The popularity of special-purpose acquisition companies (SPACs) has risen in the limping IPO markets due to a pandemic-induced recession. Last month, Bill Ackman, the billionaire founder of Pershing Square Capital Management, announced his plan to raise $3 billion from the public market for a blank check company. The SPAC, called Pershing Square Tontine Holding, aims at merging with a mature unicorn. Akman’s Pershing Square will also commit a minimum of $1 billion into the blank-check company.
The months of March, April, and May saw SPAC IPOs largely reach or exceed parity with traditional IPOs in deal counts and values. According to 2020 Pitchbook data, SPACs have accounted for 38% of total US IPO filings and raised $6.5 billion as of May 20th – more than the total capital raised by institutionally backed IPOs during the same period.
What is a SPAC?
A special-purpose acquisition company (SPAC) is an entity formed by financial sponsors for the sole purpose of purchasing or merging with another private company. The blank-check company first follows the traditional IPO process: registering with the SEC, filing prospectuses, and running investor roadshows. The entity then prices the IPO and raises the funds that will subsequently be deployed to acquire the target company. Once the SPAC becomes a publicly traded company, financial sponsors spend 18 – 24 months hunting for potential target companies. If the deal is approved by the majority of the SPAC’s shareholders, the merger effectively takes the target company public, without needing another initial public offering. The SPAC then transforms into the target company.
Why do companies go public through SPACs?
The COVID-19 pandemic has brought some unprecedent business closures, record unemployment and market volatility. The challenge of accurate IPO pricing in a wildly fluctuating stock market deters startups from going public. Under the current situation, a SPAC has several advantages over a traditional IPO:
Flexibility: To financial sponsors, SPACs are an investment vehicle in search of an investment opportunity. The deal structure affords managers flexibilities in the type of target, deal timing and terms of a future deal. The two-year deal window allows financial sponsors to be patient during times of volatility and potentially take advantage of the depressed valuations of companies desperately in need of capital infusion.
Certainty: To investors, SPACs also provide certainty amid turbulent markets. If the SPAC finds a target company that is approved by a majority of the shareholders, SPAC investors effectively become shareholders of the target company; if the SPAC fails to find a target company or obtain majority shareholder approval, investors get most or all of their initial investment back. However, excitement over SPACs has sent their share price well above the initial offering price. If the SPAC is unable to find a candidate, investors may face substantial losses due to premiums.
Simplicity: To acquisition candidates, SPACs offer a simplified process for making their shares public. The SPAC itself goes through the arduous U.S. Securities and Exchange Commission's IPO registration process when it first goes public. Although the merger between the SPAC and the target company will trigger additional SEC disclosure requirements, the process is easier and faster than filing a full S-1 registration statement for a new IPO. The immediate liquidity offered by these vehicles is also an alternative to a strategic acquisition by large private companies.
There have been several exciting SPAC headlines recently:
Virgin Galactic Holdings (NYSE:SPCE) used a SPAC formed by Social Capital Hedosophia to bring its shares onto the open market in late 2019.
In April, DraftKings (NASDAQ:DKNG) moved forward with its merger with Diamond Eagle Acquisition, after postponing it due to the coronavirus pandemic.
Electric-truck company Nikola (NASDAQ:NKLA) closed on its combination with SPAC VectoIQ Acquisition earlier in June.
A big boom for SPACs
SPACs enjoyed a similar burst during the 2007 financial crisis, although a large number of deals ended up being withdrawn as closing within the timeline proved difficult. However, for the past three months, the sharp market decline has not been followed by a wave of withdrawn deals. On the contrary, the pipeline of pending SPAC initial public offerings has accelerated to establish 2020 as a record-breaking year for SPAC volume in dollar terms.
Because of SPACs’ ability to weather the current market turbulence, we expect them to continue as some of the few IPOs going forward during this period of economic uncertainty, with the success of those listings encouraging more firms to rekindle or implement a SPAC strategy.