SPACs: Wall Street’s New Money Guzzler

Over the past year, a new type of investment firm which sits on vast quantities of cash and looks for acquisition targets has become the talk of the market. No, not private equity – special purpose acquisition companies (SPACs). Also known as blank check companies, these firms do not have any business operations whatsoever. Rather, they are created to raise capital through an initial public offering (IPO) in order to acquire an existing firm. The current market conditions have propelled SPACs’ recent rise to popularity; however, today’s conditions are very different than those that caused SPACs to emerge in the first place.

SPACs have been around for decades, but until 2019, they were more closely associated with securities fraud than with a genuine investment vehicle. The 1980s were a very unique time for public markets, with massive growth in both the number of investment companies as well as the amount of fraud and corruption. This spectacular growth came largely as the result of flourishing penny stocks – that is, companies which trade for less than $5 per share. It was a difficult time for retail investors, as the markets were skyrocketing up and all they could really trust was the word of their brokers. Accordingly, with little regulation, many unconventional investment vehicles were formed, including blank check offerings. 

By 1990, 20% of new public filings with the U.S. Securities and Exchange Commission (SEC) were filed by blank check companies. The fraudulent strategies to embezzle funds were unbelievably simple: someone creates a blank check company and IPOs as a penny stock, the owners nominate agents to purchase the company’s now-public shares, the “shareholders” – really just the original owners of the company – partner with retail portfolio managers to pitch the stock to regular individuals, and finally these end consumers cluelessly purchase the shares of a business with no actual operations. In the end, both the founders and the investment management firms profit immensely, and the citizens who own the stock are led to believe that their holding loses value over time and is attributable to the nature of the stock market. The scam was so dangerous that the SEC stepped in and created new disclosure laws, after which blank check companies essentially disappeared until post-2008 financial crisis.

Typically, with a SPAC, a group of investors with expertise in a particular sector will form a holding company and essentially write a cheque intending to acquire a firm. Often, they will not disclose the name of the business they hope to acquire, this being the main driver behind the term “blank check company”. The funds that a SPAC raises are placed into an interest-bearing trust fund account, the purpose of which is to cover expenses associated with the De-SPAC transaction (the process of transitioning from an empty shell company to the acquired company), to be liquidated in the case that no acquisition target is found, and in some cases finance the working capital needs of the business. Rather than having to go through the stressful process of marketing and organizing an IPO, a SPAC makes the procedure very painless for a private company.

While an IPO process can have more upside for a company and is generally the preferred route when times are good, the coronavirus pandemic has created arguably the most volatile business environment in history. Companies are bleeding cash while central banks continue to pump liquidity, leading to increased speculation and little certainty in company value. Accordingly, many private companies now see SPACs as a golden opportunity to avoid the risk in a public valuation and secure a sizeable return – the major downside being the steep discount SPACs may try to negotiate in return for taking on the extra risk typically associated with an IPO.

Blank check deals have grown in popularity over the past decade, but recent months have seen a particularly astonishing rise. In 2015 and 2016 33 SPACs held IPOs, whereas in the second quarter of 2020 alone there were two dozen such companies raising a whopping $8 billion. This year, some notable blank check deals include electric truck manufacturer Nikola Corp. and sports gambling operator DraftKings, and others such as electric car maker Fisker Inc. have said they plan to go public soon through a merger with a blank check company. July was perhaps the most active month for SPACs to date. The largest ever SPAC deal was announced on July 12, with Churchill Capital Corp. III acquiring healthcare service provider MultiPlan Inc. in a deal valuing MultiPlan at $11 billion dollars. Several days later, on July 22, hedge fund billionaire Bill Ackman launched an IPO for Pershing Square Tontine Holdings Ltd., raising $4 billion and making it the largest SPAC initial public offering to date. On July 28th, Billy Beane – the baseball executive featured in the movie Moneyball – filed an IPO request aiming to raise $500 million for RedBall Acquisition Corp., a blank check company created in partnership with private equity firm RedBird Capital Partners.

It is possible that the biggest winner of the rise in SPAC deals is neither private companies nor the SPACs themselves. Blank check deals pay banks hefty advising fees as well as a portion of the money raised from selling shares in a public listing, and with higher quantities and values behind the deals, Wall Street banks have been raking in large amounts. Citigroup, Credit Suisse, and Goldman Sachs are the three leading underwriters in this area and make up approximately half of total underwriting revenue – a half that is projected to be at least $400 million just from the companies that have already listed this year. Investment banks typically charge around 2% of the money raised from an IPO, whereas from a SPAC they take a cut of 3.5%, making the latter a significantly more advantageous deal. Further, while SPACs accounted for just 1.1% of IPOs a decade ago, they have made up about 40% of such activity in 2020.

Special purpose acquisition companies, Wall Street’s once forgotten investment vehicle, have risen to the forefront of investing quicker than anyone could have imagined. Both private businesses and investors are happy, because it provides a unique opportunity for the former to go public without the risk of an initial public offering, and for the latter to raise large quantities of capital in an unconventional manner. However, as heavy volatility and a slowed M&A market make SPACS the ideal option for the near future, the biggest winner from their revival is Wall Street.