SPAC Acquisitions And Others: Distorting Markets

Nov. 14, 2020 5:25 AM ET24 Comments21 Likes
John M. Mason profile picture
John M. Mason


  • Lots and lots of money is being drawn into financial opportunities these days because there is lots of liquidity available and some investors are picking up substantial returns.
  • Analysts are speaking of the "greatest gigs" for investors and buzzy areas of the market and about market distortions arising from all the money around.
  • Investors need to be aware that the real sector of the economy might not be keeping up with the frothiness of the financial sector, and this could be problematic.

There is plenty of money around. Some analysts would say that this is an understatement.

Whatever, there is plenty of money around.

And, this money is finding outlets.

The question is whether or not all this money circulating around is beneficial to the economy or not. Some would say that it is very beneficial. Others, myself included, have some doubts.

One of the stars of the current investment binge is the SPAC investment vehicle, or the Special Purpose Acquisition Company, otherwise know by the name of “blank check” company. These are shell corporations designed to take companies public without going through the traditional IPO process.

They are not new, but they have become particularly popular this year as a result of all the liquidity floating around in the financial markets.

The data provider Refinitiv reports that, so far this year, there have been 156 SPACs that have raised $55 billion in new money, and 76 SPACs in the U. S. have announced acquisitions.

This is a lot of new business in this particular space.

Results and Publicity Draw Investors

But, there are some real winners, and this is drawing a lot of investors into the area.

And, it is drawing a lot of celebrity investors into the mix, people like investment fund managers, retired political figures and big-name sports stars.

We read in the Financial Times that former Citigroup investment banker Michael Klein raised more than $60 million from a $25,000 investment and this return was achieved in less than two years.

This $25,000 investment was the requirement from prominent sponsors, who are paid in the form of a “promote.”

"The promote usually involves sponsors taking 20 percent of the Spac’s equity for a nominal purchase price of $25,000. That stake converts to a smaller slice of equity in the new company when the Spa executes a merger, and can lead to a big pay-off if the acquired company prospers.”

The authors of the Financial Times article quote Bill Ackman, the hedge fund billionaire as saying that this structure is “one of the greatest gigs for the sponsor.”

Mr. Ackman continues: “You get 20 percent of the company tax free until you sell the stock. That’s why you have so many people doing it.”

And, The Idea Spreads

The idea is to find companies to buy. I have already written an article discussing how the search for companies has spread to other areas like that of venture capital where investors are moving companies into IPOs far earlier than had been the case for the past 20 years.

The arguments for the existence of SPACs? The vehicle is a less risky path for private firms to go public; the vehicle is a method for finding cheap sources of money, often from naïve investors; the vehicle to take advantage of pricing dislocations arising from all the activity going on; the vehicle to take advantage of price differences between private and public markets; the vehicle to take advantage of “what’s hot!” Or, the reason could be “all of the above.”

Stories, like the one about Mr. Klein provided above attract attention. People want to participate in these returns. And, so the market draws more and more investors into the fold.

But, the question becomes, is this particular situation one of promoting an asset price bubble?

Today, the Wall Street Journal has an article on SPACs and how these efforts are getting into “buzzy” areas of the market.

Of course, that is not usually known until… after the fact. Therefore, one can only say that it is too early to tell.

But, There Are Other Stories

Historically, we see that asset price bubbles do not just exist in one particular market or another. When there is a major buildup in liquidity, distortions can appear in several different areas.

Currently, we are also seeing this market liquidity spread to what analysts have now called "zombie" companies and have estimated that almost 20 percent of U.S. companies are seen as zombies.

I have written that:

"Zombie companies are defined as firms whose debt servicing costs are higher than their profits but are kept alive by relentless borrowing."

This is where the market liquidity comes in.

The hope is that these companies can stay alive long enough to work themselves out of their financial difficulties before they have to fold. That is, the market liquidity is buying time for these firms. Many will still run out of time… and will have to declare failure.

This, however, builds additional risk into the economy.

And, my posts have discussed many other areas where distortions like these are taking place.

Distorted Markets

The Federal Reserve has supplied the market liquidity. And, the Federal Reserve had to act as it did in order to protect the financial system from the impacts of the spread of the coronavirus pandemic and from the resulting economic recession. Markets and institutions had to be protected. And, the Fed doesn’t want to pull out anything now, because they don’t want to start something.

But now investors face the reality that with all this money floating around, the markets can get out of line. And, with people like Bill Ackman talking about this situation being “one of the greatest gigs,” and the Wall Street Journal writing about “buzzy” areas of the market, and even thinking about market distortions, should lead investors to keep on their toes about some areas where the market might be fragile.

If the real economy doesn't start picking up, then inflated financial markets could be missing downside protection. Investors take note.

This article was written by

John M. Mason profile picture
John M. Mason writes on current monetary and financial events. He is the founder and CEO of New Finance, LLC. Dr. Mason has been President and CEO of two publicly traded financial institutions and the executive vice president and CFO of a third. He has also served as a special assistant to the secretary of the Department of Housing and Urban Development in Washington, D. C. and as a senior economist within the Federal Reserve System. He formerly was on the faculty of the Finance Department, Wharton School, the University of Pennsylvania and was a professor at Penn State University and taught in both the Management Division and the Engineering Division. Dr. Mason has served on the boards of venture capital funds and other private equity funds. He has worked with young entrepreneurs, especially within the urban environment, starting or running companies primarily connected with Information Technology.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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