Investor Column | Special-purpose acquisition companies are boosting the IPO market
What is a SPAC?
A SPAC, sometimes called a blank-check company, is a shell company that has no operations but plans to go public with the intention of acquiring or merging with an operations company with the proceeds of the SPAC’s initial public offering. These entities have been around for decades, but in the last couple years they have been greatly increasing their share of the traditional IPO market. In 2020, SPACs have already raised over double ($30 billion) the amount raised from 2019 and they are not done yet!
Why would a private company ready to go public go the route of a SPAC? There are multiple reasons to go public using a SPAC. SPACs allow a private company wishing to go public multiple timing choices. There can be a much quicker time frame for SPACs than traditional IPOs (2-5 months) to become a publicly traded company or a private company can go the typical 24 month period that a SPAC is allowed to purchase a company before the SPAC is required to dissolve. During times of uncertainty, such as our current situation with Covid-19, a SPAC allows an alternative avenue to access liquidity faster than the 12-18 months that traditional IPOs take. Another reason is that due to the excess liquidity in the market, pension funds, mutual funds, and retail investors are looking for new stocks and generally places to invest cash. One of the most important benefits of a SPAC IPO versus a traditional IPO is the lower cost. According to Jay Ritter’s stats from the University of Florida, companies that traditionally IPOed (non-SPACs) in 2020 have been underpriced by 31%. That is a huge premium! SPACs are much cheaper.
Much of the attention this past summer has been in the electric vehicle sector where advancements in battery and vehicle technology has created a race to market with each companies’ unique approach to the hot electric vehicle space. The SPAC option has allowed these entrepreneurs to garner the money they need quickly and to compete at the financial level necessary to grow and advance in their respective market.
I would be remiss if I did not throw out a few curveballs of the different types of SPAC management teams that are searching for a company to purchase. The first unusual one is a company desiring to become a SPAC run by a famous baseball statistician, that is looking for a sports analytics company or even a mid-sized sports franchise to buy. There is another SPAC IPO that successfully occurred in aerospace technology tied to space travel.
Excess market liquidity inflates market valuations, so be cautious when evaluating any company that is either going public through a traditional IPO or a company that is using a SPAC to go public. According to a recent study by IPO research and investing firm Renaissance Capital, they found that of the 89 SPACs that had gone public since 2015, they have posted an average loss of 18.5%, compared to an average gain of 37.2% for traditional IPOs. The question is - are the new SPACs higher quality companies that will break the mold of lower performance versus traditional IPOs or are they another round of companies that would not qualify for a traditional IPO and thus they add additional risk to investors?
Danny Wood is a principal and founder of SeaCoast Financial Partners. To learn more, visit MySeaCoastFinancial.com. The opinions expressed in this material do not necessarily reflect the views of LPL Financial. Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.