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SPACs Party Like It's 2020

The enthusiasm for blank check companies continues in 2021, and electric vehicles and mobility tech could benefit.

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In 2020 there were close to 250 special purpose acquisition companies, or SPACS, which raised more than $83 billion, with an average size of $334 million, according to spacinsider.com. So far this year, the count is already at 75. Why all the excitement for SPACs?

Serial SPAC’er Chamath Palihapitiya invested in two companies going public via a SPAC in one day. This is on top of the six blank-check vehicles he helped raise in 2020.

Why 2020?
The sustained volatility and the distinct price declines earlier in 2020 made initial public offerings and direct listings impractical options for the majority of private companies, which is where SPACs have found an opportunity.

“Unlike SPACs, direct listings do not allow private companies to raise any new capital during their transition to the public markets, which presents a problem for many start-ups, given the elongated economic ambiguity driven by the pandemic,” explains analyst Cameron Stanfill of PitchBook, a Morningstar company.

Essentially, he describes SPACs as large “boxes of money, that necessitates a much lower level of diligence than a similarly sized IPO of an operating entity, since there are no financial statements to scrutinize.”

Now that there are relatively fewer traditional IPOs, investors have flocked to SPACs in hopes of hitting upon the next Tesla (TSLA), or PayPal (PYPL). With this increased demand, existing sponsors have raised higher amounts. 

And if you want more diversification and easy trading of your SPACs, don’t worry-- there’s an exchange-traded fund (or three) for that!

New SPAC ETFs
In the first month of the new year, Morgan Creek Capital Management and Exos Financial launched 2021’s first SPAC exchange-traded fund, and the third SPAC ETF overall.  

Morgan Creek Exos SPAC Originated ETF (SPXZ) follows the first-ever SPAC ETF, Defiance Next-Gen SPAC Derived ETF (SPAK) and the first-ever active SPAC ETF, SPAC and New Issue ETF (SPCX); both launched in the last quarter of 2020, and both are up more than 15%.

SPAK’s portfolio holds mostly established companies that have gone public via SPACs. SPCX holds shares of SPACs looking for companies to bankroll. With SPXZ, you get a mix of both.

What Are SPACs?
A SPAC is a company with no real business operations. It exists only to raise capital via an IPO, and to then use that capital to buy existing private companies.

“This atypical pathway to the public markets was once a niche strategy for small investment firms," Stanfill explains.

These companies own and manage nothing except the cash that they raise. Because of this, they are called blank-check companies. They are generally formed by investors, also called sponsors. Sponsors usually have experience and expertise in a particular sector, and it is assumed that the acquisition targets will be companies in that sector. Many sponsors are seasoned private equity investors.

"These early embracers saw SPACs as a way to extract fees from adding structure to a reverse merger," notes Stanfill. "The strategy has now become the hottest financial topic of 2020 after a massive uptick in the volume of these blank-check vehicles and as the stature of the investment professionals involved legitimized the space.”

How Do They Work?
“At first, the SPAC follows the traditional IPO process registering with the SEC, filing prospectuses, and running investor roadshows," explains Stanfill, "This entity then prices the IPO and raises the funds that will subsequently be deployed to acquire the target business. At this point, the SPAC is a publicly traded shell company and has assumed much of the cost and time commitments usually borne by the target company.”

Once the SPAC raises capital, it usually has two years to complete a deal. If it does not do so, it faces liquidation. The capital is placed in a trust account, which earns interest at market rates.

Meanwhile, these publicly traded companies don't have to identify the companies that they want to acquire. Put another way, if you buy into a SPAC, you will have no idea which company you might end up owning--You don’t even know if you will end up owning an acquired company.

The concept of a SPAC itself can be boiled down to a pre-sold IPO for the private company that it acquires, without many of the stringent requirements, checks, and balances that go into a traditional listing.

SPACs and EVs
Last year, we talked about how if the lofty dreams of renewable-energy-powered, self-driving cars are realized, they may have the 2020 SPAC bonanza to thank for it. In 2020, 26 mobility tech companies merged with SPACs (or are in the process of doing so), representing a combined valuation in excess of $100 billion and generating an average return of 63.8% since their announcement dates, according to PitchBook data.

The blank-check activity is being powered by public investor demand, the capital needs of these R&D-heavy startups, and broad tailwinds for electric vehicles. Arguably, there has never been a better time for makers of unprofitable and often unproven technologies to go public. "Investors are willing to pay up for almost anything in the EV supply chain," said Morningstar senior equity analyst Seth Goldstein.

In a recent report, The EV/Mobility SPAC Handbook, PitchBook analysts Asad Hussain and Zane Carmean point out that the strength of recent mobility SPAC listings indicates high investor enthusiasm for transportation technology, such as EVs, and demonstrates that mobility startups may be able to raise more capital in the public markets than they could as private entities. 

“In the latter half of the year, our Mobility SPAC Index generated a return of 77.7%, well above the S&P 500 total return and Nasdaq 100 total return of 22.2% and 27.4%, respectively,” the report says. The Morningstar U.S. TME Index returned 18.64%.

Areas of interest that the authors uncover in the space include the EV sector, electric charging infrastructure and next-generation battery technology, autonomous driving, lidar technology, micromobility services and the emerging electric air taxi industry.

Should You Buy A SPAC?
As always, we recommend caution.

First, You do not know in advance the acquisition target; you’re taking a bet on the founder of the SPAC. Retail investors rarely have insight into the minds of founders, and they can make bets based only on public perception. This is a risk.

Second, even if the founder has a target in mind, the SPAC might not be able to close the deal. If this is the case, and you get your money back a few years after the initial investment, that is an opportunity cost. An opportunity cost is what you lose in gains you could have potentially made had you not invested in the SPAC.

Third, as Stanfill’s note on fees to investment banks shows, a lot of people are making a lot of money from SPACs--and those people don't seem to be retail investors.

Fourth, the success of the SPAC depends on the success of the company it acquires. As established, the research, due diligence, and checks behind these acquisitions may not be as stringent as it would be in the case of a traditional IPO or public company acquisition. Again, it seems like the investor is the loser.

So before you invest in a SPAC, ask yourself who is making the money, what are they making the money on, and whether there are alternatives you could consider. And as always, invest based on your financial goals, risk appetite, and time horizon. When in doubt, seek a financial advisor.

Ruth Saldanha does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.