Yes Advisors, You're Likely Going to Talk About SPACs This Year

Blank-check mania is reaching a fevered pitch and that's saying because 2020 was the year of the special purpose acquisition company (SPAC). At least according to Goldman Sachs.

That assessment was spot on. It may also need to be revised to anoint 2021 the year of the SPAC. As Yahoo! Finance notes, 175 SPACs went public this year as of Feb. 26, raising $56 billion. For all of 2020, 223 blank-check firms commenced initial public offerings (IPOs).

“Data from SPAC Insider shows that through Tuesday, some 204 SPAC IPOs had come to market; on Tuesday alone, no fewer than 12 SPACs were announced, according to data from Street Insider. At this rate, 2020's record year for SPACs might be eclipsed by week end. SPAC Insider data shows that from 2009-2019, there were 226 total SPAC IPOs,” according to Yahoo! Finance.

For advisors, there are multiple reasons why, like it or not, they're likely to talk SPACs with clients at some point soon. First, although SPACs have been around for about three decades, the asset class is getting “shiny new object” treatment. Second, blank-check firms are partnering with companies in an array of hyper growth industries such as clean energy, electric vehicles, fintech, online gambling and consumer internet, among other.

Where Advisors Fit In

Combine those factors with the tendency of blank-check stocks to shoot higher when a deal is confirmed and it's easy to understand why client inquisitions on this asset class are rising.

As I noted last month, advisors can bring value to SPAC-happy clients. In fact, there are several avenues for advisors to either add value or save clients from potentially disappointing blank-check outcomes.

“Like almost everything else in this world, it all depends on several factors; in this case, timing, valuation of the merger target, and potential equity dilution,” notes Morningstar analyst Dave Sekera.

One of the most obvious points to discuss with clients is opportunity cost or time value of money. Here's the thing with SPACs. The companies have two years to get a deal done or be forced to liquidate and return cash to shareholders. While time from IPO to deal announcement is declining, multiple months, a year or two years can be long periods of time to hold a stock that will likely trade flat while not delivering any dividends. For many clients, that's not a suitable investing style.

Then there's the matter of due diligence. It's easy for clients to get swept in SPAC fever, particularly if they're hearing about gains from colleagues and friends, but advisors should tell clients that due diligence is tricky and many SPAC targets aren't anywhere close to being profitable.

“Investors should conduct due diligence on the sponsor. We recommend looking for those sponsors that have a strong record of both valuing and buying companies as well as operational and managerial experience that will provide value to help the merger target grow its business,” adds Morningstar's Sekera. “Lately, it appears that a multitude of new sponsors without these track records are trying to jump on the SPAC bandwagon to raise capital.”

Other Matters Clients Overlook

Enthusiasm and fear of missing out (FOMO) are powerful emotions in a variety of everyday, normal life settings. That's particularly true in financial markets.

Problem is too much ebullience and FOMO can cloud an investor's vision, making them overlook things such as timeline to profitability and potential SPAC dilution. Regarding the former, consider the case of DraftKings (NASDAQ:DKNG), one of the more successful companies born out of a SPAC merger. Indeed, revenue is growing at the sportsbook company is growing, but it probably won't stop losing money until 2023 or 2024.

As for dilution, SPACs often to issue more equity or procure other forms of financing to get deals done.  Either way, early public investors can be diluted, but because of the hype, they overlook this risk.

“Investing in SPACs should not be undertaken lightly. Based on the required due diligence, the valuation of the eventual merger candidate, and the determination of potential dilution, investing in SPACs should be limited to investors with the skill set and time to properly analyze the myriad additional risks that are not inherent to investing in normal stocks,” says Sekera.

Those are points for clients to remember and for advisors to emphasize.

Related: How to Talk to Clients About SPACs