Mergers | Tremendous

Special Purpose Acquisition Companies, or SPACs, have become all the rage in the last year. These “blank check” companies raise money from investors and then look for a company to acquire. They’re multiplying like rabbits:

More than 300 such blind pools have come public so far this year according to SPACInsider, raising an aggregate $99 billion. That blows past the prior $83 billion, full-year record established in 2020. For context, the pre-coronavirus peak in aggregate IPO proceeds stood at just $64.8 billion.

More here (see the 4-9 post).

That means hundreds of companies all competing for the same pool of private acquisition targets. This has pushed up prices substantially, and SPACs may be overpaying for their acquisitions:

SPAC-sponsored deals took place at a median price of 12.9 times sales in the first three months of the year, more than triple the 4.1 times median price-to-sales ratio for non-blank check transactions.

SPACs typically have two years to find a company to acquire. If they succeed, the people who run the SPAC will get about 20% of the total value of the deal. If they don’t acquire a company, the party ends, and the money goes back to investors.

With hundreds of companies from this year and a backlog from previous years all searching for deals before their two year window is up, it’s no surprise they’re overpaying.

With 117 SPAC-related deals announced so far this year, 497 blank-check entities are currently seeking their own dance partner, according to Refinitiv, while only about a quarter of all SPACs listed in 2020 or 2021 have completed a transaction.
The clock is ticking: Entities that fail to find a merger target within two years are typically unwound, with promotors obliged to return capital to investors. “There is a lot of indigestion,” a senior bank executive tells the FT.

If the SPAC sponors buy an overpriced company, they still get 20% of the money. If they don’t buy anything, they don’t. What do you think they’ll do?
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The incentives aren’t well aligned. If the SPAC sponors buy an overpriced company, they still get 20% of the money. If they don’t buy anything, they don’t. What do you think they’ll do?

Sure enough, overpaying for companies is leading SPACs to perform poorly. An index of SPACs is down about 20% from its peak earlier this year.

Expect to see more and more SPACs frantically overbid for deals as their two year cliff approaches. Bad for SPAC investors, good for private company shareholders.

For more on SPACs and financial markets, check out these posts:

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Photo: “YIELD TO THE MAN FALLING OFF THE CLIFF!” by Bods is licensed under CC BY-SA 2.0

So Tesla is doing great, right? And I sure would love to make as much money as Elon Musk! So let’s make our own vehicle startup.

What should we call it? Hmm, picking a name is hard. Let’s just go with Tesla’s first name, Nikola!

Now we have to make a truck. But making the whole engine thingy is a pain! How about we just let it roll down a hill, take a video and raise lots of money? Yay!

Believe it or not, this is exactly what Nikola, the electric truck startup, did. And they even admitted it…once they were caught. But hey, they didn’t technically lie:

Nikola described this third-party video on the Company’s social media as ‘In Motion.’ It was never described as ‘under its own propulsion’ or ‘powertrain driven’.

How is this company with no real product even public? That’s where Special Purpose Acquisition Companies, or SPACs, come in. A SPAC raises money from investors to buy a private company to acquire. They’re exploding in popularity:

Amid the global stock market volatility, last year’s $83 billion haul by SPACs was six times the amount raised in 2019 and nearly equaled the figure mustered by IPOs.

Nikola went public via a merger with a SPAC in March of 2020. Just a few months later, it wound up under a federal investigation for securities fraud. Its stock is down from a high of over 60 to barely 20.

What made this SPAC want to acquire such a questionable company? SPACs collect a big fee if they acquire a company, but if they don’t acquire anything, there’s no fee. This gives the people who created it (“sponsors”) a strong incentive to acquire anything, regardless of merit:

More than 300 SPACs need to pull that off this year or risk being liquidated. But with only so many quality targets to go round, and SPAC founders’ strong incentive to close deals — even at the expense of shareholder value — SPACs may well end up in a negative spiral of poor quality/bad press/tighter regulation.

Since so many new SPACs are being created, and there are only so many quality private companies to go around, they’re getting less and less picky:

Then there is the fact that many firms taken public by SPACs have little to show in terms of business plan or revenue, in some cases triggering shareholder lawsuits by disgruntled investors.

Typically, a company with no profits isn’t a good candidate to go public. A company with no revenue is even more suspect. Maybe that’s why they’re not going the traditional IPO route.

Indeed, research on a large pool of SPACs and normal IPOs (127 SPACs and 1128 IPOs) show that the SPACs do much worse:

SPAC firms are associated with severe underperformance in comparison to the market

If they have such a well-documented record of underperformance, why are SPACs so popular? My hunch is it has to do with the fees for the sponsors, which are often several times greater than for a traditional IPO. That’s peachy for the sponsors, but I think investors are better served by avoiding all but the strongest SPAC deals. You’ll probably just wind up paying too many fees and buying an inferior company.

Photo: “Nikola Two Semi Truck” by 666isMONEY ☮ ♥ & ☠ is licensed under CC BY 2.0

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Tag Archives: Mergers

Beware the SPAC Cliff

SPACs Are a Bubble and Nikola’s Fake Truck Is Proof

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