What is a SPAC? | CNBC Explains - YouTube

Imagine someone famous asking  you to invest in a company.

Chances are, you will want to know more.

As it turns out, there is no company, at least not yet.

Will you part with your money?

That is the pitch by owners of SPACs, or  special purpose acquisition companies,

which is arguably the hottest asset class in the  U.S. of late, led by notable investors such as

hedge fund billionaire Bill Ackman and former  Facebook executive Chamath Palihapitiya.

We’re getting a lot of questions about SPACs this week.

SPACs this year have raised triple the  amount that they did in all of 2019.

With companies slashing dividends and interest rates at rock bottom levels, investors are flocking to SPACs.

So what exactly are SPACs, and why are they so popular?

Once shunned by investors, SPACs, also known  as blank check companies, have become an

increasingly popular method in recent years  to list companies on a stock exchange.

SPACs are shell companies with no actual  commercial operations but are created solely

for raising capital through an initial public  offering – or IPO — to acquire a private company.

This is done by selling common stock — with shares  commonly sold at $10 apiece — and a warrant,

which gives investors the preference to  buy more stock later at a fixed price.

Once the funds are raised, they will be kept  in a trust until one of two things happen.

First, the management team of a SPAC — also  known as sponsors — identifies a company of interest,

which will then be taken public through an acquisition,  using the capital raised in the IPO.

Or second, if the SPAC fails to merge or  acquire a company within a deadline

— typically two years — the SPAC will be liquidated,  and investors get their money back.

SPACs have existed in one form or another as early as the 1990s, typically as a last resort for smaller companies to go public.

The number of SPAC IPOs has waxed and waned over  the years in tandem with the economic cycles,

and they have been making a resurgence of late.

Notable SPACs include Palihapitiya’s  Social Capital Hedosophia Holdings,

which acquired a 49% stake in British  spaceflight company Virgin Galactic in 2019.

The biggest SPAC on record raised $4 billion in July 2020,

led by hedge fund manager Bill Ackman’s  Pershing Square Tontine Holdings.

The structure of SPACs allows investors  to contribute money towards a fund

without any knowledge of how their capital will  be used, thus the term ‘blank-check companies’.

But what’s the difference between a  SPAC IPO, and a traditional one?

There are several ways a private company can go public.

The most common route is through a traditional IPO,

where it’s subject to regulatory and investor  scrutiny of its audited financial statements.

An investment bank is usually hired  by the company to underwrite the IPO,

which usually takes 4-6 months to complete.

This involves roadshows and pitch  meetings between company executives  

and potential investors to drum up  interest and demand in its shares.

And not all IPOs succeed.

Co-working-space company WeWork withdrew its  high-profile IPO in 2019 amid weak demand  

for its shares after massive losses and  leadership controversies were revealed.

Other companies such as Spotify and Slack went  public through direct listings, saving on fees

paid to middlemen such as investment banks,  although there are more risks involved.

And while private companies listed through  SPACs are similar to reverse takeovers,  

such as the case for insolvent fintech company Wirecard,  

they are different in that SPACs start off  on a clean slate and have lower risks.

Because SPACs are nothing more but shell  companies, their track records depend on the

reputation of the management teams.

By skipping the roadshow process, SPAC IPOs also typically list in a much shorter time.

This has led some investors to become wary of  buying shares in companies listed through SPACs  

due to the lack of scrutiny compared to traditional IPOs.

SPAC sponsors also typically receive 20% of founder shares in the company at a heavily discounted price,

also known as the “promote.”

This essentially dilutes the ownership of public shareholders.

For example, initial shareholders of Palihapitiya’s Social Capital got 20% of the company at $0.002 cent,

while public shareholders got the remaining 80% at $10 a share.

But how have SPACs fared in equity markets,  especially for ordinary investors?

A study of 56 SPACs that completed acquisitions  or mergers since the start of 2018 found that

they tend to underperform the S&P 500 during a three,  six and 12-month period after the transaction.

A separate study of blank-check companies  in the U.S. organized between 2015 and 2019  

found that the majority are trading below  the standard price of $10 per share.

Between 2017 and the middle of 2019, there  were slightly over 100 SPACs in the U.S.,  

with an average return of a mere 2%.

If there’s one thing that markets hate, that’s uncertainty.

Even before the pandemic, SPACs were already on the rise, buoyed by the equity boom and hot IPO market in 2019.

While the pandemic has slowed the pipeline of  traditional IPOs, SPACs have bucked the trend.

With the quality of management teams  improving, fewer disclosure requirements  

and a relatively straightforward listing  process, blank check companies are booming.

In fact, funds raised through SPACs outpaced traditional IPOs in August — a rarity on Wall Street.

In the first ten months of 2020, there were 165 SPACs IPOs globally, of which 96% of them were listed in the U.S.

That is nearly double the number of global SPACs  issued in 2019 and five times that of 2015.

Of the $56 billion poured into global SPAC  listings in 2020, 99% was raised in the U.S.,  

and that figure is nearly 12 times the amount  raised globally in 2015 over the same period.

While largely an American phenomenon, SPACs have caught the attention of investors in other jurisdictions.

In 2018, Antony Leung, the former finance  secretary of Hong Kong, raised $1.5 billion on the  

New York Stock Exchange through his SPAC, which  bought a mainland hospital chain a year later.

Other players include Masayoshi Son’s SoftBank,  

and the investment arm of Chinese  state-owned conglomerate CITIC Group.

Despite having sponsors from Asia looking  to acquire international companies,

these SPACs are ultimately listed in the U.S.

It’s a similar story in Europe, which  has seen muted SPAC activity.

For example, the management team of blank check company Broadstone Acquisition Corp is based in London,

targeting private companies in the U.K. and Europe, but is listed on the New York Stock Exchange.

One main reason is the different  rules for SPACs across jurisdictions.

In the U.S., investors can vote to  approve the acquisition the SPAC proposes,

or redeem their funds if they do not support the proposed deal.

This, however, isn’t a requirement in some  European jurisdictions, including the U.K.

There is also a lock-in period for British investors once an acquisition is announced until the approval of the prospectus,

which ties them into deals that they may  not support in that indefinite period.

But changes may be afoot.

As SPAC activity reaches fever pitch in the U.S., regulators are putting these blank check companies under the microscope.

Competition to the IPO process is probably  a good thing, but for good competition and

good decision-making, you need good information.

And one of the areas in the SPAC space  that I'm particularly focused on is

incentives and compensation to the SPAC sponsors.

However, investors like Palihapitiya have  defended SPACs transactions, saying that they

are no different from the fees that banks  collect in a traditional IPO process.

As more ordinary investors jump on the  SPAC bandwagon, experts are concerned

that this will overheat markets and  affect any fragile economic recovery.

While SPACs provide a straightforward route  to invest through a trusted intermediary,  

its performance so far means that it is  a dicey bet for ordinary investors.

Hi, guys. What's your thoughts on SPACs? Would you invest in one?

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