Do-Nothing SPACs Sag, Offering Investors a $1.1 Billion Return
(Bloomberg) -- What would you do if someone offered to let you buy dollars for 99 cents and walk away with a billion-dollar profit?
That’s the opportunity, at least in theory, presented by underwater SPACs. Some 300 special purpose acquisition companies debuted in the first quarter of this year, creating an oversupply with at least 302 that hadn’t bought anything yet and were trading for less than the cash raised in their public offering. They’re also facing an eventual deadline to liquidate if they don’t come up with a deal.
Typical discounts as of March 31 averaged around 1.22%, with some selling for as little as 96 cents on the dollar, according to data compiled by Bloomberg. Count up all those pennies plus interest earned by SPACs on their idle cash, and the potential take amounts to a cool $1.09 billion.
“It’s creating mark-to-market losses, but also extraordinary opportunity,” according to Steve Katznelson, chief investment officer at Radcliffe Capital Management.
The possibility stems from how SPACs are created. The investment vehicles go public, typically at a price of $10, with the intention of making an acquisition within a self-imposed time-frame. In the meantime, they park their cash in short-term Treasuries. If they’re unable to complete a deal, their cash trust is liquidated and investors get their money back less expenses.
As of March 31, it would cost about $81.4 billion to buy all those SPACs -- shares and units -- trading below $10, according to data compiled by Bloomberg. Assuming a Treasury yield of 0.05%, two years from IPO to expiration and warrant values of zero, an investor would walk away with around $82 million in accrued interest on top of the principal.
Some notable examples include Sports Ventures Acquisition Corp. whose shares were trading for $9.62 a share last week. Epiphany Technology Acquisition Corp. stock could be had for $9.79 and Colin Kaepernick’s Mission Advancement Corp. was going for $9.95.
To be sure, a lot could go wrong along the way to cut into the hypothetical gains. Executives might agree to disastrously overpay for a company they buy, or extend their deadline and make investors wait longer for their payoff, diminishing the time value of the strategy.
But history loves the concept, according to data from Jay Ritter, a University of Florida finance professor who tracks initial public offerings. By his reckoning, purchasing a SPAC at the initial offering and selling at the time of its merger from January 2010 through October 2020 would have returned 9.3% annually on an equal-weighted basis. If no partner emerges, investors who buy at a discount at least collect the difference when the SPAC liquidates.
“No one loses money on this investment strategy,” Ritter said in an interview. “Worst you can do is redeem. It’s free lunch sitting there for years.”
With the glut in SPAC issuance, liquidations are likely to rise, according to Ritter. Of those that went public from January 2010 to May 2018, roughly 15% wound down without reaching a deal. Given the current imbalance of SPACs and targets, Ritter estimates that half will simply return money to shareholders.
In the event that the rush to find a target leads to a dubious deal, an investor who bought the discount can redeem before the merger is completed. That strategy outperforms buying the companies that emerge from SPAC combinations and holding them for one year, with Ritter’s data showing an annualized loss of 15% on an equal-weighted basis.
As the enthusiasm for SPACs wanes, investors seem keenly focused on time -- how long before an actual deal emerges -- which may result in persistent discounts. While it isn’t entirely unusual for pre-deal SPACs to trade at a slight discount, the market has changed in the past couple of months, with almost every one trading below $10, according to Tyler Silver, a partner at New York-based investment firm Apex Capital Holdings.
“The market is short-term focused,” said Julian Klymochko, chief of Calgary-based Accelerate Financial Technologies, which specializes in alternative investing. “I’ve heard from a number of retail investors who say they don’t have the patience to wait two years.”
Older SPACs just months away from signing a definitive agreement have fared better than newer ones amid the weakness, he said. With roughly 500 days remaining until deadline day for the average SPAC trading under $10, newcomers in particular could have trouble getting attention.
“SPAC IPOs used to trade 30% to 40% of float on Day One; now the retail bid is gone,” Klymochko said. “If you’re new, you’re getting smoked.”
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