2020 was an interesting year for markets, as the onset of the coronavirus caused a market dislocation in March and April. Still, indexes eventually recovered, with the S&P 500 Index finishing up 18.4% on the year and the technology-dominated Nasdaq Composite posting a total return of 43.6%. 2020 also represented a banner year for special purpose acquisition companies (SPACs). A SPAC, sometimes referred to as a “blank check” company, is a public investment vehicle created to acquire and merge with a private company. As the SPAC is a holding company, rather than an operational business, the filing and completion of documents are simpler than with a traditional initial public offering (IPO). The SPAC sponsor will also host a roadshow, showcasing management’s ability to find an attractive acquisition target. The sponsor, generally a hedge fund or private equity firm, receives a fee (or “promote”) equal to 20% of the shares for putting up capital to fund various transaction and reporting costs while evaluating merger targets. A SPAC theoretically could buy a company in any sector or industry. However, many will choose a target industry before the IPO, ideally one where management has proven success.
Once a SPAC is formed, the sponsor will have 24 months to identify a “target,” or a company the sponsor finds attractive. In exchange for their investment, public shareholders of the SPAC receive a redeemable common share, a warrant and occasionally the right to a fraction of a share. In the IPO (or “de-SPAC”), the common shares will normally price at $10 and the warrants will have an exercise price of $11.50. However, this can scale up or down based on how much capital the sponsor is looking to raise. If the sponsor fails to identify a target within the 24-month window, the entity will liquidate and return all funds to shareholders, plus interest.
The benefits of a SPAC for companies, investors and sponsors can be significant. For a target company, closing a deal is typically much quicker and more certain than with a traditional IPO, and some companies may find a strategic partnership with a sponsor worthwhile despite the large fees. For investors, many can’t get access to traditional IPOs and SPAC shareholders are allowed to redeem their shares in full, plus interest, if a sponsor can’t find a suitable acquisition target. For sponsors, there is upside potential in the SPAC shares post-IPO, which can lead to large gains as well as gifting sponsors with access to high-quality private companies. A number of businesses going public via SPAC have been largely venture capital- and private equity-backed companies poised for further growth, and the SPAC structure offers these companies an opportunity to partner with an experienced sponsor while raising capital quickly through the public markets. Finally, the valuation at which these businesses can go public via a SPAC may be more attractive than through a traditional IPO process.
A number of prominent investors have raised SPACs recently, including Bill Ackman of Pershing Square and Chamath Palihapitiya of Social Capital, as well as non-investment professionals such as baseball executive Billy Beane, former U.S. House Speaker Paul Ryan and 15-time NBA All-Star Shaquille O’Neal. In 2020, SPACs raised $82 billion, a figure larger than all previous years combined, according to Dealogic. As shown in the chart above, SPAC merger announcements started to increase dramatically in June of last year as the virus continued to impact the global economy. According to Reuters, a record 28 SPACs raised over $6 billion in just the first week of 2021, with hundreds of blank checks looking to get in on the action.
From a total return perspective, performance has been largely mixed, with deals that were unveiled in the last three months of 2020 climbing 5.4% on the day of those announcements and trading 16% higher one month later, per a Dow Jones Market Data analysis of trading in 39 such companies. According to data provider Preqin, of the 223 SPAC IPOs (as of Sept. 23, 2020) since the start of 2015, just 89 had completed mergers and taken a company public. Of these 89 SPAC IPOs, only 29% had generated positive returns. As investors look to generate alpha and deploy capital in a low-interest-rate environment, there are a few companies that have gone public via SPAC and performed well, including DraftKings Inc. (+424.8% since inception), Immunovant, Inc. (+357.1% since inception) and Virgin Galactic Holdings, Inc. (+206.7% since inception). As some investors have generated outsized returns from investing in SPACs, I would expect to see these vehicles continue to raise capital throughout 2021 and beyond.
2020 was an up-and-down year for markets but a particularly big year for SPACs. Hedge funds, private equity firms and even celebrities sponsored these “blank check” companies, looking to access some of the most well-performing private companies. When evaluating a SPAC, it is key to diligently research the sponsor’s experience, previous success in a certain industry and investment track record. For limited partners in private funds, SPACs offer another avenue for liquidity. For others, they can provide access to later-stage private companies in a vehicle that differs from a traditional IPO. As returns have been largely mixed, I will be interested to see how many of these SPACs perform over the long term, versus any short-term trading gains in today’s market.
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