Booming Blank Check Companies Are the Talk of Reddit and TikTok
(Bloomberg Businessweek) -- The SPAC boom that seemed to come out of nowhere in 2020 is still going strong. Billionaires, celebrities, and money managers are lining up to start special-purpose acquisition companies and hedge funds are clamoring to buy an early piece of them. Retail investors are piling in, with Reddit boards and even a corner of TikTok lighting up with discussions about these unusual stocks. SPACs, also known as blank check companies, are empty corporate shells that raise money from investors and then aim to merge with a private business, essentially taking that company public through the back door.
“This stock has the potential to double or maybe triple your money in 2021,” crowed one TikTok user, who donned a beanie as he walked users through his investment ideas over the sounds of electronic music. The SPAC he was hyping had recently announced a deal to buy a financial technology company. His video garnered almost 18,000 likes.
Last year more than 200 blank check companies raised $80 billion from investors, according to data compiled by Bloomberg. That exceeded the combined total in all previous years and made up almost half of the year’s volume of initial public offerings, the data show. So far in 2021, another 67 SPACs have hit the market. “The trends we were seeing in 2020 are the ones we’re seeing in 2021—that’s continued acceleration and the continued acceptance of the SPAC product as a tool for companies to go public,” says Russell Chong, co-head of North American equity capital markets at Citigroup Inc.
SPACs are started by a sponsor, who might be a large private equity fund, a venture capitalist, or perhaps someone with a well-known name. Former Speaker of the House Paul Ryan is the chairman of one SPAC; basketball legend Shaquille O’Neal is a strategic adviser to another. Sponsors create a company and work with a bank to sell shares in an IPO. The company will have no actual business, other than to take the cash it raises to invest in another company that’s yet to be identified.
In its IPO the SPAC sells units that include a $10 share of the company and something called a warrant, which is a right to buy more shares at a cheap price if they rise in value. The vast majority of the proceeds—which average about $250 million—come from hedge funds and other institutional investors who are able to get in early. The clock is then on: A SPAC has two years to find a company to merge with. If it can’t find anyone to do a deal with within two years, the company dissolves. The sponsors lose whatever investment they’ve put in, and the other investors get their cash back.
If the blank check company does find a partner to merge with, shareholders can choose to hold on or, if they don’t like the deal, redeem their shares for $10 plus a bit of interest. This is why some investors consider a SPAC to be a low-risk bet, and redemptions actually happen more often than not: More than two-thirds of SPAC shares are usually tendered. When a deal goes through, sponsors typically get paid in the form of cheap stock in the newly merged company. The target company, merging with the already-public SPAC, gets listed on the market without going through some of the hoops required in an IPO. (After the deal, the SPAC typically takes on the target company’s name.)
That’s a lot moving parts, so it’s worth reviewing: A SPAC can be a great deal for early investors, sponsors, and target companies. Which raises the question, who pays for all this good stuff? Critics says it’s usually the investors who buy in later and hang on after a deal is completed.
For hedge funds that invested early and redeemed their shares when the merger was announced, the average returns were about 11.6%, according to a paper on SPACs by law professors Michael Ohlrogge of New York University and Michael Klausner of Stanford, and management consultant Emily Ruan. But for investors who stick around, shares typically lose one-third of their value or more in the year following the merger. Part of the problem is that the sponsors’ take and the warrants held by early investors dilute the value of the shares left over for everyone else.
“It’s very strange,” says Klausner. “I fundamentally don’t understand why these things exist.”
Blog posts warning individual investors of the risks inherent in SPACs now dot the websites of many of the biggest retail brokerages. “It’s important to conduct due diligence and be prepared for undesirable outcomes,” says one from TD Ameritrade. Another, from Fidelity, says SPACs allow companies to go public while “avoiding the usual regulatory scrutiny required of companies pursuing a traditional IPO.” Investors seem to be hungry for new companies, including some that in other times might have had difficulty going public, and SPACs are greasing the rails.
“I do not think this is sustainable in the medium term,” Goldman Sachs Group Inc. Chief Executive Officer David Solomon warned in an earnings conference call in January. “And there will be something that will, in some way, shape, or form, bring the activity levels down over a period of time.” But many banks—including Solomon’s—have bolstered their fees this year by helping SPACs go public.
In a way, the rise of the SPAC also marks a return of investor interest in active money management. Think of a SPAC as a fund whose aim is to buy just one home-run stock, and the sponsors’ take as a fat management fee. Many blank check companies are even led by the biggest names in hedge funds, such as Pershing Square Capital Management’s Bill Ackman or Glenview Capital Management’s Larry Robbins. (Ackman has said his SPAC is less costly for investors than most, because it’s not designed to pay him with the usual chunk of cheap shares, though he can profit from warrants.)
Still, even the titans of Wall Street can have trouble generating big returns when too many money managers start chasing too few deals. Another six dozen blank check companies that have announced plans in January to raise a combined $18 billion are awaiting their IPOs. “It just seems like that may be too much, and there just isn’t capacity for additional SPAC IPO activity,” says Jim Shanahan, a senior equity research analyst at Edward Jones.
The U.S. Securities and Exchange Commission recently provided guidance for disclosure requirements for SPACs, suggesting watchdogs have been looking more closely at the newly booming stocks. But it’s unclear at this point if Gary Gensler, President Biden’s pick to be the leader of the SEC, will focus on them. Blank check companies were associated with a lot of penny-stock scams in the 1980s, but they largely faded away in the 1990s after regulators and Congress made tougher rules for them.
SPACs have some big forces behind them for now. Investors are still hunting for better returns as interest rates languish near record lows around the world, and there’s lots of appetite for risk. There are also plenty of companies eager to cash in on high equity valuations. For bankers, there’s no time to waste. Citigroup, the No. 2 underwriter for SPACs in 2020, has hired four bankers dedicated to helping special-purpose acquisition companies in the last 18 months alone. “There’s a recognition that there’s a lot of uncertainties in this market still, despite the fact that indices are marching upwards,” Citigroup’s Chong says. “No one is taking anything for granted.”
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