SPACs have hit a wall. Some have gone splat. The momentum is dying a swift death. Whether or not it lasts is a question yet to be answered, but with more eyes on the group, the easiest money is likely in the rearview mirror. I’d argue the quality of sponsors and managers at the highest levels coming to the forefront with a SPAC offering is stronger than what we’ve seen in the past. Unfortunately, with the huge surge in popularity, we’re likely also attracting many first-time sponsors or managers chasing easy money. We may be seeing some questionable track records coming into play. Again, it’s about knowing not only what you own (post-merger), but also who (manager) you own pre-merger.
One area I believe needs to be examined is the performance of SPACs up against a deadline of completing a deal or having to liquidate. While the potential for liquidation provides a known downside for holders, the potential for liquidation also encompasses some risk for those that choose to hang onto a SPAC post-merger rather than redeeming. The risk comes from the need to do a deal.
When a SPAC is formed, Founders receive Founder shares. The plus for holders of the SPAC stock is these shares that come to the Founders at virtually no cost aren’t factored in the redemption process. In other words, they aren’t cashing those shares if no deal happens. Additionally, there are private warrants purchased outside of those attached to the units initially issued. The proceeds from these warrants are kept outside of the trust and used to cover the ongoing expenses of the SPAC pre-merger. In short, this is the sponsor money at risk.
All of this leads to the biggest concern I have regarding SPACs. Are founders/sponsors incentivized to do a bad deal rather than no deal at all?
I’d posit that they are.
This may sound ironic coming from me since I spent this space yesterday essentially defending SPACs, but this is an example of acknowledging and understanding the risks associated with any equity you may be trading or holding for the longer-term. We should always be able to do this with any of our holdings.
What this equates to is a unique risk-reward setup for late stage SPACs. If they are trading under their redemption value, then they likely make an attractive buy and hold with the caveat that you don’t hold through the merger. In other words, if there is no deal, then you’ll take your redemption value and walk. If there is a deal, you’ll likely sell into any pop (for a gain) or choose to redeem your shares rather than accept the merger. Another approach would be to simply sell on a deal announcement even without a pop.
This isn’t a hard and fast rule. You may love the company the SPAC is buying. The market may love the company the SPAC is buying. Again, you do your due diligence. However, I think this is a question worth examining. Do late-stage SPACs completely a last-minute deal before liquidation perform significantly different than SPACs that cement a deal well before their deadline?
It’s certainly something to consider as SPACs grow in popularity, but rather than immediately brushing them aside or ignoring all criticisms, I urge investors and traders to get to the next level of due diligence in the space.