Why SPACS are facing a reality check

The numbers suggest the special acquisition company explosion of 2020 boomed even louder in 2021. There was $153.2 billion of SPAC issuance in the US during the first 11 months of the year, according to data from SPAC Research. This compares with $83.4 billion in full-year 2020. The number of deals has more than doubled, from 248 in 2020 to 567 so far in 2021.

SPACs are designed to find an acquisition target within a limited timeframe and take it public. Investors receive their money back if the SPAC fails to secure a target, and can opt out prior to the deal if they don’t like the asset.

GPs such as Ares, Apollo Global Management and Oaktree Capital Management got onboard in 2020, drawn to the opportunity of holding assets for longer than the fund structures allow, and by the huge pool of retail capital that SPACs can potentially access. The temporary closing of the IPO window due to the pandemic – plus pure fear of missing out – added fuel to the raging fire.

In February, while acknowledging the success of the market, Carlyle Group chief executive Kewsong Lee chimed a note of caution: “Raising the money for these SPACs, that’s kind of the easy part of the equation. The hard part is putting it to work.”

In January, the US Securities and Exchange Commission called on SPAC sponsors to do an inventory of potential conflicts of interest and to clearly communicate it with investors. It also expressed concern that as SPACs got close to the deadline by which they had to transact, the target company would have so much leverage that it could drive terms that were unfavourable to investors.

“It is an area that’s fraught with potential misalignment, potential governance issues,” said Dan Bienvenue, interim chief investment officer at California Public Employees’ Retirement System, in March.

At the same time, questions started to be asked about how good these deals were for investors. Michael Cembalest, chairman of market and investment strategy for JPMorgan Asset Management, analysed 98 SPAC mergers that closed or liquidated between January 2019 and March 2021. He found that while sponsors did famously well, netting a median return of 507 percent as of August, most other investors lost out.

The median PIPE investor – which contributes funds separate to the SPAC when more cash is needed to take down a deal – was 62 percent down against an index of newly listed businesses, and 45 percent down against the Russell 2000 Growth Index. Retail investors also lost out.

“If people avoided SPACs instead of avoiding covid vaccines, the US would be both wealthier and closer to herd immunity,” Cembalest concluded.

According to Howard Kenny, a partner with law firm Morgan Lewis, these factors led to a notable drop-off in SPAC activity around May. The deals getting done today tend to be smaller, and sometimes with stricter time constraints. PIPE financing will occasionally include convertible debt or preferred stock, not just pure equity, in order to increase alignment between the sponsor and investors.

Kenny expects the current steady but unspectacular pace to continue into 2022. “[SPACs] still make a lot of sense for some companies that want to go public,” he said.