The red-hot SPAC market is getting even hotter in 2021, and it raises concerns about unbridled speculation, detached from the reason small investors may want to keep the GameStop bus fresh.
Special purpose acquisition companies not only raise a record level of capital – more than $ 30 billion so far for its largest quarter ever – but SPACs before the merger also see an exorbitant pop on the first day of trading.
New transactions recorded an average jump of 6.5% on their debut this year, an almost six-fold increase in their historical levels (from 2003 to 2020, the average return on the first day of SPAC stockbrokers is only 1.1%) , according to University of Jay Ritter, Florida’s financial professor.
“Each of them has risen in price. It’s not driven by one or two outliers,” Ritter said.
Unlike traditional IPOs where debut recordings are generally seen as a sign of a healthy investor appetite and a positive market environment, the initial meetings of SPAC are less rational. These blank check businesses are empty corporate shells that raise money from investors and then merge with a private company within two years while it is made public.
So when yield-hungry investors offer prices for blank check transactions, they are essentially taking a leap of faith and betting on something without valuation or a real business. Many believe that the rise in SPAC prices could be a sign of speculative behavior in a new bull market with massive liquidity and uncontrolled animal spirit.
“There’s a lot of money coming into the market,” said JJ Kinahan, TD Ameritrade’s chief market strategist. “It lends itself to people who go beyond the course of the S&P 500 or Nasdaq 100. You will continue to see this behavior just because people look around to see what’s there, except to buy the same stocks that everyone else buys.”
Retail investors jump in
There are signs that the SPAC boom is getting caught up in the market rust of retailers. Bank of America’s customer flow showed that in January retail investors represented 46% of the trading volume in SPACs on its platform, up from around 30% two months ago. By comparison, retail staff occupy only about 20% of S&P 500 trading on Bank of America’s platform.
“The speculative nature of SPACs seems particularly for retail,” Bank of America analysts said in a note. “We certainly do not need to remind anyone what can happen if something speculates on the retail radar (ahem, GameStop).”
There is an allure of getting an early part of a SPAC deal for many small investors who are watching big business with big growth. Since the majority of individual investors buy SPAC shares on the open market, they are likely to miss the first day’s pop-up. In addition, many brokers do not trade with SPAC warrants, which is a sweetener that early investors offer more compensation for their cash.
In fact, for buy-and-hold investors who only come in after a deal is made, they almost always lose money.
For the 114 companies that have become known through SPAC mergers over the past ten years, investors lose an average of 15.6% if they buy ordinary shares of a merged company on the first day of trading and hold them for a year, according to Ritter. And they lose an average of 15.4% if they own the shares for three years.
However, this is a different story for institutional investors. Hedge funds and other players participating in SPAC IPOs can often get offer prices of $ 10 plus the benefit of warrants. They also tend to sell shares once the merger is complete, which can negatively affect the price.
“Institutional buyers realize that this is a lot,” Ritter said. “The SPAC IPOs are essentially cheaper convertible bonds that are below standard price. The worst they can do is $ 10 plus interest, and no one has lost money.”
Competitive valuations
Another worrying factor is the large number of transactions that are currently chasing targets. A record of more than 300 outstanding SPACs is being hunted, giving private companies more bargaining power and enabling investors to play off against each other to get a better valuation.
“The valuations have obviously become more competitive,” said Soumya Sharma, a corporate lawyer for Troutman Pepper. “The reason it’s going to survive is that high targets agree to merge with SPACs because they believe it’s better valued.”
As the target companies’ valuations increase higher, this reduces the upward potential for the SPAC investors. Meanwhile, sponsors can compete for lower quality companies, many of which do not yet have to manufacture a physical product.
“The last few months have been great for the SPAC investors, but the returns have been very high, but I don’t think it will be able to continue like that,” Ritter said.
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