SPACs : another factor of uncertainty for the stock market

Kofi Azède
Kofi Azède

In 2020, Special purpose acquisition companies or SPACS, have raised around $83 billion. This amount is superior to what they had been able to raise during the last decade and they seem far from slowing down since they’ve already raised around $26 billion in January 2021.

A SPAC is a company with no commercial operations that is formed for the sole purpose of raising capital through an initial public offering (IPO) to acquire an already existing company. They were created by David Nussbaum in 1993 and they used to raise sums inferior to $1billion but since 2019, their number and the amount of money raised started to grow exponentially which led to raising concerns about their impact on the stock market.

How do SPACs work ? 

SPACs are corporate shells, or also “blank check companies“, meaning that they have no commercial activity. They are formed by market experts with the intention of raising capital from underwriters – who can be companies, financial institutions like Goldman Sachs or retail investors – in order to acquire another company and making it go public. 

However, the investors have no idea of what the SPAC is doing with their money, there is no transparency because they avoid identifying their targets not to go through the whole process of a traditional IPO. Their activity is based solely on the confidence that investors place in the said experts at the direction of the SPAC. If no acquisition is realized after two years then investors see their money reimbursed to them. 

Why are they making a sudden comeback ? 

The principal reason of their comeback to the front scene is the liquidity injected in the market by the Federal Reserve. Indeed, the Fed implemented a Quantitative Easing (QE), cut its federal funds rate and eased credit to fight against the coronavirus crisis and to prevent markets and the economy from collapsing. These measures resulted in more than $2.3 trillion injected into the U.S economy at of the end of April 2020 according to the Washington Post and way more since then. This extra money allowed investors to borrow at a very cheap cost which affected negatively the return of bonds which led many investors to invest on the stock markets since return is higher due to higher risk. 

This situation, in conjunction with the reduction of the number of stocks on the market for the last decade, brought SPACs back on the front scene since they facilitate acquisitions and usually increase returns for their underwriters. In the end, SPACs represent an answer to the higher demand in stocks and to the hope of finding the “next big thing“ but with a higher return since they decrease the acquisition cost. 

Why do SPACs represent a risk for investors and increase uncertainty on the market ? 

SPACS are accessible to everyone. Indeed, retail investors can invest easily whereas it is more difficult for them to buy shares in traditional IPOs. The average price of a share in a SPAC is $10. However, SPACs represent a risk because not only are they years away from generating revenues when they go public, but an IPO doesn’t always go as planned and retail investors are the most fragile on the market so losing their investment has an non-negligible impact for them. For example, Churchill Capital IV Corp’s shares had risen as much as 548% from its IPO and the firm was valuated at $17 billion after a report stating that it was close to merging with Lucid Motors, a luxury electric vehicle startup with a $12 billion valuation. Yet, the share price shrank by 42% last week leading to a $8 billion loss in market value because the deal saw a last-minute private investment diluting stock market investors. 

So SPACs are actually a means of investment based solely on the reputation of the leaders of the firm and not on economic facts and firms’ earning reports which increases the risk for investors because information and transparency are an important driver of a firm’s attractivity on the market so the more opaque a firm the riskier the investment and its share price volatility. 

In the end, the renewal of SPACs is the consequence of the current situation of the stock market with low rates easing speculation and making stocks more attractive than ever. But the higher demand for stocks and the presence of these firms tend to increase market volatility and making the future more uncertain. Moreover, even though the Federal Reserve announced that it wouldn’t change its monetary policy on the short term, if growth resumes at its pre-coronavirus pace, inflation might become a serious threat to SPACs because growth stocks are their principal targets but perform better in a low inflation environment thanks to lower input costs. 

An SEC intervention seems more and more necessary to regulate SPACs’ activities and to reassure investors. This should be one of the hot topics of Gary Gensler’s – President Biden’s pick to become head of the SEC – mandate.

Sources 

Young, J. (n.d.). Special Purpose Acquisition Company (SPAC). [online] Investopedia. Available at: https://www.investopedia.com/terms/s/spac.asp.

‌The SPAC Bubble Is About to Burst. (2021). Harvard Business Review. [online] 18 Feb. Available at: https://hbr.org/2021/02/the-spac-bubble-is-about-to-burst 

BFM Bourse. (2021). La folie des Spacs prend des proportions impressionnantes à Wall Street. [online] Available at: https://www.tradingsat.com/actualites/marches/la-folie-des-spacs-prend-des-proportions-impressionnantes-a-wall-street-953091.html [Accessed 1 Mar. 2021].

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