Investment

The SPAC boom is over. What next for family offices?

We have hit peak SPAC. Recent data shows the first-day return for shares in the sector has fallen to zero, against a jump of 30% earlier this year. 

The data from Florida academic Jay Ritter implies the market now sees no value in SPAC deals.  New issues are a tenth their record of 109, set in March. SPAC prices are down a quarter from their peak, wiping out all their gains this year.

Regulatory proposals by the SEC have added to the pressure. One investor said the collapse of Bill Hwang’s family office Archegos Capital had persuaded them to look more closely at complex investment vehicles, like SPACs.

I’ve been in the business a long time, and I’ve never seen a market go up 10X like it has in the past year. There are probably a lot of issuers who probably shouldn’t have access to the markets

Investors are also starting to wonder why SPACs let their sponsors to generate gains from shares and warrants as high as 800% while running up fees to financiers to keep its plates spinning. 

Lex van Dam, founder of the SFO Alliance network, says: “SPACs have too many layers of fees and dilute returns for the end investor.”

A glut of SPACs are looking for a deal, following debuts totalling $88 billion in the year to mid-March against $83 billion in 2020. Sectors like electric cars are crowded with SPACs. No less than eight of them are planning high-risk missions in outer space, where one manned explosion could damn the sector. One SPAC space deal, Virgin Galactic, has just fallen 50% from its peak, after a sale of shares by founder Sir Richard Branson.

Private equity giants like Apollo Capital and KKR have been trying to muscle into the SPAC action. But maybe they will change their mind.  Hedge fund Marshall Wace has warned that SPACs will end badly. It has increased its short positions.

As Bank of America has pointed out there is also a risk that frustrated sponsors rush through unsuitable deals to comply with a requirement that they must find a transaction within two years, so they can keep their shares and profit from them. With a decent narrative, it can be hard to tell a good deal from a bad one.

Many still argue that SPACs are a good innovation compared to the laborious IPO process dominated by investment banks. And that’s probably right. They are certainly better than unregulated blind pools which pulled in cash during prior bull markets. It is highly likely that someone will build on current achievements, with regulatory approval, when the dust settles.

For now, however, advisers are saying family offices can be expected to dial back their involvement: “Is the market taking a pause? Yes.” Leon Wagner, chairman of advisory firm LW Partners told Sportico “Should it be taking a pause? Yes.” 

Prior to March, US SPACs were beneficiaries of booming markets fuelled by retail investors who readily lapped up SPAC tips in the social media.

In the second half of 2020, retail investors accounted for 40% of trading on Bank of America’ SPAC trade. One SPAC investor said: “SPACs relied more heavily on retail investors than they ought to have done.”

Retail interest has ebbed as overnight profits generated through SPAC launches and their deals have evaporated. Retail flows are a tenth of the level struck in 2020.

Institutional managers also feel they can afford to wait when deciding to build positions. According to one manager:  “If Fidelity feels it can take its time, so can I.”

Until recently hedge funds invested in early-stage SPACs to reap a steady return from their share price arbitrage following a deal. Gains were achieved with the help of surplus capital, generated by low interest rates and pandemic savings. Gains also benefited from an absence of short-sellers, following a squeeze on their positions after the GameStop affair.

Fears of inflation and a rise in bond yields began to erode support for speculative growth stocks from the middle of February just when SPAC issuance was set to skyrocket. The market had travelled too far, too fast. 

According to LW’s Wagner: “I’ve been in the business a long time, and I’ve never seen a market go up 10X like it has in the past year. There are probably a lot of issuers who probably shouldn’t have access to the markets.”

Investors now wonder why sponsors should be able to take their profits as soon as deals were finalised. One investor said he wanted to see SPACs tell sponsors to take profits only when performance targets were hit. Another expressed concern over the limited number of auditors in the sector.

Investment banks Morgan Stanley and Evercore are each producing SPACs which align the interests of sponsors and SPACs more closely. 

To be fair, a few SPACs have achieved this. But a German investor slammed the early exit of US sponsors, leaving overseas companies to soldier on alone:  “What happens when they walk away leaving companies alone to deal with their Wall Street listing?”

The SEC chose to intervene in SPACs at the precise moment that its warnings would have a big impact, not long after the arrival of the Biden administration. 

On 10 March it warned that investors should not necessarily believe the stories spun by celebrities retained by SPAC sponsors with a vested interest in personal gains from equity and warrants equivalent to 20% of initial SPAC equity. 

Bloomberg has calculated that the entry price can be set so low that family offices could make a 800% return following a deal. Everyone wants the deals to work, of course. But BofA adds: “Targets and shareholders bear the cost of the sponsor’s promote and the free warrants via dilution.” 

Sometimes sponsors dash for the exit early, to set up another SPAC, rather than bedding down an existing deal. Sometimes they try to run more than one horse at once. Celebrities almost never hang around. 

On 8 April, the SEC came up with more ideas. It said SPACs may not merit “safe harbour” protections that protect managements from being sued over forward-looking guidance. Cheerful data on corporate, or sector, prospects, builds a powerful narrative in the absence of less appealing data, which is why you see long health warnings in IPOs. The SEC also raised the possibility that the de-SPAC process, could use IPO-style regulations so post-deal investors get fully informed. 

On 12 April, the SEC said warrants could end up being treated as expenses on corporate books, rather than equity issuance. This could lead to a rewriting of financial accounts across the SPAC sector. 

The SEC’s ruminations could also make it harder for SPACs to find private credit to finance deals as sponsors pull back. This process draws on Private Investment in Public Equity (PIPE) deals, where private equity firms provide private credit to clients. It has been quite a popular source of income for family offices. However, a glut of SPAC credit requests in February and March has clogged up the process. Following the recent erosion of liquidity credit offerings remain subdued.

The SPAC market is down, but not out – particularly in Asia, where Malaysia’s Anthony Tan has agreed to inject Grab, his ride-hailing business into a Nasdaq SPAC for a record $40 billion. The deal has maintained a 29% premium.

 Back in February, however, the shares would have been rated somewhere in the stratosphere. Or maybe, like Virgin Galactic, beyond it. 

 

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