The glowing SPAC market will get even hotter in 2021, raising concerns about rampant speculation that has been sane and could leave private investors fresh from the GameStop bankruptcy.
Not only are special-purpose acquisition firms raising record capital – more than $ 30 billion so far for the biggest quarter ever – pre-merger SPACs are also seeing oversized pop on day one of trading.
New deals saw an average jump of 6.5% on their debuts this year, a nearly six-fold increase from their historical levels (from 2003 to 2020, the average first-day return on SPAC IPOs was just 1.1%), so University of Florida finance professor Jay Ritter.
“Every single one of them has gone up in price. It’s not driven by one or two outliers,” said Ritter.
Unlike traditional IPOs, where debut pops are generally viewed as a sign of healthy investor appetite and a bullish market environment, the initial SPAC rallies are less rational. These blank check companies are empty corporate shells that collect money from investors and then, within two years, merge with a private company and take it public.
When return-hungry investors raise the prices of blank check deals, they are essentially taking a leap in confidence and betting on something with no valuation or an actual deal. Many believe the spike in SPAC prices could be a sign of speculative behavior in a new bull market with massive liquidity and unchecked animal spirits.
“There’s a lot of money going on,” said JJ Kinahan, TD Ameritrade’s chief marketing strategist. “This is useful for people who are going outside of the S&P 500 or the Nasdaq 100. They will continue to see this behavior just because people look around to see what else is there but the same Buying stocks that everyone else is buying. “
Private investors jump in
There are signs that the SPAC boom is getting caught up in the retail-fueled market frenzy. Bank of America’s customer flows showed that retail investors represented 46% of trading volume in SPACs on their platform in January, up from about 30% two months ago. By comparison, retail volume only took up about 20% of the S&P 500 trade on the Bank of America platform.
“The speculative nature of SPACs appears to be particularly attractive to retailers,” Bank of America analysts said in a note. “We definitely don’t have to remind anyone what can happen when something speculative appears on the retail radar (ahem, GameStop).”
For many private investors who have their eye on high-growth start-ups, it is an attraction to conclude a SPAC deal early on. However, with the majority of individual investors buying SPAC common stock in the open market, they would most likely miss the pop on day one. Also, many brokers don’t offer trading in SPAC warrants, which are a sweetener that gives early investors more compensation for their money.
In fact, buy-and-hold investors who only get in after a deal are closed almost always lose money.
Of the 114 companies that went public via SPAC mergers in the past 10 years, investors lost an average of 15.6% if they bought common shares of a merged company on the first day of trading and held them for a year, according to Ritter. And they lost an average of 15.4% if they held the stocks for three years.
For institutional investors, however, this is a different story. Hedge funds and other actors participating in SPAC IPOs can often get an offer price of $ 10 plus the benefit of warrants. They also tend to sell stocks once the merger is complete, which could have a negative impact on prices.
“Institutional buyers have found this to be a great deal,” said Ritter. “The SPAC IPOs are essentially undervalued zero default convertibles. The worst thing they can do is $ 10 plus interest and no one has lost any money.”
Another worrying factor is the sheer number of deals currently pursuing goals. A record of more than 300 outstanding SPACs is on the hunt, giving private companies more bargaining power and allowing them to pit investors against each other for a better valuation.
“The ratings have of course become more competitive,” said Soumya Sharma, corporate attorney at Troutman Pepper. “The whole reason this will survive is because high-end targets agree to merge with SPACs because they believe they will be better valued.”
As the valuations of the target companies rise, the upside potential for SPAC investors diminishes. In the meantime, sponsors could compete for lower quality companies, many of which are not yet required to produce a physical product.
“The last few months have been great for SPAC investors as the returns have been very high, but I don’t think it can go on like this,” said Ritter.
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