SPACs trigger bad case of Wall Street amnesia

Reuters

2 days ago

NEW YORK, May 28 (Reuters Breakingviews) - Tragedy plus time is the formula for comedy, but on Wall Street it equals opportunity. Wait a while and even the costliest failures will be resurrected. Look no further than the phenomenon of cash-stuffed shells designed to find takeover targets, which are making an unlikely return just a few years after a fateful farce.
Investors freely underwrote such blank-check firms in 2020 and 2021. In those two years alone, special-purpose acquisition companies raised some $250 billion with which to go shopping. Their 860 initial public offerings accounted for, opens new tab 62% of all market debuts, according to research outfit SPACInsider. Roughly half of them, however, failed to find a target within their typical two-year deadline, instead returning the cash to shareholders.
They were the lucky ones. By custom, SPACs list at an initial price of $10. More than 90% of those that both found a merger partner and are still publicly listed trade below that all-important benchmark price as of early May. Dozens of them - including shared office-space lessor WeWork and electric-truck maker Lordstown Motors - collapsed, adding to the bonfire of billions.
Disaster is no deterrent in finance, however. Onetime bond trader John Meriwether managed to raise money for an ill-fated second hedge fund following the $3.6 billion bailout orchestrated by the Federal Reserve of his highly leveraged Long-Term Capital Management. Jon Corzine was hired to run brokerage firm MF Global, and presided over its collapse in 2011, after he had already been ousted from both Goldman Sachs and the New Jersey governor's mansion. Before being elected U.S. president, Donald Trump kept luring investors into casino ventures despite his propensity for bankruptcy, opens new tab.
Serial SPACsters flaunt a similar bravado. Among the 80 shell companies that have gone public this year or disclosed plans to do so, according to SPAC Research data, are ones sponsored by dealmaker Michael Klein, opens new tab, investment banking boutique Cantor Fitzgerald, opens new tab and buyout firm The Gores Group, opens new tab.
The trio is part of a small club of 14 sponsors with at least eight SPACs apiece to their name, accounting for a combined 150. Even these impresarios have struggled, however. A fifth of their shell companies were liquidated. More than 40% are trading, or were sold, below the $10-a-share threshold, according to a Breakingviews analysis.
Worse, there hasn't been much soul-searching about how to remake SPACs, beyond some enhanced disclosure requirements implemented, opens new tab last year by the U.S. Securities and Exchange Commission. There's a market nonetheless. This is partly because the money a blank-check firm raises is held in a trust typically earning interest from ultra-safe Treasury bills, and shareholders can get a refund on their contribution once the SPAC unveils a deal. Hedge fund managers therefore tend to regard shell companies as akin to fixed income investments with equity upside, which are especially appealing when markets swing wildly. The cash redemption rate in 2022 exceeded 80%.
As CEOs and investors search for alternatives to sluggish traditional M&A and IPO markets, though, SPACs could represent a fresh opportunity, albeit with refinements.
One would be to share the spoils, as started to become more of the norm. Sponsors typically receive a 20% stake in founder shares at a steep discount. Instead of keeping this entire 'promote,' setting some aside for other owners could persuade them not to redeem their shares. It would put real money on the table. Early SPAC advocate Chamath Palihapitiya boasted of making roughly $750 million from the vehicles he sponsored through his Social Capital, even as many other investors lost money.
Another important factor is the size and cohort of investors a sponsor attracts by privately placing shares ahead of, or alongside, an acquisition. These private investments in public equity tailed off at the end of the boom. Their presence, depending on the reputation of the investors and the amount committed, can help validate a deal's valuation, one of the potential virtues of SPACs.
Price discovery in an IPO can be dicey, as Venture Global (VG.N), opens new tab discovered earlier this year. The liquefied natural gas exporter had to slash its valuation after investors balked. Even then, shares tumbled when they began trading and are 48% below where they started. Simply having Fidelity or T. Rowe Price in a SPAC deal can't guarantee success, of course, but it at least adds an outside stamp of approval.
Most important, however, is to seek healthier, more established companies as merger partners instead of unproven science projects. A SPAC is a poor substitute for early-stage venture-capital fundraising. The initial flood left a lot of firms hungry to do deals, though, in turn prematurely ushering too many private firms into publicly traded life.
Gores provides a useful example of how deals can optimally work. In 2016, its first SPAC bought century-old Hostess Brands from buyout shop Apollo Global Management (APO.N), opens new tab and billionaire Dean Metropoulos for $725 million. JM Smucker (SJM.N), opens new tab paid $5.6 billion for the Twinkies maker seven years later. Verra Mobility's (VRRM.O), opens new tab share price also has more than doubled since another Gores SPAC acquired the electronic toll-payment service in 2018.
The recent blank-check resurgence, by contrast, is sending mixed signals. Private equity firm Ares Management (ARES.N), opens new tab successfully extended the life of one it is sponsoring with only about 1% of shareholders redeeming, opens new tab, an indication of confidence. Backers including Soros Fund Management are kicking in $110 million of financing to supplement the $550 million of cash in its trust. And yet the vehicle is buying, opens new tab Kodiak Robotics, a self-driving truck technology startup that looks to be an incongruously early-stage venture for the New York Stock Exchange, in a $2.5 billion deal.
Perhaps the biggest reason to remain skeptical about SPACs and their skewed economics is to consider which side of the trade buyout shops prefer: they are more likely to sponsor than sell into them.
Collectively, private equity funds own stockpiles of aging companies that are proving difficult to sell or take public. If the industry starts embracing SPACs for exits, as occurred with Hostess and a handful of others, they might be worth a second look. For now, it's just a degenerative case of Wall Street amnesia.
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