Making sense of the SPAC spectacle

Many investors would add to that list special-purpose acquisition companies (SPACs). They are an alternative way of taking firms public that bypasses the cumbersome initial public offering (IPO) process. The pace of deals has been furious. Between January and April some $100bn was raised through SPACs, many of which are now hunting for firms to buy. Some 84 companies have announced they will float via SPAC mergers so far in 2021, versus 123 using IPOs. The SPAC trend is a giant experiment with a different way to take firms public. And it is also a test of the firms involved, most of which have either been hidden away in private markets for years, or are so nascent that they are more concepts than companies.

So just how mad is the SPAC frenzy? At first glance, pretty mad. This boom has occurred in spite of the dodgy track record of some firms that have gone public in this way in the past. Regulators grumble that the process is easy to manipulate. The executives who run SPACs frequently take a whopping slice of equity for themselves, to the detriment of the outside investors who usually stump up far more cash. Often they make fanciful promises. The Economist has totted up the management forecasts of a panel of 50 recent or pending SPAC deals. Around half of the firms are loss-making. In aggregate the 50 firms generate about $1bn of annual gross operating profits today but have forecast to investors that this will rise to a miraculous $15bn by 2023. There are pockets of extreme delusion. Of the eight electric-vehicle (EV) firms ushered into public markets by SPACs in 2020, five expect to progress from making no revenues to $10bn-worth in under five years. Not even Google, one of the most successful firms in history, pulled that off. It took it eight years.

Yet while the overall figures look wild, the good news is that the SPAC boom is becoming more discerning. The market capitalisation of Virgin Galactic, a space-technology company, has fallen from $13bn to $5bn since February. Shares in Opendoor, a real-estate firm, have halved. Investors who funded the VectoIQ Acquisition corporation saw their money grow seven-fold after it merged with Nikola, an electric-truck maker, in June 2020. But shares in the firm have since dropped back below its debut price. Investors have cooled on SPACs that are still hunting for targets. Bill Ackman, a Wall Street tycoon, has a $4bn vehicle that was trading at a 50% premium to its cash value in February, in anticipation of it doing a deal that would be instant alchemy. The premium has since fallen to just 17%.

There are other signs of market discipline in action. Short interest is growing as sceptical investors bet against SPACs and the firms they have backed. After a spectacular start to the year just $2.5bn has been raised through new SPACs since March 29th, as fund managers grow less giddy and warier of writing blank cheques. This scepticism is a healthy sign of the market maturing.

Institutional investors should use their clout to improve the process. That means making sure that the slice of shares that SPAC creators are awarded is not excessive, insisting managers’ pay is tied to delivering on the forecasts they make, and applying a discount to firms that give outside investors limited voting rights. Not all companies that go public through SPACs will succeed, but having an alternative way to float companies is welcome. Still, if anyone comes up with a SPAC for a firm selling NFTs in EVs, run for the hills. ■

This article appeared in the Leaders section of the print edition under the headline "The SPAC spectacle"