Are Spacs good investments?

Spacs are publicly listed shell companies — or blank cheque companies — that are set up to raise cash in an initial public offering (IPO), which will be used to merge with or acquire a private company, thereby taking the latter public. The private company then takes the Spac’s place in the stock market and trades with a new stock ticker.

The flurry of Spac listings in the past couple of years and the involvement of many celebrity names have attracted huge amounts of retail money. It has also triggered questions of potential froth in the market.

In essence, Spacs offer retail investors opportunities to invest in firms before they go public, an option otherwise open only to private equity investors or hedge funds.

An investment in a Spac can be seen as a bet that the sponsor (like founding shareholders) will successfully find a suitable business to buy within 24 months. The sponsor will “de-Spac” when a target company is identified, and a merger or acquisition is completed.

In the case of the SGX, Spac sponsors can seek an extension of 12 months, subject to conditions.

What’s behind the Spac frenzy?

While Spacs have risen to prominence over the past couple of years, it is not new. In fact, Spacs have been around for decades. These investment vehicles are having their moment in the sun as businesses and investors alike rush to cash in on the IPO wave.

The economic disruption and tighter financial market conditions triggered by Covid-19 underscored the inherent benefit of being publicly listed. For one, listed companies are well-positioned to access capital in public markets that can help provide liquidity support and shore up solvency.

Last year, the sudden decline in demand due to the synchronous and widespread shuttering of businesses, stressed companies’ cash flows, pushing many to the brink of collapse — except those which were able to raise capital quickly.

Listed companies could access public debt and equity markets and were able to raise capital through the issuance of common shares, convertible preferred stock, debt and so on — options that were not readily available to private companies which largely depended on credit lines and relationships with banks.

The capital raised prevented bankruptcies and helped operations continue, essentially allowing companies to bide their time until containment policies were loosened and economies reopened.

While many saw the benefits of having access to public capital, going public through a traditional IPO can be a tedious process. In this case, Spacs offered an attractive alternative to gain access to public markets quickly.

Firms worldwide have raised a substantial US$129 billion ($174 billion) this year via Spacs, according to a Bloomberg article dated Sept 1. In fact, a record-breaking frenzy saw more than 500 Spacs reel in over US$180 billion in the five quarters that ended March 31.

However, the pace of listings has abated in recent months after a recent Spac earnings disaster raised concerns, and the US Securities and Exchange Commission called for more disclosure. In the case of Singapore, the SGX has said that disclosure requirements at de-Spac will be the same as for typical IPOs.

The mechanics behind Spacs

Spac founders, also known as the sponsors, are a group of investors who set up the Spac to pursue a deal — usually focusing on an industry or market segment in which they have expertise. Potential merger targets are not disclosed during the Spac IPO process. As a result, investors often rely heavily on the reputation of Spac sponsors when choosing which Spacs to invest in.

In the case of Singapore, to ensure good target companies end up being listed, SGX will focus on sponsor quality and track record, and has introduced requirements to increase their alignment with shareholders’ interest.

For one, sponsors must subscribe to at least 2.5% to 3.5% of the IPO shares, units or warrants, depending on the market cap of the Spac. Their aggregate shareholding interests should not exceed 20% of the total issued share capital.

There will be a moratorium on sponsors’ shares from IPO to deSpac, and a six-month moratorium after de-Spac. For applicable resulting issuers, a further six-month moratorium will be imposed on 50% of shareholdings. Once the Spac sponsor has identified its target company and the merger has been announced, the management will perform further due diligence and negotiate the terms of the merger.

The deal is then brought to Spac shareholders for a vote. With the SGX, the de-Spac can proceed if more than 50% of independent directors approve the transaction and more than 50% of shareholders vote in support of the transaction.

Do your homework

There are many episodes in history when an investment craze with unclear fundamentals, turns sour and causes significant misery for investors who get caught up in the exuberance — either for fear of missing out on the latest fad or with hopes of making a quick buck. The Spac craze is no different.

Those putting their money into Spacs should be aware that it comes with risks. One of which is that a Spac has to deploy its funds to make an acquisition within a limited time-frame, usually two years. This time pressure may result in a less-than-ideal acquisition being made, translating to poor returns for investors. Also, exuberant sentiment and strong IPO cycles may increase the likelihood that companies of questionable fundamentals — which are not ready to go public — may still do so.

It is important for investors not to overinvest in Spacs or speculate excessively in them. Remember how those who had overinvested in dubious internet companies during the dot.com craze of the late 1990s, then suffered sizeable losses when the bubble burst in 2000.

There is no way to be sure what a Spac will eventually invest in, or if an acquisition will prove to be profitable. To reduce risk, investors should do as much research as possible and assess a Spac’s management team, and their track record, as a great deal hinges on their ability to identify good acquisition targets.

Devoting capital into the hunt for the next unicorn also involves high opportunity costs. It means foregoing owning other listed equities or other financial assets during the life of the Spac. Ultimately, for investors, they will have to decide if making this trade-off is worthwhile.

Vasu Menon is executive director of investment strategy, OCBC Bank

Photo: Bloomberg