Are SPACs Losing Attractiveness?

Some insiders of the SPAC space even see flashing warning signs of a decline.

In my humble article, I will take up current arguments of concern and will elaborate why SPACs did indeed not lose attractiveness, provided that SPACs are really business-focused, in contrast to speculative SPACs, and that they are excellently structured.

I recently came across a very good article on Bloomberg Law, which analyses the current situation of SPACs and SPAC IPOs. An excellent work, indeed. To be fair, the article does not explicitly say that SPACs are losing attractiveness, but that “Investor hunger for SPACs is hitting limits”.

However, I do not agree with at least some of the conclusions.

The article states at its beginning:

“The insatiable appetite for U.S. SPAC IPOs may finally have reached its limit. It is not that investors have suddenly turned sour on blank-check companies. Rather, broader economic concerns, combined with the investment and insurance industries’ own limits on SPAC exposure, are producing a market pause and a trend toward increasingly discerning investing.”

One argument is: the political environment is not beneficial for SPACs anymore.

“The market experienced volatility jitters in October, reflecting worries about the election and the lack of more Covid-19 relief from Capitol Hill.” Yes, that is true, but it is not specific to SPACs. The nervous up and downs on Wall Street were reflecting – and will continue to do so – a general desperation of small and large investors in respect of trustable investments, accompanied by sudden reverse moves of enormous volumes to settle unbeneficial positions.

There is no plausible reason that psychology-backed volatility would not affect SPAC shares as well.

I agree that the dip of the DraftKings SPAC fell 40% in October, to below $22.5, is not good news for investors who buy and sell shares on Nasdaq. But this is nothing different from any shares publicly traded, be them SPAC shares or not.

It is well worth to note that a “dip” to below $22.5 of a share that was offered for $10 on the IPO, is still an extraordinary gain for both IPO investors and pre-IPO SPAC investors, called SPAC sponsors in the SPAC space.

Finally, snapshots during very volatile markets are never a good idea. Today, Nov 17, 2020, the same share is traded at a price above $45!

Efficacy of the presidential transition, the leadership in the Senate, speculations on pandemic relief support are very temporary phenomena that will continue market volatility, but not the interest of large institutional IPO investors in SPACs. Again, if SPACs are really focused on resilient business acquisitions and have a quality board with the necessary expertise and experience.

Is the pipeline for SPACs really slowing down?

The Bloomberg Law article continues saying “that filings for new SPAC IPOs peaked in September and declined substantially in October. It also reported that roughly 60% of October listings are trading below their offer price, despite the capital raised in public offerings being held in trust. This slump is an indication of nervousness among investors about SPACs’ prospects.”

The information as such is of course true. However, this is not an argument that SPACs lost attractiveness in general.

The majority of SPACs is always trading below their IPO offer price. And that is very natural. SPACs, Special Purpose Acquisition Companies are companies that go public without having any business or assets but an acquisition strategy and a (more or less) convincing board. It is common practice that the offering price is $10 on the day of IPO. It could be $8 or $15 s well, as there is no pricing based on the company’s business, because it has no business. When common shares are then open for trading, traders do buy shares because they wish to participate in a possible spike of share prices, but they are somehow reserved, as they do not know how great an acquisition a SPAC will land. Post-IPO SPAC share prices tend to remain below their offer price but gain momentum when the SPAC board starts publicly communicating its promising path toward a successful acquisition. This shows how important public communication is (not only) for SPACs. Those SPACs that have their shares trading well above the offer price are SPACs with professional market communication, and often SPACs that have prominent figures on their board.

There is one important detail that needs to be mentioned in this context: Rights are back since a few days. Rights mean the right of the investment bank and – in case of execution by the investment bank – the obligation for SPAC sponsors to purchase a certain amount of offered rights to acquire common shares. The price of one right is typically capped at $0.10. Each holder of a right will receive, without any additional payment required, one-twentieth (1/20) of a share of common stock upon consummation of a SPAC’s initial business combination, which means that right holders will get one share for 20 rights, equalling typically to $2.00.

While this is a good opportunity for sponsors and the investment banks to stock up their shareholding after consummation of the initial business combination (acquisition) at a very low price, the purchase of rights by SPAC sponsors demonstrates, to the market and to the institutional IPO investors, the confidence of the SPAC board confidence in its ultimate ability to effect a business combination because the rights will expire worthless if we are unable to consummate a business combination. Furthermore, it potentially prevents the stock market price of SPACs dropping significantly below the offer price, thus providing price stabilisation.

The Bloomberg Law article states that investors are becoming more discerning because of the number of SPACs that downsized their offerings.

The typical scenario for SPAC IPOs was going for over-allotment, collecting 15% more IPO proceeds than planned. But now, there is indeed a certain cautiousness among SPAC IPO investors, which is mainly fed by a number of speculative SPACs. Speculative SPACs are SPACs were the initiators are not primarily focused on gains that come along with resilient business acquisitions. Instead, some SPAC initiators do rather focus on gains and fees that can be squeezed out of a SPAC by artificially creating wowing momentum, trying to push up share prices and to create as much trade value as possible, to get a great deal from executing their warrants.

If you have a look at the people and entities that are behind a SPAC, those who create and set up a SPAC, you will see that there are typically two groups, which are business-focused specialists on the one hand and investment firms or investment funds on the other hand. This does of course no mean that all investment firms setting up SPACs are only into financial engineering and pushing up value.

Institutional IPO investors realised this development, which started roughly at the beginning of this summer. And they became cautious. So, this again is not an argument against SPACs or that SPACs lose attractiveness in the eyes of IPO investors. Instead, they just want to see proper SPACs, which will generate sound gains on the longer term.

In this context, having pre-IPO key investors, perhaps in the range of 20-30% of the IPO proceeds initially planned, is always a good insurance against downsizing.

Are market conditions a lid for SPACs?

“There are limitations on just how much the market can digest when it comes to SPAC IPOs. Certain institutional investors have restrictions on their level of SPAC exposure, and some have reached their internal limits”, citing Bloomberg Law.

Yes, that is true. SPAC exposure might be reached for some institutional investors. For many others there is either not such a restriction, or the limit has not been reached.

Mandatory D&O (Directors and Officers) insurance premiums for SPACs have recently spiked, because of spiking demand coming from SPACs. The total number of SPAC IPOs in 2019 was 59 in the US, while we reached 183 in 2020, and 2020 has not come to its end yet.

However, the premium of D&O insurances is not only determined by supply and demand, although only six US insurers offer coverage. When pricing D&O insurance premiums, insurers are looking at all types of risks they might be exposed to. At the end, the business of insurers is to collect premiums, and not pay damages.

A very important factor that is reflected to D&O premiums is the quality of the SPAC Board. Do the board members have Wall Street experience, do they have experience in managing listed companies? Do SPAC board members have experience in successful Mergers & Acquisitions? How familiar are board members with the industry or area a SPAC is focusing on with its acquisition strategy? How well is their network in the respective industry? Are there prominent figures on the board that stand for success? Indeed, the answer to those questions increases or lowers possible management risks insurers may be exposed to. Consequently, those answers will increase or lower the D&O insurance premium.

Another factor influencing the premium pricing is the industry or area where a SPAC plans to do its acquisition. And here we can see that in 2020, this factor does play a role. However, the reason are not SPACs per se, but the people behind a SPAC.

Humans are often herd animals. When John opens a cool burger bar at the corner of two streets and attracts a lot of customers lining up all day in front of his shop, soon there will be a few more burger bars around in sighting distance. If John has such an incredible business there, I will easily get my share, the new competitors were thinking when deciding to open the doors of their burger bars nearby.

Humans are humans, and that is not different in the SPAC space.

How many SPACs have we seen this year with the same acquisition strategy and similar acquisition targets? SPACs focusing on cannabis, SPACs focusing on fintech, SPACs focusing on e-vehicles, and so on. It was a kind of copy paste game this year in the SPAC space. And eventually, institutional IPO investors said, “I can’t see that anymore, bring me something else, something unique.” Right they are.

The copy paste games are leading to another problem, the problem of landing great acquisitions. How many possible great acquisition targets do we have in the world? How many e-vehicle developers or producers do we have? How many cannabis-based possible acquisition targets of considerable size do we have in the world, big enough for SPAC acquisitions? And how many do we need?

When insurers have to evaluate their risk exposure, they do have to guess how successful a SPAC eventually will be; meaning how great a deal will a SPAC land?

Uniqueness decreases insurers’ risk exposure and decreases the D&O insurance premiums. If you have a look at SPAC prospectuses (Form S-1) published on the website of the US Security Exchange Commission, you will see the use of proceeds and the expenditures of a SPAC. There you will see the amount considered to be paid for D&O insurance. You might be surprised how the can differ – all depending on risk exposure, as elaborated above.

Market indicators suggest uptrend for SPACs

I do agree in the last part of Bloomberg Laws insightful market analyses, saying “if a SPAC’s managers can identify trends and early stage companies that can disrupt markets, they can potentially ride those trends to far greater returns than what would be achievable from safer investment opportunities.”

Apart from that, SPACs are not going away, and they did not lose attractiveness. They are also not taking a break but are just having a very little rest from the hype this year. The new year will come with new budgets and fresh annual exposure limits for institutional investors.

We will see some speculative SPACs struggling to find really good acquisition targets, so they will go for anything – and may fail eventually. That will be a good lesson for all players in the SPAC space, and it will pave the road for more substantial SPACs that are business-focused, to deliver resilient gains for their shareholders.

If a SPAC is well designed and structured in all its aspects, has a high-quality board and a unique acquisition strategy, it will always attract key investors, IPO investors, back-stop investors, and of course investors at the stock exchanges.

Such SPACs are win-win-win models.

By Stefan Nolte, Chief Advisor at spacconsultants.com, Managing Director of Shanda Consult.

Nicosia, Cyprus, Nov 18, 2020.

Important note:
SPAC Consultants is not offering and/or providing investment advisory services in the sense of regulated investment advisory services as per respective EU Directives and their implementation into national law of EU Member States. Instead, SPAC Consultants offers SPAC Project Management services and consults regarding the general principles of US SPACs and their business structuring. Any investment, legal and financial advice that may become necessary for possible sponsors and investors at advanced stages will be provided by the network partners of SPAC Consultants.