SPAC-ulative finance

One of the hottest investment tools in the past year and a half has imploded. But don’t give up on special purpose acquisition companies, or SPACs as these peculiar financial structures are called, industry experts say.

Also called blank-check companies, SPACs are here to stay, but not necessarily at the high-flying levels of 2020 and early 2021.

In Virginia, the practice of going public via SPAC has had mixed results. Most notably, Herndon- and Seattle-based BlackSky Technology Inc. and IronNet Cybersecurity Inc., a McLean-based tech firm that debuted in late summer, have seen strong returns on investment. But other Virginia-based companies have backed away from SPAC deals before completion, and Richmond-based CarLotz is being sued by investors after its stock price fell dramatically.

“The SPAC market is a little saturated, but I wouldn’t write it off,” says Derek Horstmeyer, professor of finance at George Mason University’s School of Business. “While the crazy hype we saw nine months ago is down, a lot of money is sitting in SPACs, waiting to acquire companies.”

An alternative to a traditional public offering, SPACs are public shell companies that function as holders of investors’ cash for the sole purpose of merging with private companies and taking them public with less regulatory scrutiny than a typical initial public offering. In 2020, more SPAC deals were completed than IPOs, and SPACs outpaced IPOs at a rate of 2 to 1 early this year, Horstmeyer says.

The practice also benefited from a little celebrity sparkle, with tennis star Serena Williams and NBA Hall of Famer Shaquille O’Neal investing in SPACs. In March, the Securities and Exchange Commission issued an alert to potential investors: “SPAC transactions differ from traditional IPOs and have distinct risks. … Sponsors may have conflicts of interest, so their economic interests in the SPAC may differ from shareholders.”

The SPAC surge ended soon after the alert was issued, and the market has yet to recover. 

“Yes, there was some aggressive risk-taking and speculation, but on the other hand, there were and are many quality companies coming public through this structure,” says Chris Pearson, a senior vice president and portfolio manager at Davenport & Co. LLC, a Richmond-based investment company.

“The great ‘SPAC-ulation’ was followed by the ‘SPAC-ocalypse,’” Pearson says, referring to speculative excesses that swept through the market only to be met with an apocalyptic drop. “A lot of investors were unfamiliar with this structure but saw the performance and were enticed by the opportunity to make a quick and substantial buck. Not all SPACs are created equal.”

In a traditional IPO, pricing can change until the night before shares start trading.

“A SPAC is more efficient because the money has already been raised and held in a trust,” says Kristi Marvin, CEO and founder of SPACInsider, a data and research provider for the SPAC asset class.

Companies could spend months getting ready for a traditional IPO, she says, only to have something unrelated happen in the market that delays the deal on the night it’s supposed to be priced.

“That is partly why SPACs were so popular [in 2020 and early this year] during COVID,” Marvin says. “The traditional IPO window was shut, but the SPAC window was still open.”

However, Pearson notes that some merger deals involved subpar companies with overly lofty projections.

In turn, some investors got burned. Now, regulators are looking more closely at SPACs, clamping down on the accounting procedure, and 19 class-action lawsuits concerning SPACs have been filed this year, including a high-profile suit questioning the legality of a proposed SPAC deal sponsored by hedge fund billionaire William Ackman.

Ackman, founder of the largest-ever SPAC, Pershing Square Tontine Holdings Ltd., said in August that he will return the $4 billion in investments in the stock deal between his company and Universal Music Group N.V. He claims the lawsuit is meritless but adds it is unlikely to be resolved quickly.

Industry insiders are watching how this lawsuit will play out, since it could have a significant impact on how SPACs are structured in the future, experts say.

Meanwhile, several blank-check deals announced this year have not been completed. Most companies are looking for deals that are trading below their listing prices — typically $10 a share. At the height of the boom, stock prices almost always rose after SPAC deals were announced. That’s not the case anymore.

Faster and easier

One benefit of the SPAC arrangement over IPOs is flexibility for investors, who can choose to pull their money before a merger is completed. They are more likely to do so if the stock is trading below list price, experts say.

Hundreds of SPACs are searching for private companies to buy and take public. They typically have two years to find and merge with private companies or they must return money raised from investors.

A SPAC consists of two basic transactions — the IPO of the SPAC itself and its subse-quent merger. The acquired company takes the SPAC’s place on the stock market.

Year-to-date as of mid-September, 435 SPACs had gone through the IPO process, raising a total of $125.9 billion for an average public offering of $289.3 million, according to SPACInsider.

By comparison, only 59 SPACs became public in 2019, underscoring the sharp rise in their numbers in a short period of time, the trade publication reported.

The SPAC strategy is often quicker than a traditional IPO. Once a target company is found, a merger can be completed in months versus a year or more with a traditional IPO. Also, in a SPAC deal, the company going public can make business projections, which is not allowed in a traditional public offering. 

Up until March, “the market was really robust, with almost 100 SPAC deals landing every month,” says George Geis, law professor and expert in corporate law and finance at the University of Virginia. “Now we’re down to nine or 10 a month.”

Although SPACs have been around for years, the recent enthusiasm built on its own momentum, Geis says.

“The flavor of the day — where people rushed in for chances to get quick gains on their investments — has fallen a little out of favor,” says Brent Allred, business professor at William & Mary’s Raymond A. Mason School of Business.

“Tighter regulatory oversight has added a level of complexity,” he adds, but it could provide greater shareholder protection and awareness.

“SPACs are not necessarily the utopia mechanics for going public,” Allred says. “Without the scrutiny [of traditional IPOs], some SPAC deals turned out well, but others came back to bite the shareholders.”

Despite the pullback this year, Pearson sees continued opportunities for SPAC deals. Success will be company-specific going forward, he says. “It comes back to what wins in the long term and what creates value for shareholders.” 

There’s also considerable demand. A total of 452 SPACs, including some that completed public offerings in 2019 and 2020, are searching for new target companies — typically young startups with potential but unproven track records in hot sectors like tech or green energy. The firms tend to be smaller and potentially riskier than those going through a traditional IPO.

Some, especially those with no revenue, typically would stay private longer, but with a SPAC, they can tap into public markets earlier to raise capital and fuel growth.

A mixed bag

In Virginia, Tysons-based Cvent Inc., an event management company, said in July that it plans to merge with San Francisco-based SPAC Dragoneer Growth Opportunities Corp., which trades on Nasdaq. The deal — expected to close in the fourth quarter — values the private-equity-owned company at $5.3 billion.

Other Virginia deals include BlackSky Technology, a geospatial intelligence and global monitoring firm, which debuted Sept. 10 on the New York Stock Exchange after merging with Osprey Technology Acquisition Corp., a Philadelphia-based SPAC.

NavSight Holdings Inc., a Reston-based SPAC, merged in August with Spire Global Inc., a San Francisco-based data and analytics firm. Shares started trading on the NYSE Aug. 17 under the “SPIR” stock symbol.

Also in August, McLean-based IronNet closed its deal — announced in March — with LGL Systems Acquisition Corp. The stock, trading under the IRNT ticker symbol, opened above the $10 listing price and flirted with the $40 range by mid-September.

Richmond-based CarLotz, a used-car consignment retailer, has not fared as well since going public in January by partnering with Acamar Partners Acquisition Corp.

Its stock price, which hit $11.25 on the first day of trading on Nasdaq, fell in mid-September to the $4 range. Analysts say CarLotz faces headwinds — including a global shortage of semiconductors — that make it difficult for the company to operate. But investors are not pleased. They have sued in the Southern District of New York federal court, claiming the company violated federal securities law. 

Other Virginia deals have fallen through in light of adverse market conditions and the dwindling appetite in general for SPACs.

These include Los Angeles-based SPAC Tailwind Acquisition Corp. and QOMPLX Inc., a Tysons-based risk management company for cybersecurity and insurance industries. The companies, citing market conditions, agreed in August to terminate their merger. 

And a proposed merger between Arlington-based digital news company Axios Media Inc. and San Francisco-based sports media publication The Athletic fizzled this spring. The companies had sought to join forces by forming a SPAC, The Wall Street Journal reported in March, but by May the deal had stalled.

“SPACs are highly cyclical,” says Marvin of SPACInsider.

The current downcycle was exacerbated by a regulatory change — where warrants (a contract that allows a shareholder to buy more shares in the future at a given price) had to be treated as liabilities instead of equities, she says. That change was followed by uncertain conditions, created in part by the emergence of more contagious coronavirus variants, and the pending fourth quarter, which can be dicey for the stock market.

“We are in a protracted downcycle,” Marvin says. “There are plenty of good target companies out there. The problem is the environment.”