By Nicola Vaccaro (Bocconi University) and Ewhen Jardon Angonoa (Universidad Austral)
Summary
SPACs saw an incredible rise in popularity throughout 2020, with SPAC Initial Public Offering (IPO) proceeds to outpace the traditional IPOs’, for the first time in history. Far from over, the number and volume of SPACs in February 2021 is a monthly record high with $109 billion in transactions globally, breaking the record high established in January.
If you want to dig deeper into the beginnings of this increase in popularity, our team already identified this trend a year ago in the report Growth in Special Purpose Acquisition Companies, where a shorter analysis is made.
Table of Content
SPACS 101
SPACs are blank check companies managed by sponsors that raise money in the public markets in order to merge with a private company, taking it public.
The process tends to be straightforward, beginning with the raise of funds, then the screening for companies and finally the merge.
Trend Overview
SPACs achieved prominence during 2020, as the deal volume and proceeds raised were bigger than ever before.
Even with some critics arguing the trend is unsustainable, SPACs volume keeps reaching record highs every month as more investors and sponsors accept the financial instrument.
Trend Drivers
Flexibility, haste and convenience of the SPAC process have been considered among the most relevant factors that convinced several investors to bet on this vehicle. The significant raising of private investment in public equity (PIPE) and the increasing interest from high reputable sponsors boosted the trend growth.
Market conditions play a key role in the SPAC development, indeed the high stock valuation that characterized the 2020 represented a golden opportunity for sponsors.
Further Trend Analysis
Not everyone agrees on the future development of this trend. Among those, there is David Solomon who, highlighting SPACs riskiness, reckons their growth is not sustainable in the medium term.
The structure has slightly changed over the past years in some SPACs since sponsors have tried to reduce possible conflicts of interest with investors. Promote and warrant coverage reductions are the most relevant changes made so far.
SPACs 101
The SPAC, or Special Purpose Acquisition Company, is a blank check company managed by a sponsor (usually a hedge fund or private equity firm) that raises money from investors through an IPO in order to merge with a company later on. The sponsor thereby essentially takes the public and gives a percentage of ownership to the SPACs’ investors. There are three main players in this process: the sponsor, the investors and the company that is taken public.
The life-cycle of SPACs is usually straightforward. Initially, sponsors create the SPAC, assign a name of their preference (e.g. Queen’s Gambit Growth Capital), and set an IPO to raise the necessary funds for the expected merger. The funds, once raised, are placed into a trust while the sponsors begin to look for a target company.
A company is usually found within a two-year period. Once the target company is identified and the details of the merger are defined, it is announced to the investors. At this point, the investors can either accept or reject the prospective company. If the deal is accepted, the merger is completed allowing the company to receive the funds raised through the SPAC and to be listed on the public markets. In addition, the SPAC’s investors take a percentage of ownership in the chosen company.
If the deal is rejected then the sponsors continue their search for a suitable target. Before the merger takes place, investors can always redeem their shares and receive their money back on a pro-rata basis, limiting the downside risk.
Figure 1. SPACs structure (UBS)
At the IPO, the SPAC will sell shares, usually with a uniform price (e.g. $10). This purchase includes a warrant that gives the investor the right to purchase a fraction of a share at an exercise price higher than the purchase price (e.g. $11.50), giving upside potential to the investors. Prior to the merger, the investors can either redeem their shares and receive the $10 with some interest or sell the shares in combination with the warrant. After the merger (which requires investors’ approval), the money in the trust will be used, so investors will only be able to cash-out by selling their shares in the market, and the price will fluctuate based on the performance of the company taken public.
The sponsor, who organizes the IPO of the SPAC and orchestrates the merger with the target, does not collect any fees but rather receives an equity stake in the SPAC, which is called “promote”. Furthermore, the sponsor often makes an investment of 3-5% in the initial IPO and carries the underwriting costs. In this way, the returns of the sponsor are linked to the performance of the SPAC, so that the interests align with those of the investors. Finally, when the target is identified but not disclosed, the sponsors can go to institutional investors to raise additional funds to realize the merger, also known as a PIPE (Private Investment in Public Equity). The sponsor thereby sells additional shares and warrants to these institutional investors. If no PIPE is possible, the sponsor may provide the funds himself by purchasing additional warrants.
Trend Overview
SPACs appeared during 1993 as a way to bring new financing to small companies and avoid some of the SEC impositions, but they never reached much prominence. Until 2020, there had only been approximately 500 companies to do an IPO through a SPAC. As a normal IPO takes over 12 months to be realized on average, SPACs came into light as a faster way for companies to fundraising. Through this, small and mid-size companies were able to access needed liquidity in a quicker way while also being able to negotiate the price.
In the second quarter of 2020, when more prominent sponsors and bigger companies started to participate in the SPAC process, the interest in the instrument increased. This primarily happened as SPACs became a new respected way to invest in private companies before they go public.
Figure 2. The yearly volume of global SPAC IPOs
Note: 2021 is as of February 15, 2021
During 2020, SPAC issuance achieved a total volume of $82 billion, representing a growth of over 45% year over year. The total number of SPACs reached 248, overtaking the number in 2019 by more than three times. While growth companies often run into difficulties regarding debt financing from banks - due to high investment risk - SPAC sponsors are able to provide that needed capital through mergers.
Much of the SPAC frenzy has been focused on the technology sector as these companies are expected to have the brightest future. These SPAC mergers have also contributed to higher tech valuations as more funds are available to acquire them, including Bill Ackman’s $4 billion SPAC. In fact, among the 248 SPACs created in 2020, 40% merged with private companies focused on technologies and information.
Figure 3. US SPAC IPO targets by industry, % total funds raised (Goldman)
Note: It includes 2020 and January 2021
Although there were some flagship SPACs throughout 2020 and early 2021, where multiple billion-dollar IPOs were made, SPACs remain an instrument better tailored for Small and Medium Enterprises (SMEs) looking for quick financing. During 2020, the average SPAC IPO proceeds were $334,8 million, a record high, yet still in the SME zone. At the same time, the deals tend to be bigger in size, as PIPE funds become more available and debt is issued with lower interest rates.
Figure 4. US SPAC IPO proceeds and # of SPACs by size (Goldman)
Note: It includes 2020 and January 2021
Trend Drivers
Flexible and convenient process
Going public via SPAC merger allows executives to avoid the lengthy process of a traditional IPO and the 180-day lockups. In addition, SPACs enable transparency as the disclosures and risk outlines are similar to those of the usual IPO. At the same time, SPACs follow merger rules rather than IPO rules and companies involved in a merger are usually protected from lawsuits for alleged misstatements in projections. SPACs also provide projections with forward-looking statements that are usually absent in the IPO. This evidence shows a contrast with the traditional opinion that deemed SPACs as speculative vehicles that did not create sustainable value for the company acquired.
Moreover, since pre-merger investors invest in a shell company without operating activities, it may seem that SPACs structure is highly risky and causes more uncertainty than a traditional IPO. However, pre-merger investors have a limited downside and unlimited upside potential gain since, before the merger with the private company, they always have the possibility to redeem their shares and receive $10 plus interest per share, even if the current SPAC price is less than the issuance’s one. As a result, they cannot lose money before the merger. Furthermore, because the price of the SPAC is known in advance and it usually remains stable at its issuance level before the merger, investors have more stability than in a traditional IPO where at the day of issuance the price can have significant fluctuations, thus increasing the volatility and the risk of that stock.
Private Investment in Public Equity is rising
The PIPE’s function is to provide cash to a business, allowing the company to retain a minimum threshold of cash to operate. Contrary to the past, redemptions have been quite low due to the improving quality of the companies that have gone public through SPACs as well as the importance of the PIPE as an integral part of the SPAC merger process.
A SPAC’s ability to raise additional capital through a PIPE at the time of deal closing enhances the quality of the deal and validates the transaction. In addition, the PIPE raise has been a crucial aspect for two different reasons. First, it allows more investors to participate in the process. Second, the PIPE provides external validation that the target company will be listed at the value that the SPAC and the target company have agreed to. Otherwise, if the external validation is not provided, the PIPE gives the sponsor and the company an opportunity to reset the valuation and adjust it so that investors can become interested.
SPAC sponsors’ fame and experience
The importance of high reputation represents a key aspect in finance, especially in the case of SPACs because shareholders invest without even knowing the company that will be bought. Trusting the sponsor is critical in one’s decision to invest in the vehicle before any merger is announced. In 2020, a significant number of highly reputed professionals decided to opt for this alternative method of capital raising. This significantly contributed to the incredible upward trend in SPAC popularity and success. Among the famous sponsors are hedge fund manager Bill Ackman, who recently raised $4 billion in the largest SPAC ever, venture capitalist Chamath Palihapitiya who has raised five SPACs, and firms like Apollo Global Management, Millennium Management and TPG.
Market conditions
To exploit market conditions dominated by optimism and high valuations, especially for growth stocks, SPAC sponsors targeted 2020 as the perfect year to raise money and buy private companies that operate in cutting-edge industries. For illustration, consider the fact that between 2010 and 2019, more than half of SPAC acquisitions were in the industrials, financials and energy sectors while one-third were in tech and healthcare. In contrast, almost half of the SPAC deals completed in 2020 were in innovative industries such as technology and healthcare while just 24% were in industrials, financials and energy. Investors are in a growth mindset and SPAC sponsors, who target purchases in growth industries, have had success raising capital.
Furthermore, owing to economic and political uncertainty, several central banks have lowered interest rates, and this has incentivized investors to find alternative assets such as SPACs, to pour their money into. At the same time, pre-merger investors earn interest on the money stored in SPAC trusts, so that SPACs can serve as an alternative to holding bonds or cash.
Figure 5. Trend between SPAC capital raised and FED funds rate (Goldman)
Further Trend Analysis
Although the SPAC trend has interested several reputable investors, not everyone thinks that this trend will be sustainable in the medium term. David Solomon claimed that even though the previous year’s positive trend could continue in 2021, SPAC structure is not risk-free and is still evolving. Further analysis was provided by Michael Klausner, Law Professor at Stanford, who underlined that in some cases SPACs create dilution risk. Furthermore,post-merger returns of SPACs observed in 2019-2020 are not totally enviable either since, as of October 2020, the median of three, six, and twelve-month returns were -4.6%, -15.9%, and -34.6%.
Not all the SPACs follow the same scheme, and some sponsors in 2020 have considered making some structural changes that could enhance SPAC relevance and reduce conflicts of interest with the investors.
Sponsor’s promote reduction
This structural change has been adopted to reduce dilution risk because if several pre-merger investors opt to redeem their shares, a hole is created that usually is covered by sponsors through promoting reduction or PIPE. In fact, the median level of redemption before the deal closing is about 73%, with a range from 0% to 95% according to Goldman Sachs.
As a result, after raising $750 billion in a SPAC IPO named Ajax I, the hedge fund manager Daniel Och, has affirmed that he will reduce his promote to 10% because he underlined that the first aim for the sponsor is not to promote someone else’s capital, but rather to invest their capital to find a company able to perform in the long term. A stricter approach was adopted by Bill Ackman who claimed that he will not receive a promotion because, in his opinion, a 20% promote represents a misalignment of the incentives between the sponsor and the investors. He added that the dilutive effect of the founder’s shares complicates reaching attractive deals. Lastly, Morgan Stanley has developed a new promote structure called Stakeholder Aligned Initial Listing (SAIL), where the promote is performance-related and it is calculated only on the capital the SPAC delivers to complete the acquisition.
Warrant coverage reduction
In 2020 this trend has been remarkable since sponsors desired to avoid the risk of shares and warrant dilution before the merger. Indeed, almost two-thirds of the SPAC raised in 2020 offered a warrant coverage inferior to ½ per share. Precisely, this downward trend highlights that the number of 2019 SPACs that offered a ½ warrant per share was slightly more than 30%. This change can be explained by the increased demand for the SPAC product, especially from fundamental investors whose intention is not to speculate, rather to invest in the long term. In addition, it is also possible not to offer warrants, as happened with Therapeutics Acquisitions Corp.
Figure 6. Warrant coverage (SPAC Research)
What to expect?
Despite 2020 being considered an incredible year for the SPACs development, 2021 has started even better. After slightly more than two months into 2021, statistics say that 207 SPACs have been created, representing more than 80% of SPACs raised in 2020. In addition, their current average volume ($317.1 million) is only second to that of the previous year ($334.8 million).
SPACs are attracting increasingly qualified and famous sponsors, such as Softbank and ARK Investment. While most of the SPAC deals closed in 2020 were mainly geographically focused on the US due to favourable regulations, other parts of the world like Europe and Asia are currently late followers and are becoming more open to this alternative. For instance, Singapore Stock Exchange is preparing to become the first major Asian bourse that will allow SPACs listing and it aims at rendering the SPAC structure more “investor-friendly” including requirements that only qualified sponsors can possess. This factor, due to the high innovation and technological development of Asian firms, could be beneficial for SPAC development. Eventually, following this rhythm, we believe that SPACs raised in 2021 will set a new all-time high before the end of the year.
Significant Deals
Announcement date: 9th July 2019
Acquirer (SPAC): Social Capital Hedosophia
Target: Virgin Galactic
Acquirer advisors: Credit Suisse
Target Advisors: LionTree Advisors,Perella Weinberg Partners
Value: $1.5 billion
Cash or stocks: $650 million SPAC cash, $100 million PIPE cash
Rationale:
The deal allowed Virgin Galactic to be considered as the first commercial human spaceflight company to be listed, and the company’s rationale was to raise funds in order to invest in growth and commercialization.
The company is expected to start its first commercial space flights in 2020 but owing to the pandemic Richard Branson decided to postpone the endeavour. The flight price is estimated to be around $250,000. 60 high-net-worth individuals from 600 countries already poured $80 million in refundable deposits as of June 2019.
Despite the unencouraging financial data, VG has ambitious long-term goals and Branson plans to increase the number of both aircraft and rocket-power spaceships that will enhance the Virgin Galactic space system. As a result, Chamath Palihapitiya, who is also the SPAC sponsor’s executive, invested an additional $100 in PIPE to support the deal.
Announcement date: 3rd March 2020
Acquirer (SPAC): Vector IQ Holdings
Target: Nikola
Acquirer advisors: Cowen, Deutsche Bank
Target advisors: Morgan Stanley
Value: $3.3 billion
Cash or Stock: $237 million SPAC cash, $500 million PIPE cash
Rationale:
Nikola is expected to transform the transportation industry and the deal is aimed at expediting the production of electric battery and hydrogen fuel-cell electric vehicles. Furthermore, the company has high expected growth due to the $10 billion in potential revenue from pre-orders.
Nikola’s preference to go public through a SPAC was due to its strong valuation awareness despite the pandemic, and the shorter issuance process relative to the traditional IPO process, Nikola CFO Brady said.
Announcement date: 13th July 2020
Acquirer (SPAC): Spartan Energy Acquisition Corp., backed by Apollo
Target: Fisker
Acquirer advisors: Citi, Goldman Sachs, Credit Suisse
Target Advisors: Cowen
Value: $2.9 billion
Cash or stocks: $500 million SPAC cash, $500 million PIPE cash
Rationale:
Due to its ESG commitment, the acquirer will enhance Fisker energy transition development, and the deal will fund the company in order to produce from 2022 the electric SUV Fisker Ocean which is designed as the world’s most sustainable vehicle.
The company is planning to build the SUV on the Volkswagen electric vehicle platform to save costs and ease sales.
Announcement date: 23rd December 2019
Acquirer (SPAC): Diamond Eagle
Target: Draftkings
Acquirer advisors: Deutsche Bank, Goldman Sachs
Target Advisors: Raine Group
Value: $3.3 billions
Cash or stocks: $400 million SPAC cash, $380 million PIPE cash
Rationale:
Several states are legalizing sports gambling, positively impacting the company’s plan to expand its business geographically. US Sports betting is expected to grow from less than $1 billion in 2019 to between $7 billion and $13 billion in annual revenue by 2023.
Within the same deal, Draftkings spent $200 million in cash to buy a provider of innovative sports gaming technologies named SBTech
Announcement date: 7th January 2021
Acquirer (SPAC): Social Capital Hedosophia Corp V
Target: Social Finance (SoFi)
Acquirer advisors: Connaught,Credit Suisse
Target Advisors: Citi,Goldman Sachs
Value: $6.7 billion
Cash or stocks: $800 million SPAC cash, $1.2 billion PIPE cash
Rationale:
SoFi CEO chose to go public through SPAC IPO due to a “deal certainty” and underlined his willingness to enhance the strategic advantage of building a mobile-first financial company. When it was founded in 2011 it offered student loan refinancing but as time went by, it expanded its services into cryptocurrencies trading, wealth management, and personal and mortgage loans.
The “King of SPACs” Palihapitiya claimed that SoFi was an attractive bet due to its ability to provide lower fees than traditional banks thanks to its technology. He also compares the company to Amazon.
Positive future expectation additionally comes from the 20-year deal made by SoFi and the Los Angeles Football team, which consist in nominating the LA stadium as “SoFi stadium”.