As of December 14, 2020, according to SPAC Alpha, there were 230 special purpose acquisition company (SPAC) IPOs completed YTD – more than 50% higher than the number of SPAC IPOs in the previous four years combined. In this opinion piece, David Erickson explores how the SPAC market exploded in 2020 and what may happen in the future. He is a senior fellow in finance at Wharton, where he co-teaches Strategic Equity Finance, and is co-director of the Stevens Center for Innovation in Finance. Prior to teaching at Wharton, Erickson worked on Wall Street for over 25 years, helping private and public companies raise equity strategically.
Twenty years ago, there was tremendous speculation in the equity market when hundreds of very early-stage companies (often referred to as “dotcoms”) were doing IPOs, fueled largely by enthusiasm from retail/day traders. I remember this period vividly because back then I was one of the bankers that worked on many of those tech/internet IPOs. During this period, I would often get into a taxi in San Francisco (yes, people used taxis back then) to race from one meeting to the next with these dotcoms; and when the driver found out I was a banker, he would often describe his best dotcom trades and ideas. In late 2000, this “bubble” burst, and today this period is often referred to as the tech (or dotcom) bubble. Twenty years later, similar characteristics seem to now exist in the SPAC market. To give a perspective on how big the SPAC market has become, according to Statista, the number of traditional company IPOs in the U.S. averaged just over 150 per year. This compares to 230 IPOs — just in the SPAC market — that had been completed by December 14, 2020, raising $77.6 billion, with another 56 on file (vs. a total of 59 SPAC IPOs completed in 2019).
In March of last year in our Strategic Equity Finance class, I got a question from a student about SPACs. He asked, “Will we talk about SPACs in this course?” At that point, while there had been a couple of high-profile SPAC mergers completed in the recent months including Virgin Galactic and DraftKings, the equity market had started to tumble as the coronavirus pandemic was taking hold. I responded somewhat dismissively, “We’ll talk about it later in the term, but SPACs are not a very big part of the equity market.”
Fast forward to now and I have received numerous inquiries from private equity firms and hedge funds interested in my view as to whether they should “sponsor” a SPAC. My apologies to that student back in March (as maybe he was prescient about what was to follow later in the year).
While the SPAC market has been around for about twenty years, it really took off in 2020, with all of these SPAC IPOs as well as SPAC mergers announced exceeding over $125 billion in volume, according to Axios). So, what has caused this emergence? Before we talk about the emergence of SPACs this year, lets clarify what a SPAC is (and isn’t).
What Is a SPAC?
A SPAC (short for special purpose acquisition company, and often referred to as a “blank check company”) raises equity in a traditional IPO process. This shell company is formed to search for and merge with a private company (or companies); the company usually has up to two years to complete a merger, often referred to as an IBC – Initial Business Combination. A “sponsor,” often consisting of former corporate executives (and in more recent cases, private equity firms), acquires a stake in the SPAC. Historically, the sponsor’s stake is around 20% of the SPAC. The SPAC sponsor, including the SPACs management team, is responsible for running the operations of the SPAC and finding a private company to combine. The 80% balance of the SPAC ownership is what is sold in the IPO to public investors. These proceeds raised are held in escrow until the completion of the business combination or the expiration of the SPAC.
One of the nuances with the SPAC structure is that the sponsor typically has two years (from its IPO) to complete a combination, or else the investors can redeem their shares. If this happens, the sponsor not only gives back the money that is held in escrow but also will lose on the cost of the IPO and expenses to date. As a result, it could be argued that the SPAC sponsor is highly motivated to complete an acquisition, even potentially if the quality of the company they are acquiring is of lesser quality. This will probably be the case in more than a few acquisitions that have been announced (as well as those to be announced).
Why Have SPACs Emerged This Year?
A combination of factors has caused this SPAC activity to explode in 2020 including:
Financing for many private companies became more difficult in the latter half of 2019. Part of this could be attributed to the struggles of “unicorns” — Lyft, Uber, and Slack — that went public earlier in 2019 but didn’t trade well in the latter half. Additionally, the high-profile debacle of WeWork, filing to IPO in August 2019 and then having to be restructured by October at a fraction of its previous valuation, created more scrutiny on companies looking to IPO. Thus, it caused many potential IPO candidates to pause their plans. At the same time, the venture financing market became more difficult when the biggest source of venture financing in the last few years, Softbank, got very quiet as it was “licking its wounds” as the largest shareholder of WeWork, Uber and Slack. With the IPO becoming more difficult, and with less liquidity in the private venture market, the market became more price-sensitive and selective for many private companies. As a result, some of these companies started looking for alternative sources of financing.
Retail investors embraced more speculative, volatile stocks. Early this year, two of the best performing stocks daily were Tesla and Virgin Galactic. While the “cult” following of Tesla’s stock has been well documented in recent years, Virgin Galactic — which in recent months had started trading after merging with venture capitalist Chamath Palihapitiya’s first SPAC — developed its own cult following. Even though it was already aggressively valued, Virgin Galactic’s stock (SPCE) went from $11.70 on January 2nd to $38.79 on February 20th – more than 330% in less than two months. Then, DraftKings started trading in late April, following the completion of its merger with the Diamond Eagle Acquisition SPAC, and five weeks later had traded up more than 250%. And as the “Robinhood cohort” (as these aggressive retail traders are called today vs. e-/day traders back in the 1999/2000 tech bubble) continued to make money on these more speculative names, they got even more aggressive. Instead of waiting for a merger to be completed, they also started speculating on the IBC announcements. One example of this speculation is TPG Pace Beneficial Finance SPAC (Ticker: TPGY), which, after announcing its acquisition of EVBox, opened up 245% the next trading day. While EVBox, the leading charging platform for EV cars in Europe, is the latest company in the “hot” EV/AV space that announced its intention to be acquired by a SPAC, 245% is a still a huge “pop,” and that was probably absorbed by many in the Robinhood cohort of traders. Now this retail interest is not limited to SPACs; they also have been actively speculating in the IPO market and even in Bitcoin’s rise in the last month. As SEC Chairman Jay Clayton noted in an interview on CNBC about the speculation happening in the market, “There is a new paradigm. There are more retail investors participating in the market than ever before.”
With interest increasing, supply follows. The need for capital from some of these private companies combined with enthusiasm for SPACs from investors has generated more interest from SPAC “sponsors” — and as a result, more SPAC IPOs have come.
Additionally, as data from SPAC Alpha shows, there had been 104 SPAC mergers announced as of December 14, 2020, 48 of which have been completed. This compares to 28 completed in 2019. Currently, there are 221 SPACs that have completed their IPOs (some of which were done in 2019) and are looking for an acquisition target.
With all of this supply, SPAC sponsors have gotten even more aggressive and have announced mergers with an increasing number of earlier-stage companies.
Where Does the SPAC Market Go from Here?
While there is still a lot of enthusiasm for SPACs as I write this, with new SPAC IPOs being filed and mergers/IBCs announced daily, the SPAC market, like with all markets after they’ve had a significant run, will likely see a correction soon. What could cause this?
As we saw back in 2000 with the tech bubble, the fraying started as more and more of dotcoms went public, and the stocks of those companies that had just done their IPOs started to trade poorly. As a result, investors began to lose money, and eventually they lost their enthusiasm. This eventually caused the dotcom IPO market to seize up, as more struggled to complete their IPOs. To parallel what could happen in the SPAC market, we will likely first start to see some of the mergers completed in recent months struggle from a trading perspective. I would assume that it would start with some of these earlier stage/pre-revenue companies. Why these companies? Because it is likely that with all of the SPAC IPOs out there looking for targets, some of these sponsors probably stretched to get deals done with some earlier-stage companies that may not quite be ready to be public. At the same time, with all of the SPAC IPOs completed, there will likely be a correction, as many of these companies looking for acquisitions will likely fail to complete a merger/IBC.
That having been said, what 2020 has taught us is that SPACs are a viable way for some private companies to go public in the future. Just like we saw from the tech bubble, some great companies emerged from this period, and the quality of technology and internet IPOs that have come since has improved dramatically. I would expect the same type of positive evolution to occur in the SPAC market going forward.