Your Question Answered: SPACs’ Surge Explained

Your Question Answered: SPACs’ Surge Explained

April 19, 2021
This week’s reader question is about special-purpose acquisition companies:

SPACs aren’t new, so why are they so popular now, and is this a bubble?

Josh McCourt, Equity and Quantitative Research Analyst, had this to say:

That’s right, SPACs (special-purpose acquisition companies) are not fresh on the investment scene—they’ve been around since the ’90s. But they returned to center stage last year, raising billions of dollars and making a media splash with big-name institutional underwriters and celebrity sponsors.

These so-called “blank check” companies are a type of shell corporation. A SPAC has no business yet it conducts an initial public offering (IPO) to raise cash, and then looks for a private company to acquire. If the SPAC doesn’t find a company to buy within a set timeframe, investors get their money back. If it completes a buy, then the private company becomes a public company, and shareholders of the SPAC now own the new entity—which takes the money in the SPAC and (hopefully) uses it to fund growth.

Why are SPACs so popular right now? Some of the surge can be explained by market conditions. Pandemic-fueled volatility made it more difficult for companies to go public via a traditional IPO. Going public through a SPAC vastly simplifies the process, with quicker closings, lower costs and fewer regulatory requirements compared to a traditional IPO.

On top of that, there’s a FOMO (fear of missing out) aspect in play. Headlines touting splashy SPACs—including online betting company DraftKings and payment firm Paya—have raised their profiles and made SPACs seem like a compelling investment for retail investors who have little to no access to the IPO market.

Some of the SPACs out there may turn out to be decent investments, but we consider the current market for them to be a bubble.

What’s more, SPACs are highly speculative—you are trusting the sponsor to make one good (ideally great) investment bet when it merges with a private company. SPACs themselves tend to trade around their (almost always) $10 listing price until a merger has been confirmed. After that, the sponsors exit and prices often fall below $10, leaving investors holding the bag. Despite the trend, SPACs have already raised more money in 2021 than they did in all of 2020.

They’re also raising eyebrows at the Securities and Exchange Commission, Wall Street’s federal watchdog, which warned that some companies may need to restate their financial results due to questionable accounting practices. SPACs have come under increased scrutiny from lawmakers as well.

Speculation aside, any investment entails understanding what you own, how it’s valued and who is steering the ship—with a SPAC, virtually all of those questions remain unanswered until it’s too late. Caveat emptor!

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