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The rise and fall of the SPAC empire (EN/FR)

-------------French Version Below-------------

A year after the SPACs hype, let’s see how SPACs became key to the investment landscape in a year and back to a shameful product in even less time.

I- The origination

Special Purpose Acquisition Companies, or SPACs, are management teams raising money to merge with a privately held company to facilitate the target company going public.

They are a subset of the larger category of blank check companies which refer to any company that does not have a business plan. Besides not having a commercial purpose, SPACs have the specificity to pool funds to finance an acquisition within a set timeframe.

SPAC’s main advantage is to reduce risk and shorten the IPO process for the target company. Indeed, going public through a SPAC takes less than half of the time it would take through a traditional IPO! Moreover, the valuation of the target company is negotiated prior to going public, providing its shareholders with less risk and more certainty regarding the capital raised.

Comparison table of key points for a target company to go public through a SPAC and an IPO.

The SEC tightly regulates blank check companies, specifying for example the money collected from the investors be held in controlled escrow accounts and restricting their use until the mergers are complete. Indeed, SPACs must generally acquire a target company within 2 years after raising the money from the investors, otherwise returning the money in its entirety.

While other types of blank check companies are considered as “penny stocks” by the SEC, in general associated with greater risks, SPACs were protected under the safe harbor provision of the Private Securities Litigation Reform Act of 1995, restricting investors to sue SPACs’ managers over financial forecasts. Whereas traditional IPOs do not have safe-harbor protection and thus do not include forward-looking financial projections, holding the managers liable for the relative performance of the projections.

At the beginning, SPACs focused on distressed companies or niche industries, representing merely a few IPOs a year.

II- The golden age

SPACs first became popular when the US government shut down in late 2018 after the Senate refused to fund the US-Mexico border wall. Due to the shutdown, the SEC was unable to review traditional IPOs.

During this month-long shutdown, companies were only able to go public through SPACs, without requiring the SEC’s approval.

In 2020, the global macroeconomic context drastically changed: lower-than-ever interest rates, excess of available cash, and standardization of SPAC products.

Established hedge funds, private equity, and venture capital investment firms all seized the opportunity and heavily invested in SPACs. Simultaneously, public figures such as Shaquile O’Neal, Stephen Curry, and Jay-Z sponsored some SPACs, feeding the hype.

As a result, SPACs IPOs skyrocketed both in their quantity and value, booming from $14b in 2019 to $80b in 2020 and $160b in 2021!

In both 2020 and 2021, SPACs IPOs represented half of the IPOs in the US market.

III- The fall of the SPACs empire

The hype around SPACs came down as quickly as it soared!

The SPACs market collapsed, reaching much lower levels than before the SPACs boom. In the last three quarters of 2022, SPACs IPOs raised $3b, less than half the amount raised over the same period in 2018.

This collapse can be explained by 3 factors.

(i) New regulations

In March 2022, the SEC issued a new legal framework tightening SPACs regulations:

  • higher information disclosure requirements, similar to a traditional IPO.

  • removal of the safe harbor provision, that is underwriters will be liable for financial projections they announce in the prospectus.

These new rules shook the SPAC market by erasing most of their advantages.

As a result, many investment banks announced exiting the SPAC market, sweeping away all hopes for a future recovery of the SPAC market.

(ii) Dire performance

After using aggressive financial performance to lure investors, SPACs performance came out far below expectations when publishing yearly earning reports.

The De-SPAC index, an ETF of companies that went public as the result of a merger with a SPAC, already registers a 76% loss since its inception in May 2021 (compared to an underperformance of 5% of the SP500 over the same period).

SPACs led by celebrities were also proven to be disasters. Jay-Z’s cannabis-focused SPAC, The Parent Company, performed even worse, shedding over 98% of its initial value!

A countless number of SPACs have failed in the past months. For example, a younger SPAC, FastRadius, that went public in February 2022, helplessly watched its stock plummet over 96% ; the company is filing for bankruptcy. Once valued at $1.4b, the SPAC bubble was generated by speculative investments, decorrelated from fundamental values.

(iii) Changes in the macroeconomic environment

Eventually, the SPACs collapse was significantly affected by the deterioration of the macroeconomic environment, in particular driven by the rise in interest rates and in geopolitical tensions around the world.

Traditional IPOs were also victims of this hardened context, shrinking over 95% compared to 2021.

IV- Conclusion