There was an instrument in town last year that has got a lot of news and traction on the stock market, Special Purpose Acquisition Companies, or SPAC. But what are they and should I be investing in them?
A SPAC is formed by a sponsor, which consists of a management team, that raises money from outside investors with the sole purpose to identify a private business or asset at an attractive valuation. The goal is to take the target company and merge it with the SPAC to provide a listing for the private company.
Many private companies such as WeWork are looking at SPACs to go public. This allows folks like you and me to buy these glorious or maybe overpriced private company shares.
The SPAC ticker that I can buy on the stock market changes to the company that is being acquired and now that is the company that I would hold a stock position in.
Benefits and costs to a company
| Benefits | Costs |
| No need to go through extensive registration process | Company still needs to have approval from regulators over a quicker time |
| Speed of listing 3 to 4 months vs years | Increased costs with sponsor fees (costs the target company a large portion of equity) |
| Greater transparency on how much they raise | |
| Certainty of a deal and price | |
| Partnering with a successful investor or investor in the same sector as the company |
Historical returns for SPAC stocks
Goldman Sachs noted that in 56 completed transactions since January 2018. Also, on average SPAC stocks initially outperformed the broader equity market, but then significantly underperformed over the subsequent three-, six-, and twelve-month period. In addition, the range of outcomes was extremely wide, with the top decile generating >60% returns, while the bottom decile lost more than 80% of their value.
However, past performance is not an indication of future performance. Nevertheless, for us retail investors we do not get the same benefits as institutional investors with SPACs. Clearly, the more money that is being invested the greater the advantage to that investor. Undoubtedly, this is at the cost to the small guy!
I believe a key to successfully investing in a SPAC is to back one with an experienced investor or sponsor who has strong domain knowledge. However, one should be sceptical of this approach. I might pay a lot higher than the $10 issue price of a SPAC and I have to workout potentially what company do they acquire. So in essence you are making a bet on the SPAC team.
Furthermore, SPACs are becoming a commodity, and it’s important to look at the right one. Moreover, there are so many SPACs today that you just wonder is this just another bubble waiting to burst.
Without a doubt, SPACs are hot right now. Just look at some of the notable institutional investors that have invested in SPACs, Millennium Hedge Fund invested $4.4bn into SPACs 2020. Seth Klarman of Baupost Group has also invested $400 million into Ackman’s SPAC.
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