SPACs: A Bubble On The Verge Of Collapse
Summary
- SPAC IPOs have shot up in popularity, reaching 200 last year and are expected to surpass 1,000 this year, due to key benefits the firms offer companies looking to go public.
- SPACs often underperform the outside market, largely due to over-generated hype and dilution that is inherent to the SPAC IPO process.
- SPACs exhibit the patterns of a bubble as companies begin trading above sensical values and interest in the alternative IPO system steadily rises.
In the wake of Churchill Capital’s (CCIV) meteoric rise, and subsequent fall, I was left with a desire to review the special purpose acquisition company (“SPAC”) system as a whole. SPACs have shot up in popularity recently, becoming a favorable means of an IPO for a host of different companies. While the latest high-profile debuts have largely been related to EVs, the variety of companies covered by these special purpose firms is wide. In this article, I will take a look at the SPAC’s rise to power and why investors should heed caution when considering an investment. For an overview of the SPAC process, check out this video from Seeking Alpha.
The Rise of the SPAC
Over recent years, this past year especially, SPACs have seen a meteoric rise in popularity. For the first time ever, SPAC-based IPOs exceeded those made by the traditional IPO process. While the $64 billion raised by the 200 SPAC IPOs came up $3 billion short of the $67 billion raised by the 194 traditional IPOs, SPACs made their presence known. With $9.69 billion raised in 2019, $3.49 billion in 2018, $3.83 billion in 2017, and $1.7 billion in 2016, the previous two years represented the strongest periods of growth for the blank check firms.
To provide some context to the scale of this growth, Churchill Capital’s deal with Lucid Motors (LUCIDM) is large enough to surpass total SPAC performance of these earlier years. This trend is far from slowing, with over 170 SPAC mergers already this year having raised a combined $52.8 billion. If this pace is to continue, we could see over 1,000 SPAC mergers this year, raising over $300 billion.
The promise of a SPAC can be intriguing to companies with a range of different backgrounds, which is why its growth is on the rise. One such benefit is the time it takes a company to go public via a SPAC compared to a traditional IPO. While the SPAC itself is likely to be listed on an exchange for quite some time, the IPO timeframe from the perspective of the target company is, relative to a traditional IPO, rather short.
Additionally, merging with a SPAC allows the target company to avoid the standard IPO underwriting fee of between 5-7%. Through this, the target company is able to retain more of the capital that has been raised via their public offering. Finally, shareholder owners of the target company tend to have more control of their future position in the company when following the SPAC process, a factor that is often appealing to executives brokering the deal.
There are also fewer quantitative benefits for a SPAC offering. Chief among them is the experience that the SPAC sponsor can provide the firm. With a growing number of SPACs headed by established financial professionals and former executives, the value that the sponsors themselves bring with them can be a significant consideration. This additional asset can be ideal for young companies that may be looking for stronger, or just more experienced, leadership to bring them to success. With SPACs going nowhere soon, it is important that investors know exactly what they’re up against.
The Disappointing Reality
To put it simply, SPACs tend to offer a value proposition that is too good to be true. When analyzing the past performance of SPAC mergers, this trend presents itself rather clearly. A study published by Harvard Law demonstrated this trend rather clearly. Separating SPACs into two categories, high-quality and non-high-quality, the study aimed to eliminate any obvious confounding variables. The simple, yet effective, qualifications for a high-quality SPAC is one that has over $1 billion under management or is led by former CEOs or senior officers of Fortune 500 companies.
While high-quality SPACs, unsurprisingly, outperformed their counterparts, neither group was able to perform well. Taking a look at the table below, the figures, which are measured from the date of the merger, are able to speak for themselves. With one clear outlier among the high-quality SPAC mergers, the median return seems the most effective measure of the average.
Source: Harvard Law
Certainly, you must be thinking, there is justification for this unimpressive performance. Well, if you are indeed thinking this, you’d be correct. SPACs often suffer from fair amounts of dilution. This dilution occurs over multiple stages, post- and pre-merger.
This dilution can be broken down into three different steps, all inherent to the long and often inefficient SPAC process. Beginning with SPAC sponsors, who receive shares equal to 25% of the SPAC’s IPO proceeds. Additionally, issuing incentives, in the form of warrants, creates dilution later down the road as it provides essentially free equity to exercisers of the rights. Finally, when listing, SPACs pay an underwriting fee that is based on the capital raised by the initial IPO, even as most shares end up becoming redeemed during the merger.
All of this may sound alarming, but it is at this time where these effects are quantified. The median dilution for SPACs is 50.4%. This means that for every share reportedly worth $10, dilution brings this value down to just $6.67 as the remaining $3.33 is the value of dilution. As the majority of SPAC deals negotiate a merger based on the cash value of the SPAC shares, this dilution then often causes the shareholders to bear the cost of such dilution.
The study demonstrates that this phenomenon, where SPACs see strong levels of dilution, often causes a proportionally negative performance following the merger. In essence, the greater the dilution, the worse the future performance of the company is. The notion that SPACs underperform the market is not unique to this one paper, as studies run by Goldman Sachs (GS), Bloomberg, and more report a similar trend.
However, I believe that the study overlooked another important aspect of the, often disappointing, performance of SPACs. For retail investors, such as myself, SPACs offer the rare opportunity to invest in an IPO from the get-go. As such, it’s not too difficult to understand why retail investors love the SPAC system so much. However, this is where I believe the disproportionate amount of hype related to SPAC IPOs originates from.
This overgeneration of hype towards the front end of the IPO process can often lead to solid performance leading up to the announcement of a target company, but usually dies in as reality sets in. This emotional response, a less quantitative observation is what I believe the most important factor of weak SPAC performance is. This was overlooked in the study, likely due to the inability to quantify “excitement,” but is a leading cause of this common SPAC performance.
As SPAC shareholders have no idea how much equity they’ll be left with in the target company before the completion of the merger, dramatic spikes in value are tremendous gambles that are incredibly difficult to win. Later on, after this initial correction, the dilution identified earlier can often contribute to these further weakened losses. However, the period following the announcement of a target company is likely to continue to represent the sharpest downside for a SPAC’s life.
This has led to a disproportionate number of lawsuits being filed against SPACs compared to the standard IPO process. I believe that this is a fair way to judge the emotional side of the SPAC process. The issue of a lawsuit arises when the disconnect between what was expected and what is now the reality becomes evident. The rising number of lawsuits seems to be representative of the growing number of SPACs as investors are caught out time and time again. It seems that the initial instinct, which indicates that something that seems to be too good to be true, indeed holds up.
Identifying the Bubble
For many investors, a feeling of déjà vu may be starting to creep its way into their minds. The parallels to the dot-com bubble, in my eyes as well as others, are clear and plentiful. A multitude of these companies currently do not produce any revenue, instead relying upon the power of their promise to turn out strong revenue in the future. Currently, this seems to be a market driven by emotion rather than fundamentals. I believe that the SPAC system is creating a similar bubble that is bound to pop soon.
The expectation to see over 1,000 mergers via SPACs this year is staggering. In 1999, the market saw a total of 489 IPOs. Since then, nothing has been able to match the number. The 1,000 SPAC mergers this year would more than double this 22-year record. Beyond the sheer volume of upcoming SPAC IPOs, the blank check companies don’t have the fundamentals to back their rising values. Trading at an average premium of 20.9% over their net asset value, today’s SPACs are quite literally equivalent to someone paying $120.90 to receive $100.
Granted, this is a bit of an oversimplification as the SPACs are vying to bring a company public that will, hopefully, surpass this 20% premium, but the point remains. However, there is never a guarantee that SPACs will find an acquisition target. Actually, with an average success rate of just 30% among SPACs since 2015, it is more likely than not that a given SPAC will prove unsuccessful. The other alternative is that the acquisition target will prove not valuable enough to justify such premiums. Churchill Capital is a prime example of this.
With a deal between Churchill Capital and Lucid Motors all but guaranteed, investors sent the stock up to nearly $60 per share. However, when the deal was confirmed shares dropped over 50%. Since then, shares have only dropped further and the performance since the announcement has been undeniably abysmal. Just before the merger announcement was made, Churchill Capital was trading just under 475% above its net asset value.
This extreme example is symptomatic of the SPAC market at large. SPACs see their values begin to exceed their net asset value as excitement grows, but upon the release of fundamentals regarding the merger, investors are given a reality check. Looking back to the performance of SPACs after the merger is finalized, these companies tend to be unable to justify the value that they were initially assigned and continue to fall. These two aspects are where the bubble lies: the merger announcement and the performance after the merger finalization. Historically, performance is weak and for good reason.
Investor Takeaway
In every case, there will always be outliers. I believe that given time, Lucid Motors will prove to be one such outlier. However, the term “outlier” implies that it is something against the norm and, in this case, the norm means underperforming. This means, for the most part, avoid SPACs. However, finding the non-high-quality SPACs, and shorting them, could prove to become a strong investment solution.
Non-high-quality SPACs often face greater dilution as their management team is usually not considered nearly as valuable as one offered by a high-quality SPAC. As such, these mergers tend to follow only the cash value of the SPAC, causing most to see dilution bring per-share value to drop below $7 per share - often facing even greater dilution. In fact, the greatest cluster was between post-merger values of $2 and $3 per share as a result of dilution.
The ideal targets for this thesis are non-high-quality SPACs that are currently in talks to merge, but have not yet been confirmed. Confirmed deals that have not yet officially merged can also be good targets. SPAC Track provides an active list of SPACs with search filters to find the SPACs that you’re after. As a volatile market, I would advise caution when trying to play it. However, I do believe that those who remain skeptical of this trend stand to ride this trend successfully.
This article was written by
I tend to focus on long-term stock ideas, oftentimes rooted in tech or EVs. I have been a casual investor for years with solid returns and want to share what I have learned with others who may find value in my thoughts.
Analyst’s Disclosure: I am/we are long CCIV. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (25)
- XLE: drive.google.com/...They were the best buy-low then HOLD investments I ever made. First was XLF that offered whopping 85% discount during 2008/09 GFC, and after a few years of Stress Tests, the Fed allowed them to distribute dividends now amounting to more than 10% yields on (my) costs. I bottomed fish 130 stocks and ETFs in Feb/March 2009 over-weighted in the most hated TBTF banks.Then when crude oil collapsed very badly due to combination of Covid19 + Oil Price War, XLE offered 'unimaginable' 77% discount being the collateral damage of short-term oil plunge that greatly disconnected from it's long-term fundamentals. Hence bought lots and lots of oil/energy stocks, ETFs, and CEFs last March 2020 with 10-30+% super-yummy dividends and 70-90+% price discounts as investors panicked sold beyond belief. 10-30+% annual dividends is much better than 8-10% Dow Jones CAGRs and par excellence vs. 1+% treasury yields.They are my primary sources of Nest Eggs for 20-40 years of retirement.-----------------------If history is to be repeated and the USA wanted to become great again, then Entrepreneurship has to be encouraged again. - 1940s = the Wealth Gap Decade due to World War II;
- 1950s = the Golden Decade due to Mass Manufacturing Revolution;- 1980s = the Wealth Gap Decade due to 1965-74 Lost Decade;
- 1990s = the Golden Decade due to High-Tech Revolutions;- 2010s = the Wealth Gap Decade due to 2000-09 Lost Decade;
- 2020s = the Golden Decade due to more High-Tech Revolutions?Industrial Revolutions of the late 19th century made Europe the wealthiest, most modern, and most powerful in the world wherein the English Empire reigned supreme. - the Big Picture: drive.google.com/...After Henry Ford invested Assembly-Line Concept in the 1940s and became the Mass Manufacturing Revolution of the 50s to early 60s; USA became the wealthiest, most modern, and most powerful country in the world. After Japan Inc. 'stole' MM-Rev crown from US in the 70s to 80s, Japan became the miracle economy and USA suffered 2 lost decades of Stagnation + High/Hyper Inflation in the late 60s to early 80s that made Dow Jones the 'Sick Man of the World' during 1965 to 1974 Lost Decade (= 9 years). After China Inc. 'stole' MM-Rev from Japan in the 90s to 2000s, Japanese economy suffered Stagnation + Deflationary Pressures for 3 lost decades to date. China became the Miracle Economy of the 90s to 2000s able to industrialize and modernize it's huge country in just 2 decades.USA was able to fight back in the 80s by inventing the PC + Automation Revolutions that made the economy most productive in the world in the 1990s and therefore the economy BOOMED again like the 1950s. Thanks mostly to PC + Software Revolution that enabled millions of Americans to become entrepreneurs and become successful and wealthy in the 1990s.,Post 2000-02 Dotcom Bust, the SEC started 'strangulating' entrepreneurship via excessive regulatory compliance regulations and aggravated by the 2008/09 Financial Crisis of the Century. In effect the US economy has suffered 2 Lost Decades from 2000s to 2010s with Stagnation + Deflationary Pressures not unlike Japan's.- Global GDPs: drive.google.com/...- Global Trade and Commerce: www.businessinsider.com/...
- EM Future Outlook: www.businessinsider.com/...Fortunately despite stagnant US economy: Corporate America was able to offshore (huge) factories to China and other EMs in late 1990s with slave labor and able to compete globally on level playing fields; followed by the Service Sectors expending their operations abroad in the 2000s that resulted into 50% of CA revenues coming from abroad from 'tiny' 20% in the 80s and 90s. Mostly coming from China and the EMs where GDPs averaged north of 6% and inflation were high enough (5-10%) giving Corporate America substantial pricing powers and lots of revenue growths the past 11 years despite domestic 'cut-throat' competitions aggravated by deflationary pressures and low interest rates. Then post 2008/09 GFC, the Tech Sector also massively expanded their operations abroad spearheaded by AAPL with mere 1% back in 2011 toward 65% in just 5 years toward 2016.However, despite successes of Corporate America wherein the whole world is now their 'oyster' the US economy remained stagnant with the Services Sector growing into 70% part of the economy. An economy dominated by low-income (temporary) manual laborers. Low-productivity menial jobs is not the right receipt for economic success, and having a 'chastity belt' against (high-income highly productive) entrepreneurs will keep the US economy stagnant for the foreseeable future toward economic 3 Lost Decades or more. Neither is Corporate America going to relocate their operations from abroad back home and spend $Trillions of capex domestically as they are already very profitable globally out there making oodles of money and taxes for good old Uncle Sam.China in recent decades steered their education system toward STEM and encouraged Entrepreneurship enabling China to become the most productive country in the world in the 2000s. In recent years China produced the most number of entrepreneurs joining the Million$ Club and also created more patents than the former champion USA. It is now expected China's economy to surpass the US within the next 5 to 10 years. Unless the USA do something drastic to catch up against China's massive successes in developing their highly productive STEM industries.,SPACs compared to over-hyped Internet IPOs is a lot less risky comparatively but they did not succeed well in the 1990s, tough luck. Some of my colleagues became 'instant' $millionaires back in late 1990s just by flipping internet IPOs during the Dotcom Mania. Upon entering the equity markets in early 2000s I didn't know a thing about flipping McMansions and was not able to take advantage of the Housing Craze back then.- Entrepreneurship Death Knell: www.bloomberg.com/...- how to identify Irrational Exuberance: www.tradingview.com/...
- Nasdaq High Tech Manias: www.tradingview.com/...- Nasdaq = 9,200% cap gains 1974 to 2000 = 26 yrs secular rally;
- SnP500 = 2,500%, ditto;
- Dow Jones = 1,930%, ditto.That's how irrationally exuberant Nasdaq turned out to be with whopping 400% cap gains during 1996 to 2000 super-bubblicious rally.Thus far, we had Digital + Cloud Revolutions for 2010s, but like the 1980s with PC + Automation Revolutions were not enough to make the economy highly productive and wealth. It was only when entrepreneurship became entrenched in the economy in the 1990s that became the Golden Decade as millions of Americans highly productive and also became middle-class citizens.- BEV Revolution: www.tradingview.com/...
- Biotech Revolution: www.tradingview.com/...Those are among the most expected incoming high-tech revolutions of the 2020s. Unlike the 1990s where Finland became a miracle-economy because of Nokia Cell Phones and the Internet Craze being mostly No Revenues = No Problem and No Earnings = No Problemo Jose,- Cisco: www.tradingview.com/...
- AMZN: www.tradingview.com/...vs.- Tesla: www.tradingview.com/...Cisco was the prime-mover of Internet Revolution in the 1990s that resulted into massive Irrational Exuberance 1994 to 2000 the crema-dela-crema of Dotcom Craze. Among the dotcoms Amazon became the most successful but not because of the Internet but by inventing AWS that made Amazon hugely profitable in recent years. SaaS and DaaS are now the most recent trend in high-tech computing that should start making IoT productive into the next decades instead of mostly (unproductive) Social Networking and Tweeting around all day long by millions of Americans and billions of people across the world.Tesla is the prime-mover of incoming 2020s BEV Revolution for the US the past decade, and if TSLA and/or GM also discover level 4+/5 FSD the USA will have a global upper hand on Autonomous Driving Software + Robotaxis. Unfortunately, China is way ahead of the USA when it comes BEV Revolution and not necessarily behind Tesla and GM in FSD R&D, including VW for Germany and another FSD company in Israel with a working FSD prototype.And thanks to Covid19 global pandemic, investors are now pouring $Billions of seed capital to cutting-edge R&D gene therapy not solely for fast-tracking vaccines but also to invent new cures for (all) diseases mankind suffered throughout history. The holiest of Holy Grails among high-tech revolutions that benefited mankind in modern history. But then again, due to lack of STEM graduates, the USA might lag behind China and Europe for that matter.- FAII: www.tradingview.com/...
- DGNR: www.tradingview.com/...
- CCAC: www.tradingview.com/...
- ENVIU: www.tradingview.com/...
- HZON: www.tradingview.com/...- DGNS: www.tradingview.com/...
- GSAH: www.tradingview.com/...
- AGCB: www.tradingview.com/...Those are the SPACs bought recently as close to $10 base as possible using limit buys as Nasdaq started collapsing toward 11.4% minor correction today's bottom, since most of those SPACs are geared toward high-tech IPOs. I am risking about 5% of portfolio on this one. With potential 25% outright loss for management fees for a SPAC that failed to find suitable IPO candidate, the other potential risks author innumerate that could result into total 66% losses due to potential (unregulated) abusive practices may or may not actually happen and therefore not necessarily predictable. Objective is to profit greatly with 3x multiples conservatively.And possibly 10x or more multiples within the next 2 years if (and only if) SPACs proved the saving grace and became the champion of IPOs and in effect of Entrepreneurship for the USA - with or without the help of the Government and the SEC in reducing the excessive 'Red Tapes' of regulatory compliance they imposed upon Corporate America and lots of VC companies who are very reluctant to IPO to avoid very expensive regulatory compliance costs.Unlike the Dotcom IPOs and other ordinary IPOs where individual venture capitalist may or may not have sufficient background in Economy and Finance; most of the SPAC managers are intellectually capable and highly experienced with lots of knowledge not only how companies in the real-world operate and more likely also have the know-how of better ways to contribute toward betterment of the US economy Perhaps the last chance to make America Great Again with entrepreneurship.Cheers and Good Luck.
Do you think XLE is going to retrace soon? Or it will blast through $53 quickly? I sold my energy fund position two days ago, concerning about the coming correction of long term interest rate and oil price, also wanting to use the money to catch the falling knife of current market. Unfortunately, I immediately felt regretted and both the interest rate and oil price jumped high these two days. Thanks ahead.
