SPACs Have Raised More This Year Than All of 2020 – a Bubble Set to Burst?
SPACs – Special-Purpose Acquisition Companies – are becoming an increasingly common vehicle when it comes to raising capital. Since 2019, raised funds via SPACs have increased five-fold. Many individuals suggest the SPAC scene is a bubble getting closer to a burst—and for good reason.
IPO as a Double-Edged Sword
In some communities, there is hardly anything more dreaded than for a beloved company to go public. By going public via IPO – Initial Public Offering – the company lists its shares on a stock exchange like NASDAQ, based on its initial valuation done by an underwriter — an investment bank. In turn for potential gains in raised capital due to publicly traded stocks, the company exposes itself to public scrutiny and trends.
It can also gain more traction and better lending terms by becoming a publicly traded company. Unfortunately, the company also becomes enslaved to its shareholders. After the initial capital is raised, and when its profits plateau but the company remains perfectly healthy, this is not good enough for shareholders who want to see perpetual growth of their shares.
This inevitably leads to companies undercutting their business model in order to appear profitable and exciting. EA and Blizzard are notorious for doing this on a yearly basis. Just last month, Activision Blizzard (ATVI) fired 190 employees despite continuing to reap record profits. Usually, layoffs occur when the company is struggling, but not so with those who have gone public.
Long term degradation of such a company is also encouraged by SVCI clauses – Shareholder Value Creation Incentive. Effectively, such clauses make the CEOs do everything in their power to raise the stock value, in order to trigger SVCI clauses to increase their astronomic bonuses. How such moves affect the company’s bottom line in the long run then becomes less important.
Why are SPAC IPOs Suddenly Gaining Popularity?
Also called blank check companies, they’ve been around since 1993. SPACs exist for the sole purpose of raising funds in order to make a merger or an acquisition. In other words, while SPAC IPO stocks can be listed and publicly traded, they hold no assets to conduct a commercial enterprise. Instead, all the funds raised through public trading go to either merger or acquisition of a private company to make it public.
In the last two years, the capital raised in this manner has gone through the roof compared to the previous two decades, currently accounting for $87.9 billion this half of the year alone.
Speaking to the novelty of SPAC IPOs, NYSE hadn’t listed a single one until 2017. After that initial dam had broken, it has gone on to list over 60 SPAC IPOs since. The Tokenist touched upon the reason for this popularity previously – corporate consolidation. Even prior to the emergence of the pandemic narrative, corporate consolidation has continued at a pace as if no antitrust laws exist. Since 2020, it is clear the financial world is coalescing around corporate behemoths.
As a consequence, there are fewer companies going public than ever, their number cut in half compared to a decade ago. Simultaneously, the flow of capital has increased. In that imbalanced space between supply and demand, SPAC IPOs are showing up.
Pros and Cons of SPACs
Seeing the necessity of SPACs to fill the dearth of companies going public, the SEC’s increased regulation has improved their standing as legitimate vehicles for raising capital. The SEC now sets their price, redemption and voting rights for all the investors. With the negative perception of legitimacy largely neutralized, SPACs offer several advantages over traditional IPOs:
- By being publicly traded, SPACs make it possible to achieve higher valuation. eToro’s SPAC has set its valuation to $10.4 billion, as it merges with FinTech Acquisition Corp. V shell company is just the recent example of this strategy working.
- SPAC IPOs are significantly quicker to finalize, in a matter of months compared to an IPO process which may take years.
- SPACs provide immediately available liquidity via raised cash, in addition to being more cost-effective.
- Company owners are left with a greater stake in the company compared to IPOs.
Some SPAC benefits can be viewed as both positive and negative. While such a financial mechanism spreads the initial risk across investors, it also passes a greater risk burden to ordinary stakeholders. Moreover, there are alarm bells sounding from surprising sources. Goldman Sachs, the same one that had no qualms un-blacklisting convicted trader Bill Hwang, had warned about SPACs at the beginning of this year.
In a nutshell, GS CEO is warning about a bubble burst. This is likely related to SPACs being a type of reverse merger, the difference being that the shell company in SPAC has funds to spare. Outside of that, in both cases – reverse merger and SPAC – private companies become public by purchasing a controlling stake in the public company.
By the same token, SPACs could follow the road already paved by reverse mergers – an initial spurt of growth followed by rapid deflation. It took about five years for that to happen with reverse mergers, from the mid-2000s to 2010. This time, the period may be shortened by the growing realization that SPAC IPOs tend to underperform, based on Renaissance Capital research examining 313 SPACs since 2015.
In the meantime, the crypto world is onboarding the SPAC train. Diginex (EQOS), was actually the first crypto exchange listed on NASDAQ, prior to Coinbase. At the time of the SPAC deal, it was valued at $276 million. Subsequently, it now has a market cap of $232.1 million, representing a 19% underperformance. Although this example fits the SPAC underperformance study, there will still be a gap present between the flow of capital and not enough companies going public.
Note: Since this article was published, eToro has subsequently delayed its plans to go public via SPAC.
Have you partaken in any SPAC IPOs listed on stock exchanges this year? Are you pleased with your investment? Let us know in the comments below.