SPAC Week Continues…Bigger, Louder, Faster…The SPAC Locomotive Continues…For Now

Because it is SPAC week, I thought I would answer the number one question being asked…how does the SPAC work?

Bloomberg’s Matt Levine does a really nice job of explaining the SPAC mechanics here:

A special purpose acquisition company is a blank-check company that raises money from investors in an initial public offering, puts the money in a pot, and uses the pot to buy a stake in some existing private company, merging with that company (in a “de-SPAC merger”) and taking it public.

Traditionally the SPAC does its IPO at $10 per share; if it sells 100 million shares then it will have $1 billion in its pot. It will go out and find a private company and negotiate with it, and the negotiations will be over how big a stake the SPAC gets for its money. The SPAC has a billion dollars; it will go to the private company and say, for instance, “we think you are a $4 billion company, if we give you $1 billion you’ll be a $5 billion company, so our $1 billion should buy 20% of your stock, so after we merge you should have 500 million shares outstanding of which our SPAC shareholders should own 100 million.”[1] And the company says “no we are a $9 billion company, if you give us $1 billion we’ll be a $10 billion company, so your $1 billion should buy 10% of our stock, so after we merge we’ll have 1 billion shares outstanding of which your SPAC shareholders should own 100 million.” And then they go from there and hopefully find a compromise price everyone can live with.

And there will usually be a PIPE, a private investment in public equity, alongside the de-SPAC merger deal: Some big institutional investors will put in new money to buy shares directly, so that the newly public company raises money not only from the SPAC but also from other big institutions. So perhaps the final deal will be a $6 billion pre-money valuation plus $1 billion from the SPAC and $1 billion from PIPE investors, for a total valuation of $8 billion; SPAC investors will get about 12.5% of the company (one-eighth, the amount of cash they put in divided by the total valuation), the PIPE investors will get another 12.5%, and the existing private shareholders will keep the other 75%.

Then they will announce the deal and hopefully the stock—the SPAC stock, which is already public—will trade up. The deal will be well received; investors will think the company is worth more than the agreed valuation. Perhaps the market will say the company is worth $10 billion, which means that the SPAC shareholders’ 12.5% stake is worth $1.25 billion, which means that each $10 SPAC share should trade to $12.50.

This is the same basic mechanism as a traditional initial public offering. The people who agree to buy a private company’s shares at the moment it becomes public are taking a risk and doing the private company a favor; they expect to be able to buy those shares at a bit of a discount. After the company goes public—in an IPO or a de-SPAC merger—the stock should trade up, to reward the initial purchasers. In an IPO this is called the “IPO pop,” and it is much criticized by venture capitalists. In a SPAC this phenomenon doesn’t exactly have a name, but it obviously exists and is the basis for the current SPAC mania. If investors didn’t think “buying SPAC stock at $10 gives us a ticket to get some cool private company at a discount,” they wouldn’t be excitedly buying SPAC stocks; there would not be a dozen SPACs going public each day, and multiple exchange-traded funds competing to package SPACs for investors, and generally a ton of excitement for SPACs. (Of course there is no guarantee of anything; some IPOs open below their IPO price, and some SPACs trade down as investors are disappointed by the deals they make.[2] But the usual expectation, at least for hot companies in the current hot market, is for these things to trade up initially.)

So here we are in March 2021 and SPAC’s have been embraced by the hedge funds and retail investors.

I have long said, supply is the only thing that will slow down the SPAC train. Banks love this new product.

We are seeing signs of that right now. According to Goldman Sachs:

SPAC issuance has continued to roll: 175 SPACs have raised $56 billion in IPO capital YTD, an average of $1.5 billion raised per trading day. 90 SPACs raised $32 billion in IPO capital in February, the largest SPAC issuance month on record. The blistering pace of issuance is likely to prove unsustainable. However, if the current pace of SPAC issuance continues, 2021 will surpass 2020’s record SPAC capital issuance by the end of March.

2021 has seen record deal announcements for SPACs. 43 SPACs have announced acquisitions YTD totaling $123 billion in enterprise value, compared with the full-year 2020 total of $156 billion across 93 deals. 66% of the $123 billion in announced deal EV is concentrated in Consumer Discretionary and Info Tech alone, reflecting a continued shift toward Growth among SPAC sponsors and investors.

Bigger: SPACs are seeking to merge with larger targets. On February 22nd, the largest SPAC acquisition ever was announced as Churchill Capital Corp IV stated its intention to purchase a stake in Lucid Motors at a pro-forma equity valuation of $24 billion. The average 2021 announced SPAC target has an enterprise value of $2.9 billion compared with an average of $1.7 billion in 2020 and $832 million for the preceding decade. Larger average SPAC IPO capital raises ($400 mn in 2021 vs. $250 mn from 2010-19), smaller acquired stakes, and increased use of external financing (e.g., PIPEs) have all contributed to the increase in target size.

Louder: SPACs could generate over $700 billion in acquisition activity in the coming two years. We estimate that $103 billion in SPAC capital is actively searching for an acquisition target. The aggregate ratio of target enterprise value at merger announcement to associated SPAC capital has been 7x this year, a jump from 6x in 2020 and just 3x during the 2010s. If the YTD ratio were to hold, SPACs would acquire companies worth over $700 billion of enterprise value in the coming two years.

Faster: The SPAC life cycle is accelerating. The average SPAC that announced a deal from 2010 to 2019 had been public for 487 calendar days on deal announcement day. The average time has shortened to 366 days for 2020 announcements and just 175 days thus far in 2021. Northern Star Investment Corp II was the quickest SPAC to find and announce a target, doing so less than a month after its IPO.

The pace is relentless.

Yesterday, many SPAC’s traded below $10 (their cash value). One day does not a trend make, but I will explain those mechanics tomorrow.