Special Purpose Acquisition Company

A Special Purpose Acquisition Company (SPAC) or a Blank Cheque Company is a company formed specifically to raise funds from the public and utilise the funds to acquire one or more private companies. A SPAC lists on the stock exchange through an Initial Public Offering (IPO) to raise funds from retail investors. Forming a SPAC allows the investor(s) or acquirer(s) to raise funds without having to seek any sort of loans. Thus, SPAC in itself has no business but to just invest the funds into one or more private companies. SPACs are typically sponsored by high reputed individuals or companies (they receive a larger portion of equity for a smaller portion of investment). These sponsors play an important role in the IPO process to increase the reputation of the SPAC. So far, no SPACs can list on Indian exchanges. However, regulations are defined on how foreign SPACs can invest in Indian companies.

Private Investment in Public Equity (PIPE)

It is basically an arrangement where institutional investors buy the shares of public companies (in this case, a SPAC) for a share price lower than the current market price of the share. There may be several benefits to have a PIPE for a SPAC – from increased credibility / reputation to raising more funds.

Data on SPACs and its Interpretation

SPACs raised $78.6 bn in 2020 as opposed to $14 bn in 2019. Such a sharp growth could only be justified by the investor sentiment during the pandemic. According to Rifinitiv, 126 SPAC IPOs raised $44B in the first nine months of the year, more than three-times the sum raised during the same period last year, as corporate value creators and investors seek to dodge the volatility and uncertainty of traditional listings through a cash-as-equity raising.

With such a sharp increase in SPACs, we can clearly see how many options PIPE investors have to invest into. Also, all of these SPACs are now in a hunt to merger with or acquire companies. This basically increases the demand for companies looking to get acquired and hence, results in high valuation (higher than an investor would be willing to pay) merely due to the demand-supply dynamics. This may also backfire as the deals may not go through and the SPACs will not report the returns they promised. On the flip side, high value deals may go through (investment banks will earn huge!) and SPAC shares will provide high returns – but only if the acquired company was genuinely worth spending such a fortune on. If he acquired company does not live up to its valuation expectation, then again it is a problem. Whatever happens, good or bad, the result will be out in a year or more.

For now, we need to also know that there is a huge backlog. According to Financial Times, only 25% of the SPACs listed in 2019 have completed deals so far. According to Refinitiv Data, 497 SPACs are still looking for a deal. Furthermore, more SPACs are being added this year, at an increased rate. Hence, the demand if rising but supply of companies seems to be a problem.

Another hurdle for SPACs right now is that the PIPEs are slowing down because of the ocean of potential transactions, valuations, etc. A slowdown in PIPE is a problem for SPACs as it really affects the deal making ability and potential of the SPAC.

Concluding thoughts

Many call this a SPAC bubble and Harvard Business Review also predicts this bubble to burst like others. Though it sufficiently seems a bubble, let’s not label it. Rather, let’s watch what happens. The key is to understand where the M&A market is going and whether there are increasing number of companies wanting to be acquired. SPAC is technically buy-side (it BUYS companies). Hence, the watch must be for the sell-side (companies willing to sell). The buy-side and sell-side must ideally come to equilibrium (at least in terms of deal valuation if not the number) to avoid this bubble burst or a standstill in the shares of the SPACs or any of the downside risks we anticipate.

Disclaimer: These articles are intended towards novice audience trying to understand the market with little to no knowledge about the same. The purpose is educational and must not be considered as a tip of any sort. Always make your financial decisions based on expert's personal advice to you. Also, do not forget to do your background research and not fall prey to any kind of fraud or manipulation.