As various firms return to the office, families venture out on vacation and businesses resume operations amid the unknown of the delta variant, the markets have continued to run hot throughout the summer months and into early fall. The S&P 500, Dow Jones Industrial Average and Nasdaq Composite Indices have returned 22.2%, 21.2% and 16.3% year-to-date, respectively, with global merger and acquisition (M&A) volume reaching a record $3.6 trillion as of Aug. 12, surpassing the $3.59 trillion completed in 2020 and exceeding last year’s deal count by 24%.
Another hot topic over the last 18 to 24 months has been the emergence of the special purpose acquisition company (SPAC). Acquisitions by these blank-check companies have hit a new record in 2021, reaching $495 billion in value year-to-date, with sponsors looking to bring more deals to market over the next few months. The appetite for these deals still appears to exist. However, the performance of some SPACs has caused investors, both retail and institutional, to take a deeper look at the prospects and financials of these soon-to-be public companies.
The S&P U.S. SPAC Index is designed to measure the performance of a minimum of 30 common stocks for SPACs listed on U.S. exchanges. As shown in this week’s chart, the index has declined roughly 24.9% year-to-date, while the S&P 500, S&P 500 Growth and S&P 500 Value benchmarks have appreciated 22.2%, 23.6% and 30.6%, respectively. A number of companies that have gone public via SPAC earn zero or little revenue and trade at lofty valuations thanks to the buzz surrounding mobility and electric vehicles, as well as other technology-forward businesses targeting more traditional sectors such as insurance, finance and real estate.
Since February, the largest drops in market value for companies that merged with SPACs operate in the sectors mentioned previously. QuantumScape, a startup focused on the next generation of solid-state lithium-metal batteries for use in electric vehicles, has lost $10.7 billion in market value. Opendoor, a digital platform for residential real estate, has lost $9.2 billion in market value. And finally, Luminar, a business focused on lidar and autonomous driving technology, has lost $6.8 billion in market value.
For investors, it is important to research the company as well as the sponsor taking the company public. In a survey conducted by Wolfe Research, SPACs with experienced operators have performed materially better than those with non-experienced sponsors. After one year, SPACs with experienced operators averaged a 73% gain, while those businesses that partnered with a non-experienced sponsor generated a 14% loss, on average.
For LPs invested in venture capital and growth funds, it can take years for a company to generate liquidity, either in terms of a public listing or a sale of the company. SPACs have been a welcome liquidity avenue, offering another path to exit in addition to more traditional M&As and IPOs. Furthermore, partnering with a sponsor with contacts and experience in the industry can prove beneficial in terms of utilizing their network and experience to grow the business and expand into adjacent business lines that complement a company’s leading revenue driver.
In addition to understanding how a company generates revenue and the industry it operates in, it is vital for investors to be familiar with the legal structure of a special purpose acquisition company and the process for going public. One instance where understanding the legal structure of a SPAC proved beneficial was in the case of Bill Ackman’s Pershing Square Tontine Holdings, which had originally negotiated a deal to buy 10% of Universal Music Group (UMG) for $4 billion.
UMG was already being taken public by its parent company, Vivendi, and the SEC argued that Pershing Square Tontine Holdings was not actually a SPAC but rather an investment company. As a result of the pushback from the SEC and the potential for a shareholder lawsuit, Ackman decided to renege on the deal, causing the share price to drop. Pershing Square Tontine Holdings’ tracking stock ($PSTH) ended up trading below its trust value per share of $20, resulting in a potential loss for investors who had paid more than $20. Currently, the tracking stock is trading at $19.72 per share and has traded below $20 since Aug. 19.
As with any investment, it’s important for investors to conduct their due diligence. Regarding SPACs, this would include researching the company and sponsor, as well as understanding the legal ramifications and investment process. There are certainly companies that have gone public via SPAC and seen the stock price skyrocket. However, as shown above, some startups operating in new and legacy industries have forecasted lofty sales estimates and aggressive growth trajectories, but also seen material share price depreciation.
For limited partners in private funds, SPACs are a great way to generate liquidity for portfolio companies and raise additional capital for growth moving forward. As a number of these SPACs have been public for less than a year, it will take time to see which companies deserve to be public versus those that should have continued to operate in the private markets for an extended period of time.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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