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By Emir Hrnjic
The COVID-19 pandemic triggered a massive uncertainty in global markets and the U.S. Fed responded by cutting interests rate to 0.25 per cent. As investors started chasing higher yielding investment opportunities, the somewhat–obscure concept of a Special Purpose Acquisition Company (SPAC) came back to the spotlight. In 2020 alone, roughly 250 SPAC initial public offerings (IPOs) raised U$83 billion – roughly equal to funds raised by conventional IPOs. Moreover, SPAC IPOs in this banner year raised more capital than all previous SPAC IPOs combined. Even 2021 started with a bang raising roughly U$8 billion in first two weeks – on a pace to double the record of capital raised in 2020. Recently, Asian investors started jumping on a bandwagon. For instance, SPACs sponsored by Asia–based Antony Leung, Richard Li, CITIC Capital, Maso Capital, and Malacca Straits have raised more than U$2.5 billion, while Singapore–based Vickers Venture Partners, Japan–based Softbank, and Hong Kong–based Provident Acquisition recently filed to raise almost U$1 billion via SPAC IPOs. Even the Singapore Exchange is considering allowing SPACs’ listing due to their popularity. Furthermore, more than a dozen SPACs are holding talks with South-east Asia’s startups about potential mergers. For instance, Bridgetown Holdings approached Tokopedia – South-east Asia’s largest e-commerce platform, while Traveloka – South-east Asia’s largest online travel app – announced that it is going public with a SPAC as a possible option. Moreover, reports revealed that other Asian unicorns such as Grab, Gojek, and Bukalapak have all been recently approached by SPACs. While Goldman Sachs declared that SPACs in 2021 could even exceed capital raised in 2020 and Reuters reported that SPACs “arm up for Asian unicorn hunt”, investors are getting reacquainted with these alternative financial vehicles. SPACs 101 Known as a “blank check company” with no business operations, SPAC is formed to raise funds via IPO with an intention of acquiring a promising private company within two years. When a private company is acquired by a public firm, it automatically becomes public. Hence, SPACs provide the public an easy access to a mature private equity (PE) investments, while being more transparent than PE, but less transparent than conventional IPOs. Since investors do not know eventual acquisition target at the time of raising capital, SPAC resembles a flipped IPO process from demand–supply perspective. In a traditional IPO process, investment (company going public) is known and underwriters are looking for investors. In SPAC, on the other hand, lead sponsors find investors first and, then, search for investment (company to go public). After raising capital, SPAC sponsors promise to identify an acquisition target within two years. If they fail to find a target within two years, most SPACs return money to investors. Even if they find an acquisition target, the SPAC shareholders have flexibility to opt out and redeem their shares before the acquisition. Also known as De-SPACing, SPAC’s acquisition automatically makes a private company public and thus resembles a flipped RTO from the private–public perspective. While RTO represents the process of private company acquiring a public company, SPAC achieves the same outcome via the process of a public company acquiring a private company. On the other side of the table, acquisition target has to negotiate with only one party (SPAC) unlike a typical IPO company that deals with multiple parties including underwriters, lawyers, and auditors. SPAC IPOs VS. CONVENTIONAL IPOs Natural question arises how SPAC IPOs made such dramatic inroads into well–established world of conventional IPOs. SPAC proponents claim that the phenomenon of pricing a typical IPO below their market price – so called IPO underpricing – incurs an unnecessary (opportunity) cost for the company going public, also known as “money left on the table”. The IPO underpricing averaged over 20 per cent this year. In extreme cases, IPOs leave even more money on the table as in recent cases of DoorDash and Airbnb which soared 86 per cent and 115 per cent on the first day of trading, thus leaving billions of dollars on the table. They also argue that SPAC enables investors to avoid IPO underwriting fees that typically go as high as 7 per cent. Other factors include reduced underwriters’ ability to conduct traditional IPO roadshows during pandemic. Since SPACs are established by reputable sponsors who then search for additional investors through personal networks, there is no need to conduct traditional IPO roadshows. Moreover, the quality and reputation of SPAC sponsors have drastically improved over the years and institutional heavyweights such as Goldman Sachs, Citigroup, and Deutsche Bank jumped on the SPAC wagon. The improved quality of sponsors, institutions, and their networks greatly contributed to a SPAC boom. Additionally, many view SPAC as an accelerated IPO without strict regulatory scrutiny that accompanies a typical arduous IPO regulatory process. SPAC accelerates the process of capital raising as there are no operations, assets, or financial data. The entire process can be completed in several weeks, instead of several months. This efficiency reduces completion risk, especially in volatile markets. Finally, some spectacular success stories boosted the popularity of SPACs and attracted even more investors. For instance, DraftKings’ valuation quadrupled, while Virgin Galactic’s price jumped 150 per cent in several months after the SPAC acquisition. SHORTCOMINGS OF SPACs In contrast, shortcomings and hidden costs of SPACs are numerous. A recent research study documented that the median SPAC held only U$6.67 per share by the time of the merger – down from U$10 at the IPO stage. This drop was mostly due to dilution of SPAC shares as sponsors were rewarded with 20 per cent of the acquired company – akin to a “finder’s fee”. Another research study documented that the average SPAC IPO in the first decade of 2000s lost roughly half of its value over four years, while higher SPAC sponsors’ ownership was associated with worse performance. Similarly, the operational performance of SPACs was inferior to industry peers and conventional IPOs. Finally, research found that SPAC–acquired firms were traditionally small and levered firms with low growth opportunities, consistent with the notion that SPAC acquisitions attracted firms to go public in difficult times. A former SEC Chairman, Arthur Levitt, stated “I have never found any [SPAC] attractive. No matter what the reputation or what the sponsor might be. […] They are the ultimate in terms of lack of transparency.” Notwithstanding the banner year for SPACs, opponents warn that SPAC is inherently inferior capital–raising method. A potential reversal in market enthusiasm may come from increased opposition of target companies, opaque nature, or inferior post–performance. SPAC sponsors try to convince investors that these statistics derive from SPACs of old era, while new SPACs are bigger, better, and higher quality. Nevertheless, investors should do their own due diligence and do not rely on any sponsors’ promises. After all, sponsors’ incentives are very different than theirs.
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Shortcomings and Hidden Costs of SPACs (as published in The Business Times on December 23, 2020)1/15/2021 By Emir Hrnjic
As COVID-19 pandemic devastated global economy and created an unprecedented uncertainty in global markets in 2020, an alternative financial vehicle known as Special Purpose Acquisition Company (SPAC) flourished as an innovative capital–raising method. In 2020 alone, almost 250 SPAC initial public offerings (IPOs) raised more than U$81 billion – more than all previous SPAC IPOs combined. While most SPACs are sponsored by investors in the United States, Asian investors started catching up. For instance, Antony Leung, a former Hong Kong financial secretary and Blackstone executive, launched a U$1.5 billion SPAC. Additionally, SPACs sponsored by Richard Li, CITIC Capital, Maso Capital, and Malacca Straits – all based in Asia – have raised more than U$1 billion. More recently, Singapore-based Vickers Venture Partners started a process of raising U$100 million through a SPAC IPO. When news broke out that Bridgetown SPAC backed by Asian-based Richard Li and American–based Peter Thiel approached Tokopedia regarding potential merger, SPAC’s price soared by more than 30 per cent. The largest e-commerce platform in Southeast Asia, however, remained non-committal about the merger. Soon after, the Indonesian giant backed by Alibaba, SoftBank, and Temasek hired investment banks Morgan Stanley and Citigroup to advise them about going-public process and announced that it is considering traditional IPO. While Forbes claimed that the “SPAC boom of 2020 is probably the biggest Wall Street story of the year”, business press paid very little attention to shortcomings and hidden costs of these alternative financial vehicles. SHORTCOMINGS AND HIDDEN COSTS OF SPACs Notwithstanding historical popularity of SPACs and record-breaking amounts of capital, recent research study from NYU and Stanford does not support the popular argument that SPACs are a cheaper way of going public. In fact, the study documents that SPAC costs are opaque and exorbitant as the median SPAC share value starts at U$10 at the IPO stage, but the median SPAC holds only U$6.67 per share by the time of the merger. This drop is mostly due to dilution of SPAC shares as sponsors are given 20 per cent of the acquired company as a reward for their efforts in finding a target company. This is akin to a “finder’s fee” in return for leveraging their brand equity for fundraising for the SPAC. While the return to sponsors mostly comes from this reward, the resulting dilution represents the cost to other SPAC shareholders. Furthermore, investors in SPAC may have different incentives and investment horizons which may not appeal to an acquisition target. For instance, IPO investors may have longer horizons because they invest in the IPO company. SPAC investors, on the other hand, may not be vested in the future of the acquired company. A former Facebook executive, Chamath Palihapitiya, became the poster boy of SPAC boom, when he sponsored SPAC that later acquired the Virgin Galactic. Since the innovative company like Virgin Galactic will likely take a long time to generate the profit, long-term commitment of initial sponsors assumes oversized importance. For instance, when Virgin Galactic aborted a recent test flight, its shares fell as much as 6 per cent. More importantly, Chamath Palihapitiya sold 3.8 million shares worth U$98 million, thus sending bearish signals to the market. Another research study from University of Exeter dubs them “poor man’s private equity funds” because, on average, SPACs substantially underperform comparable companies. The average return in four years following the SPAC IPO is negative 51.9 per cent, significantly worse than an average return of 8.5% by comparable IPO companies. Similarly, SPACs considerably underperform the competitors based on accounting measures such as operating margins and return on sales. Moreover, SPAC performance is worse when deals are completed just before the deadline for a SPAC acquisition suggesting that SPAC managers become desperate to do any acquisition when facing the impending deadline. Performance is also worse if the deal barely meets the minimum transaction value. The overall research evidence is consistent with the notion that SPAC acquisitions attract firms to go public in difficult times. SPAC–acquired firms have lower growth opportunities, higher leverage and smaller size and thus lower quality than traditional IPO firms. SLOWING DOWN SPAC opponents claim that the boom will likely slow down. As retail investors start entering the market en masse, they argue that investor enthusiasm may lead to unsustainable overvaluations. Moreover, reduced regulatory scrutiny is a double-edged sword. Although the IPO process can be long and arduous, it was designed to provide transparency, thereby providing sufficient information for investors to make sound financial decisions. Comparatively, the SPAC acquisition process is more opaque, as investors are relying on the brand equity of the SPACs’ sponsors as opposed to carrying out due diligence by themselves. While less due diligence allows accelerated IPO process and reduces completion risk, it may fail to uncover potential accounting irregularities. For instance, the electric truck manufacturer Nikola’s stock price skyrocketed to U$93.99 before falling to U$27 due to alleged false statements about its technology. Finally, target companies are increasingly uneasy about being acquired by SPACs as evidenced by a recent example of Tokopedia. For instance, former Google executive who founded Upstart, said that “SPAC feels like reaching the next level of a video game and handing the joystick to somebody else. It’s an acquisition of [the] company despite how it might be described.” Notwithstanding the 2020 boom in SPACs, the fear remains that boom will turn into a market bubble and eventually burst. Myriad factors can contribute to the eventual slowing down such as reduced investor sentiment, increasing opposition of target companies, accounting misdeeds, eventual poor performance, or regulatory intervention. By Paul Condylis and Emir Hrnjic
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