The hot SPAC market will grow even further in 2021, raising concerns about rampant speculation unrelated to the reason it could leave retail investors fresh from the fall of GameStop.
Special-purpose acquisition companies are not only raising a record level of capital (more than $ 30 billion so far for their largest quarter in history);
This year’s new offers recorded an average jump of 6.5% in their debuts, an increase of almost six times their historical levels (from 2003 to 2020, the average profitability of the first day of the OPO SPAC is only of 1.1%), according to the University of Florida finance professor Jay Ritter.
“They’ve all gone up in price. It’s not driven by one or two outliers,” Ritter said.
Unlike traditional IPOs, where initial releases are generally seen as a sign of healthy appetite for investors and a bullish market environment, initial SPAC concentrations are less rational in nature. These blank check companies are empty corporate chapters that raise money from investors and then merge with a private business within two years, making them public.
So when investors looking for returns offer prices on blank check deals, they are essentially making a leap of faith by betting on something without valuation or real business. Many believe that rising SPAC prices could be a sign of speculative behavior in a new bullish market with massive liquidity and uncontrolled animal spirits.
“There’s a lot of money entering the market,” said JJ Kinahan, TD Ameritrade’s chief market strategist. “This lends itself to people going outside the course of the S&P 500 or the Nasdaq 100. You’ll continue to see this behavior just so people are looking around to see what’s more besides buying the same stocks that everyone buys.”
There are retail investors
There are indications that the SPAC boom is trapped in the market frenzy fueled by retailers. Bank of America customer flows showed that retail investors accounted for 46% of SPAC’s trading volume on its platform in January, up from 30% two months ago. In comparison, retail accounts for only about 20% of S&P 500 trading on the Bank of America platform.
“The speculative nature of SPACs appears to be particularly appealing to retail,” Bank of America analysts said in a note. “We definitely shouldn’t remind anyone what can happen when something speculative appears on retail radar (ahem, GameStop).”
There is an attraction to getting a first part of a SPAC deal for many retail investors looking for emerging companies with strong growth. However, since most individual investors buy SPAC common shares on the open market, they are likely to miss the pop of the first day. In addition, many brokers do not offer trading SPAC warrants, which are a bidding sweetener that offers early investors more compensation for their cash.
In fact, for buy and hold investors who only access after reaching an agreement, they almost always lose money.
For the 114 companies that went public through SPAC mergers in the last ten years, investors lose an average of 15.6% if they buy common shares of a merged company on the first day of trading and hold them for a year, according to Ritter. And they lose 15.4% on average if they hold shares for three years.
However, it is a different story for institutional investors. Hedge funds and other players participating in SPAC OPOs can often get a $ 10 bid price plus the benefit of collateral. They also usually sell shares once the merger is over, which could have a negative impact on prices.
“Institutional buyers found they were a lot,” Ritter said. “SPAC OPOs are essentially unpaid free convertible bonds that are priced lower. The worst they can do is $ 10 plus interest and no one has lost money.”
Competitive valuations
Another worrying factor is the large number of offers pursuing goals at the moment. A record more than 300 outstanding SPACs are in demand, which gives private companies more bargaining power and allows investors to play each other for better valuation.
“Of course, valuations have been increasingly competitive,” said Soumya Sharma, Troutman Pepper’s corporate lawyer. “The whole reason this will survive is that high-end targets agree to merge with SPACs because they believe they are valued better.”
As the valuations of target companies increase, it reduces the upside potential for SPAC investors. Meanwhile, sponsors could compete for lower-quality companies, many of which have yet to produce any physical products.
“The last two months have been great for SPAC investors, with a very high return, but I don’t think it can continue like that,” Ritter said.
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