Spacs did not fulfill their promise


Smaller, newer companies face a variety of challenges, some are new and some are old. The corporate concentration and near-monopoly power of digital giants continues to increase. For them, the cost of complying with many regulations is correspondingly higher, and they have fewer opportunities to enter the cheap public debt market than larger competitors.

This has caused many companies to set their sights on the stock market for funding, but the initial public offering process can be lengthy and expensive. Now, the executives in charge have another option: merge with Spac or a “special purpose acquisition company.” Proponents say that these listed blank check vehicles can provide a smarter, more reliable and faster way to enter the open market.

But what about them? Spacs is a shell company that promised to transform itself into a real company through mergers within two years, and recently hit a record high. In 2021, Spac will have 30% more issuance than traditional IPOs. In fact, the number of listed companies has dropped sharply in recent years.

A kind June OECD report Looking at the capital market, we found that since 2005, more than 30,000 companies have been delisted. This is equivalent to three quarters of the total number of listed companies in the world today. The number of new listings is not close to this number. The result: fewer and fewer companies use the public stock market, and the money raised there goes to fewer, larger companies.

Fans of Spac say this structure helps correct the balance by making it easier for young companies to enter the market. These transactions have also been touted as a kind of “private equity for the poor,” allowing retail investors to support managers who target and restructure companies like institutional investors.

Obviously, many people have been buying this story.In 2020 alone, Spacs raised as much cash as in the past ten years, and in 2021 it has already raised exceed This total.This has led regulators and top investors to label the structure Speculation and dangerThis kind of financial “innovation” is a characteristic of the top of the market.

Of course, Spacs shares some of the same characteristics—relatively novel, asymmetric information, and moral hazard—as the junk bonds that triggered the savings and loan crisis of the 1980s or the mortgage bonds related to the 2008 financial crisis. “Because they have no precedent, they can take risks that are not easily identifiable,” said Richard Bookstaber, chief risk officer of the risk technology and analysis group Fabric. “This gives innovators an advantage over the market and regulators.”

This is obviously problematic. But more importantly, whether Spacs fulfilled its promise as a cheaper, more efficient, and more democratic way to get new companies listed.

A recent working paper from the European Institute of Corporate Governance studied 47 Spacs that merged with the target company between January 2019 and June 2020. It shows no. Although academic authors found “no evidence that Spac is a hotbed of fraud or outright investor deception,” they did find that “the cost in the Spac structure is subtle, opaque, and much higher than previously thought.”

The Spacs in the study issued shares at a price of approximately $10, and investors valued the same at the time of the merger. But by then, the median Spac in the study had only $6.67 in cash per share.

In fact, these shell vehicles consume one-third of the cash they raise, or 50% of the funds they ultimately hand over to listed companies. The researchers pointed out: “These costs are much higher than the IPO costs, even if you take into account the underpricing, and even about twice the previous estimates by Spac skeptics.”

In addition, the study also found that Spac’s stock price tends to fall by about one-third of its value within a year after the merger. Since 2010, there has never been a single year of Spac consolidation that has outperformed the Russell 2000 Small Cap Index. Compared with the IPO index dating back to 2013, Spac’s return performance is worse.

ECGI research points out that Spacs, sponsored by large private equity funds and former Fortune 500 executives, generally perform better. However, there are many well-known sponsors who are already in trouble, claiming that the process provides higher prices and transaction certainty compared to IPOs.

We are pleased that the Spacs in the study are not primarily held by retail investors. Large institutional management companies have 85% ownership and 70% of the total shares are held by minority investors. The study refers to them as the “SPAC Mafia.” In fact, 5 investors hold 15% of the total shares after the IPO.

Some people might argue that this means that we should not worry too much about the Spac boom. What if some wealthy investors lose their shirts? Unfortunately, Dozens of such companies Recently joined the Russell 3000 Index, which is tracked by an investment vehicle with US$9.1 trillion in assets. Spac suddenly became more mainstream.

The US Securities and Exchange Commission, which is responsible for protecting this little guy, has expressed concerns about Spacs. Given that Spacs is structured to allow investors rather than promoters to take most of the risk, I can’t imagine a better goal for regulators to limit moral hazard.

rana.foroohar@ft.com



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