SPACs Aren't Going Anywhere, but Craze Is Cooling

Following a torrid pace of initial public offerings (IPOs) and deal making in 2020, it was reasonable to expect that entering 2021, special purpose acquisition companies (SPACs) would be a source of client interest.

Nearly eight months into the year, that's likely still the case, though not for the reasons advisors were anticipating in January. While the pace of blank-check IPOs is again hot this year – it's already eclipsed the all-time high set in 2020 – market participants are applying more scrutiny to companies born out of SPAC mergers. As they should.

“Out of the 107 companies that completed their SPAC mergers to date in 2021, only 24% (26) are trading above their $10 IPO price,” according to SPAC Track.

Things are getting so rough in SPAC-land that some companies that were previously viewed as potential crown jewels of blank-check deals are opting for traditional IPOs.

Data Dilemma

For advisors, the evolution of SPAC enthusiasm and subsequent declines in this market is actually a positive because it gives them opportunities to, well, advise. It's also a potential positive because, and let's be honest here, the blank-check companies really caught the attention of younger, risk-tolerant investors. Indeed, there's plenty to discuss with clients on this front. Data confirm as much.

“Since the IPOX® SPAC Index peaked on Feb. 17, it has lost over 25% of its value while the Russell 2000® Index is down around -2%,” says Cameron McVie of Russell Investments.

Other data points confirm that advisors should at least briefly mention SPACs to clients because it's apparent the “little guy” (or woman) is driving much of the mania in the blank-check market.

“We also have experienced a period of plenty of speculative buying across the financial markets, such as retail investors investing in meme-mania stocks via platforms such as Robinhood that have driven some wild stock price gyrations,” adds McVie. “The SPAC market provided another avenue for speculative money to find the next unicorn company. Notably, BofA Research identified that retail investors in the SPAC universe accounted for twice the trading volume, compared to the S&P 500 and Russell 2000 stocks, during the second half of 2020.”

On that note, it pays to understand clients' psyche and their motivations for embracing SPACs. Blank-check companies do democratize the IPO process and retail investors have long been tired of being shut out of traditional new offerings while early investors and Wall Street get richer off those deals.

Additionally, many of the recent SPAC mergers involve companies in hyper-growth industries appealing to clients with a flair for risk or those that simply want to access hot themes. Think electric vehicles, online gaming and more. However, by design, SPACs first and foremost benefit the sponsor.

“All these dynamics contributed to a robust demand for SPACs. And sponsors were more than happy to provide supply,” notes McVie. “While these structures are appealing for management of private companies to take their firm public, they also offer a highly lucrative return for the sponsor, who is able to reap a significant allocation of equity from a successful IPO as part of their promote.”

What's Next

Today, there's intensifying regulatory scrutiny on SPACs and supply is starting to come in a bit (likely a positive). Plus, like any asset class tinged by mania, a pullback is usually a good thing over the long haul.

“Like any market that goes on a euphoric run, there is an inevitable, and necessary pullback,” says McVie. “We have seen this occur in the SPAC market this year, which has led to some pain for investors who bought at over-inflated levels, but in reality, since last summer, the SPAC index is up commensurate with other equity indices like the S&P 500 and Russell 2000 (albeit with greater volatility).”

Bottom line: SPACs aren't going anywhere and more attention to the detail in this space will likely benefit investors in the long run. It's on advisors to tell clients not to get carried away with this asset class and inform of issues such as regulatory and sponsor risk, litigation and private investment in public equity (PIPE), among others. By doing that due diligence, which isn't as cumbersome as it sounds, clients outcomes will improve in this space.

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