to around 7.7% for deals between January 2019 and June 2020.3 Hedge fund veteran William Ackman’s Pershing Square Tontine Holdings Ltd, billionaire investor Daniel Och’s Ajax I and former U.S. House of Representatives Speaker Paul Ryan’s Executive Network Partnering Corp are just some of the SPACs that recently launched IPOs with less favorable terms for their managers than the industry norm.

Och charged a 10% promote for his SPAC Ajax I, which raised $750 million in October. Ryan’s SPAC raised $360 million in September. It pledged a 5% promote and additional shares to be paid out on condition of improved share price performance. Ackman, eschewed the promote completely. He will receive warrants, though even less than the industry norm. 

The effect of these moves is to increase pressure on other SPACs to stay competitive and offer improved terms to investors. As SPACs come to occupy a significant proportion of the IPO space, market pressures are already driving greater awareness of the need to balance competing interests. Rather than a boom and bust model therefore, there are signs that the market is maturing. Fast-moving, innovative and ambitious companies are not likely to relinquish this smoother, simpler route to public status, and sponsors face pressure to adjust their conditions to ensure that investors continue to join them in their ventures. 

1 “SPACs are now a $700 billion market,” Myles Udland, March 3, 2021.

2 “Hedge Funds Love SPACs But You Should Watch Out, ”Chris Bryant, December 9, 2020.

3 “Investors push back on blank-check company insiders’ payout bonanza,” Joshua Franklin, Jessica DiNapoli, December 9, 2002.