Investment Strategies
What To Make Of "Blank Cheque" Fundraising Surge

The SPAC sector has expanded so rapidly in the past year or so that it has caught attention in some unexpected quarters and also generated a few concerns. The CIO of a Swiss private bank looks over the terrain.
A lot of ink has been spilled lately on special purpose
acquisition companies (SPACs), or “blank cheque” entities that
are set up to raise capital to fund M&A deals. For example,
wealth managers and
private banks have become involved. The area has kicked off
some
controversy, if only because of the sharp rise in
fundraising, making people worry that the process might get out
of hand, suggesting that a bubble is taking shape.
In the following commentary, Stéphane Monier, chief investment
officer at Lombard
Odier, examines the SPAC story and what it means for
investors and other clients. The editors are pleased to share
these views and invite readers to join the debate. The usual
editorial disclaimers apply. Email tom.burroughes@wealthbriefing.com
and jackie.bennion@clearviewpublishing.com
“Blank cheque” companies are attracting billions of dollars from
retail investors and hedge funds in search of capital gains and
access to private market returns. These special purpose
acquisition corporations, or SPACs, promise firms a simpler,
cheaper and alternative path to a public listing. They also come
with caveats that investors should carefully examine.
SPACs are shell companies with a two-year lifespan, created with
a promise of buying another business within that time. When
investors place $10 shares with the SPAC, which then searches for
a firm to take public, they do not yet know what the target will
be.
Every week sees dozens of SPACs being launched. Over the last
year, SPACs have raised more than $137 billion, according to
Bloomberg, ten times more than in 2019. An estimated 40 per cent
of those investment volumes come from retail investors, around
twice the retail share of participation in regular listed US
equity markets. That has prompted a fishing frenzy for target
companies, which are often start-up technology firms developing
automotive or space technologies, sustainable energy, or older
businesses in private equity portfolios.
High-profile sponsors in high-profile industries raising capital
are helping to drive investor demand. The largest SPAC to date is
the $4 billion raised last year by hedge fund Pershing Square
Capital’s founder Bill Ackman. There are many other examples.
Chamath Palihapitiya, the venture capitalist, used a SPAC in 2017
to take a 49 per cent stake in Sir Richard Branson’s Virgin
Galactic, and was reported last month to have created another
seven special purpose corporations. Just last week one of Michael
Klein’s SPACs bought e-vehicle company Lucid Motors Inc, a Tesla,
Inc rival. On 26 February, former Credit Suisse Group CEO Tidjane
Thiam was reported to be looking for a financial services target
for a pool of SPAC investments worth $300 million.
Another large share of the cash comes from hedge funds including
Millennium Management, Magnetar Capital and Polar Asset
Management, which are reportedly active in the SPAC market, and
may also enjoy additional trading rights in the vehicles in the
form of warrants. Institutional investors may be using SPACs as a
substitute for low-yielding fixed income returns as they have the
option to exit with some equity optionality before a deal is
announced.
In this low-yield environment, one of the attractions is that
SPACs allow investors to withdraw their money, plus interest, if
they do not like the announced target. They are therefore buying
optionality on potentially high-growth private companies that
would otherwise be out of reach. If too many investors drop out
of the proposed deal, the SPAC, which usually takes a 20 per cent
stake in the common stock for a nominal price, can also withdraw
from the deal.
What’s wrong with IPOs?
Pricing is one of the most obvious shortcomings of traditional
IPOs. Because many investors take a short-term perspective on the
stock, investment bank advisors have an incentive to under-value
the initial market price. That way, when trading starts,
investors see an immediate gain. But the company’s founders and
existing owners then find they earned too little and effectively
paid for the listing from their own pockets. In 2020, data showed
that IPOs jumped 40 per cent on average in their first day of
trading. That makes them unattractive to a private company’s
board.
In contrast, a SPAC agrees the launch price with the target
company’s owners and promises a simpler and cheaper listing
process. As Sir Richard Branson explained last month when asked
about his October 2019 SPAC launch of Virgin Galactic, the
structure “gets through all of the rigmarole of public
companies.”
If the case for SPACs sounds too good to be true, it is worth
exploring the downsides. The investors’ cash pool has to pay
advisory and banking fees, diluting their original speculation.
Worse, a recent paper published by Stanford and New York
University law schools found that at the time of a merger, the
$10 per share investment is worth only a median $6.67 in cash.
The study concluded that for “a large majority of SPACs,” share
prices fall after a merger. Within three months of merging, the
authors found that SPACs had a median loss of -14.5 per cent and
a median -16.1 per cent difference with the Russell 2000 small
capitalisation index.
This means that “SPAC investors are bearing the cost of dilution
built into the SPAC structure, and in effect subsidising the
companies they bring public,” says the report. In contrast, a
separate study in December 2020 calculated that the median return
from all types of IPOs three months after listing was a positive
1.6 per cent.
Before completing an IPO, however, SPACs are posting gains. The
IPOX SPAC index of common stock held in publicly traded SPACs has
been live since the end of July 2020. It reports a rise of 64.2
per cent since then. Traditional equity markets have posted
returns of 48.2 per cent for the Russell 2000, 24.6 per cent for
the NASDAQ and 17.6 per cent, including dividends, for the
S&P500 over the same period.
Investing in success?
Critics also point out that even SPACs that make acquisitions are
not necessarily backing successful companies. The question for
many investors is then whether private companies that raise
liquidity through a SPAC are doing so because they have no other
option. And whether they are comfortable with the dislocation
between their own investment interests and the SPAC sponsor’s
eventual goal of inheriting a one-fifth stake in a listed
firm.
Virgin Galactic, often cited as an early example of the current
appetite for SPACs, has slipped on its original 2007 deadline for
delivering commercial space flight. Last week it announced the
appointment of a new chief financial officer hours before
reporting a fourth quarter loss of 31 cents per share on zero
revenue. That has not prevented its share price from rising
four-fold in 16 months of public trading, nor singer Justin
Bieber and actor Leonardo DiCaprio from booking seats. Two other
space-related companies have announced plans to go public using
SPACs: Astra, which develops launch vehicles, may be worth $2
billion in an IPO, and Momentus Space, whose Russian CEO cannot
legally scrutinise his own company’s designs under US national
security laws.
As more SPAC cash chases fewer opportunities, there is a danger
of merger values and SPACs’ shares becoming inflated as they
approach deals. Shares in Mr Klein’s Churchill Capital Corp. IV
more than halved in value over two days after the 22 February
announcement of a deal with Lucid. For months, investors bought
shares based on rumours, and then sold their holdings when they
saw the details of the deal.
Much of the capital looking for opportunities may not find
targets, and so could end up returned to investors. Enough
disappointments may eventually tip the market as investors grow
frustrated with too few acquisitions and possibly unfounded
forward financial projections.
Opaque performance
The new market for SPACs also lacks aggregate benchmarks and an
easily available track record. As a result, a high-profile
success story tends to inflate flows into the vehicles. In these
early days of SPACs’ broad adoption, there are also clear signs
of the potential for investors to talk up stocks in these shell
companies, since they trade without any fundamentals.
A second threat may eventually materialise from a sustained
increase in interest rates on the back of a resurgence in
inflation, reducing the relative attractiveness of these
growth-biased vehicles. That looks unlikely for this year.
As long as the low-interest rate, low-yield environment persists,
markets will continue to look for increasingly sophisticated
sources of return. And as long as the SPAC market does not
develop into a bubble, run out of credible companies to target,
or become mired in lawsuits, these vehicles may offer an
alternative route for companies to float on public markets.