The glowing SPAC market will get even hotter in 2021, raising concerns about rampant speculation that has been sane and may leave private investors fresh from the GameStop bankruptcy.
Not only are specialty acquisition firms raising record capital – more than $ 30 billion so far for the biggest quarter of all time – pre-merger SPACs are also seeing oversized pop on first day 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 the University of Jay Ritter, professor of finance in Florida.
“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 seen as a sign of healthy investor appetite and an optimistic market environment, the initial SPAC rallies are less rational. These blank check companies are empty corporate hulls that collect money from investors and then, within two years, merge with a private company and take it public.
So when return-hungry investors raise the prices on 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 rise 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, chief marketing strategist for TD Ameritrade. “This is useful for people who are going outside of the S&P 500 or the Nasdaq 100 price range. They will keep seeing 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 accounted for 46% of trading volume in SPACs on their platform in January, up from about 30% two months ago. By comparison, retail volume only takes 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 of 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 is closed almost always lose money.
Of the 114 companies that have gone public via SPAC mergers in the past 10 years, investors lose an average of 15.6% if they buy common 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 hold 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 receive an offering price of $ 10 plus the benefits 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 rating.
“The valuations 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 past 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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