After a record-setting beginning to this year for blank-check companies, the deal flow slowed drastically in the second quarter thanks to some regulatory interference and more investor scrutiny of some particularly risky deals.
But where do we go from here?
While the number of special-purpose acquisition company, or SPAC, deals fell 67% in the second quarter from the first quarter, there was a rush at the end of the quarter, with approximately 13 SPACs pricing and going public in the last week of June before the July 4th holiday, according to SPAC Research, along with a surge of IPOs.
They weren’t alone. Special purpose acquisition company (SPAC) maven Chamath Palihapitiya took four more blank-check companies public in June, under his Social Capital technology holding company. The four latest blank check companies to go public are focused on biotech, and are named Social Capital Suvretta Holdings Corp. I, II, III and IV, raising over $800 million combined.
Those deals were definitely a last gasp ahead of the long holiday weekend in the U.S., but may also represent the last gasp of the gold rush in SPACs, after they came to a crashing halt earlier in the quarter.
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“With greater scrutiny from both investors and the SEC, I doubt we’ll ever get back to the level of the first quarter,” said Matt Kennedy, a senior IPO market strategist at Renaissance Capital
which also manages two IPO-focused ETFs. “That said, we never really saw a sustained slowdown if you compare it to historical levels; the second quarter of 2021 far outpaced second-quarter 2020, or any quarter prior to 2020. “
“I am not seeing a whole bunch of new money rushing into SPACs,” said Sam Dibble, a partner at Baker Botts, a law firm in San Francisco. Dibble noted that the recent moves by the Securities and Exchange Commission, especially an accounting rules clarification, were designed to put the brakes on the flood of deals.
In the first quarter of 2021, according to DealLogic, SPAC IPOs reached a record, with 298 blank-check companies going public, raising nearly $97 billion, compared with 13 SPACs that went public in the first quarter of 2020. In the second quarter, 62 blank check companies went public, raising nearly $13 billion, compared with 24 deals in the second quarter of 2020.
The flow of SPAC deals slowed down earlier in the second quarter as a direct result of the increased regulatory scrutiny, which will continue to hang over future SPACs seeking to raise funds. The SEC began to pay more attention to SPACs this year, and have already made one change: decreeing that the warrants in SPACs owned by early investors should be declared as liabilities (because money is owed to the investors with a warrant) as opposed to an asset on a company’s balance sheet. This led to a slew of restatements among many publicly traded SPACs, including some high profile issues, and helped slow down the pipeline of blank check companies looking at going public.
The SEC has also been concerned about the seemingly wild or potentially inaccurate forecasts made by some companies acquired by a SPAC. Some of the electric vehicle companies that have been purchased via a SPAC, such as Nikola Corp.
and Lordstown Motors
both saw their CEOs step down, amid allegations of inaccurate projections or statements.
Lordstown, for example, recently said that a special committee was looking at the allegations in a report by Hindenburg Research that the company misled investors on its demand and production capabilities. The company said an investigation by a special committee into the shortseller’s report detected issues in how it was reporting orders and found some orders that were “too vague and infirm” to be appropriately included in pre-orders.
During an online conference last month, the annual “Fraud Fest” sponsored by the UC Berkeley Center for Law and Business, a debate raged over the legitimacy of many SPACs, and the interest in them by short sellers. Famed investor Jim Chanos, founder and president of Kynikos Associates said in his “review of the year in short selling” that the current SPAC mania has created a huge new emphasis on the acronym TAM (total available market), and not on the company itself.
“We have also seen a change in perception not how are you doing but how big is the market,” Chanos said. “A lot of us understand that is one of the problems with the SPAC world…projections rather than risk factors.”
The projections could grow even more fanciful as potential acquisition targets dwindle. Investors have noted that when SPACs finds a target to purchase, many of the acquired companies are not necessarily ready for prime time, and either at a very early state of business or are distressed in some manner.
“A lot of companies are high-growth, VC-type companies, and really for any of those companies, the caveat is buyer beware,” said Patrick Galley, chief executive officer and chief investment officer of RiverNorth Capital Management. “These companies, there is more risk with them. With that, projections are also harder. Some are going to overshoot projections and some will not meet them.”
Blank-check companies that have gone public have a two-year limit to find an acquisition target. If investors do not approve of the acquisition target, they can redeem their shares. With so many SPACs flush with money and hunting, there is going to be a rush to complete a merger.
“They are very actively shopping,” said Dibble of Baker Botts. “The clock is running out.”
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The potential targets that remain also still have a range of funding options, from getting another round of financing, doing a traditional IPO or a direct listing, while the SPACs are going to get “increasingly desperate” for acquisitions, he said.
“The economics are such that if there are enough SPACs competing, it will mean that the SPAC has to pay more money.”
Ramifications from a failure to make an acquisition vary with each specific deal, but in general, at least 90% of the invested money lands in an escrow account. The other portion (up to 10%) can be used by the SPAC sponsors to identify acquisition transactions, Dibble said. If a deal is not found, the approximate 90% of the initial investment is returned to investors.
“The sponsors are even worse off because they lose their invested stock (they get shares in the SPAC at a very low price), which then is stock in a company that has no assets,” Dibble said. “They may make a fee for looking for deals, but a failed SPAC will be a black mark on them for future SPACS since they didn’t get a successful deal together.”
That could lead to even more risky deals, with the blank-check companies buying even more at risk companies that would not be able to go public through traditional methods, in order to avoid a failed SPAC and a black mark on their reputation. For now, the private company targets may have the upper hand, and could be able to get a lot of money to fund both legitimate and pie-in-the-sky technologies ranging from everything like new self-driving technologies to flying robotic taxis.
Which leaves investors with an uncertain path to play these risky equities. Galley believes the best potential returns come before an acquisition is made. His firm has been opportunistically investing either in the IPO or the secondary market before the de-SPAC occurs and acquisition targets are found. In this phase, he said, companies are often trading below the so-called trust value, the cash that is in the coffers that will be used for an acquisition, typically $10 a share.
“What’s great about today’s market is that most SPACs are trading at discount to that value,” he said. “We can even outperform fixed income alternatives.”
As for the actual stock in the company after the merger? “That is not an interest for us,” he said.