Investors should be wary of a Spacs resurgence

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FT editor Roula Khalaf selects her favorite stories in this weekly newsletter.

The writer is a former investment banker and author of Power Failure: The Rise and Fall of an American Icon

Sometimes I wonder if investors will ever learn from their reckless choices. Take, for example, the denouement of the latest version of the craze for Special Purpose Acquisition Corporations, or Spacs.

You’ll remember that these were all the rage during the pandemic, although I could never figure out why so many investors were drawn to them. The idea behind Spacs, which have been around for decades and used to be called “blank check” companies, is relatively simple.

A few connected guys get together and decide they’re going to “sponsor” a Spac. They come up with a dumb name that aspires to greatness, write a prospectus, and then try to raise equity for their empty shell of a company by selling stock in an initial public offering to investors. If they can raise money from other people, the sponsors have two years or so to find a private company to merge with.

The formerly private company then goes public, with the hope that the stock will go up and everyone involved makes money. Of course, the sponsors usually get rich anyway because they end up owning about 20 percent of the Spac stake they paid peanuts for.

There are risks for sponsors. If they fail to find a merger partner within the two-year period, they must return the money raised, plus interest, including underwriting fees related to Spac’s IPO, to investors. This can hurt. Just ask hedge fund manager Bill Ackman. In 2021, at the height of the pandemic, he created a Spac, Pershing Square Tontine Holdings, and raised $4 billion in an IPO, the largest Spac ever. But it could not find a deal in time, and in 2022 the company announced that it had to unwind and return the money to investors. According to Spac Research, more than 350 spacs have been liquidated since the start of 2022 without finding a merger partner.

Usually, though, it’s the retail investors who end up holding the bag. A few of the many horrific examples will suffice. The spac created from the ashes of WeWork went bankrupt before being sold out of Chapter 11 protection after a debt restructuring. The one that merged with Lordstown, the electric car maker went bankrupt and emerged as Nu Ride Inc. Spac that merged with AppHarvest, an indoor farming company backed by JD Vance, when Donald Trump’s managing partner was a venture capitalist? It filed for bankruptcy protection last year and was liquidated. Bird Global, the scooter company that once boasted a market value of $2.5 billion, has filed for bankruptcy protection before its assets are sold.

According to Bloomberg, there were “at least” 21 bankruptcies of Spacs that found merger partners in 2023. Not all Spaces went bankrupt, of course. Some are like Sir Richard Branson’s Virgin Galactic, the spaceflight company that merged with a Spac sponsored by a serial launcher of these vehicles Chamath Palihapitiya. Publicly traded Virgin Galactic is down nearly 99 percent from its all-time high, while Palihapitiya cashed in 2022, raising $200 million by selling his personal shares. Bloomberg pegs the investor losses for those spacs that failed in 2023 from the top market caps at $46 billion.

Apparently, memories are short. According to the Financial Times, Spacs bounced back in the first half of the year as traditional IPOs were few and far between. Funding for them is up 20% so far in 2024, over 2023, according to Dealogic, with about $3 billion in new capital raised. More than 20 new Spacs, hoping to raise $4.3 billion, have filed IPO documents since June. This compares to the $1.8 billion they raised in the second half of last year.

Apart from the fact that everyone involved in things like Spacs – the fee-hungry Wall Street bankers, the bigoted and greedy sponsors, too many overly optimistic investors – have already forgotten the recent carnage, there seems to be an element of logic to the resurgence. .

There are still thousands of relatively large private companies looking to go public, many of which are backed by venture capital firms or private equity firms looking for an exit strategy. Even though the last week of July was one of the busiest in the IPO market since December 2021, Wall Street bankers don’t expect much new IPO activity until well after the Labor Day holiday in early September, if then. Gaps can fill the gap in the traditional IPO market.

But that can only happen if investors buy into Spac mania again. It doesn’t have to and frankly shouldn’t give away the record.

Too often it is the Spac sponsors and the Wall Street underwriters of the Spacs who come out unscathed, laughing all the way to the bank. With a little discipline and investor restraint, however, the latest spac boom can be nipped in the bud.