What a difference a year makes. In the first quarter of 2021, the US capital markets were ablaze with discussion over the rise of the biggest challenge to the conventional IPO system ever—SPACs, or special purpose acquisition companies.
While fundamentally, SPACs and IPOs do the same thing—bring a company public, allowing outside investors to invest in it—the mechanical differences between the two methods are enormous. IPOs involve companies going through a grueling “roadshow,” which assesses investor willingness to buy shares in the new company before an offering is launched and shares are available to the public for purchase and sale. In contrast, a SPAC involves, first, an IPO for a holding company, then the merger of that holding company with a private firm at a negotiated valuation. The consummation of that merger—often called the de-SPAC transaction—then enables the investing public to buy or sell shares in the target (formerly) private firm’s equity.
These different mechanics lead to different issues for investors and the firm alike. For instance, with an IPO, there is uncertainty about what the underlying stock will sell for in the open market, often leading to the much discussed IPO underpricing problem. In contrast, for SPAC targets, the process of going public is essentially a negotiation with potential acquiring shell companies, meaning that the firm avoids the crucible of the roadshow and the thorny investor questions it brings.
As a result of the more sedate SPAC process, combined with the initial success of certain early SPAC firms—most notably Virgin Galactic and Nikola—SPACs became the method du jour for going public in the US markets. But that interest has waned greatly in the last year.
First, the SEC started earnest investigations into the space and rolled out a new set of rules changing the asset and liability treatment of certain balance sheet items, most notably warrants, in SPAC transactions. This had the result of increasing liabilities for SPAC firms; but more prosaically, it put an effective chill on investor interest in the coming SPAC issues.
Then, the Fed began its ongoing campaign to bring down inflation with a series of aggressive interest rate hikes. As these rate hikes have kicked in, the resulting implicit discount rate on assets in the market has risen and that means lower valuations for assets of all stripes, but especially long duration ones. The result has been an utter collapse in the value of virtually every unprofitable company in the equity markets, which includes almost all SPACs out there. At this point, the vast majority of SPACs trade below, and in many cases well below, their initial $10 per share issuance price. Moreover, the rate increases and corresponding share price collapse have created a complete deep freeze in the market for new SPAC issues, leaving the category moribund.
SPAC issuance is down from ~$155B across 81 separate SPAC deals in Q1 2021 to ~$8.1B across 16 deals in Q1 2022. So what comes next for the market? That’s an open question, but one thing is certain—today’s SPAC market is very, very different from the one faced by investors 12-18 months ago.
Join the SS&C Learning Institute July 13th as we explore the evolution and mechanics of SPACs, why firms choose to do SPACs and the risks associated with them. Register and view the webinar agenda here: Special Purpose Acquisition Companies.
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