Investment Strategy

Time to Reconsider Investing in SPACs

All you really have to do is listen to your gut in regard to investing in SPACs. Do you really want to climb on board with such financial juggernauts as Sammy Hagar, Ciara, and Roger Staubach, to name just a few. Yes, when it seems too good to be true it usually is. I have to admit that it is pretty cool to think that you could invest with Patrick Mahomes and the Shaq and maybe get their autograph, albeit at the potential cost of your investment. A key driver of SPACs, or special purpose acquisition companies is reputation. And who else is in the spotlight more than athletes and entertainers.

So for those of you who want to get on board with the cool crowd, what exactly is a SPAC? A special purpose acquisition company is a company that has no commercial operations and is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring or merging with an existing company. Okay, that sounds pretty interesting. SPACs are sometimes referred to as “blank check” companies because at the time of their IPOs, they have no existing business operations or even stated targets for acquisition. Hold on a minute. It’s starting to sound a little fishy. Relax, the SEC says that they have up to two years to complete an acquisition or they must return their funds to investors. What could go wrong?

SPACs have been around for decades, but only in recent years have they come to the forefront as mainstream investment vehicles. The lure of high profile players and the ability for the average Joe to invest in them and possibly achieve huge gains like the Wall Street guys is new and exciting. Mergers through special purpose acquisition companies have surged to a record $170 billion this year, already outstripping last year’s total of $157 billion, according to Refinitiv data.

It only seems fitting that the brain trust of economic celebrities and athletes under-performed the overall market last year, with the notable exception being their nemesis, President Trump, who’s SPAC gained a phenomenal 400% last year. I’m sure he colluded with Russia or China to make this happen somehow. Meanwhile, rapper and financial guru Jay-Z (Does he have a real name?) managed to let go of 84% last year. The numbers don’t lie. The De-SPAC Index, a group of 25 companies that went public by merging with a SPAC, is down more than 40% through Dec. 13. The IPOX SPAC Index, a basket of 50 de-SPACs as well as SPACs that haven’t found a partner, slumped 16%. This is while the S&P 500 was up 24%.

So how did all this happen? First off, the plethora of new SPACs hitting the market made them virtually indistinguishable from each other. This opened the door for the need for marketing and big name draws, regardless of the fact that they had no corporate expertise. Given the fact that these entities are in business to buy other businesses, somebody other than Leonardo DiCaprio better be able to value potential acquisitions to put on the balance sheet. SPACs are essentially finance 101, in that they are only worth what they own. Their celebrity investors are liberal arts majors. They have no intrinsic value, much like Bitcoin, but that’s a story for another day. As with any IPO, the only ones that make the sure and real money are those company insiders selling into the offering and the SPAC through fees that are taking them public. It doesn’t take long for the death knell to happen. The unforgiving markets will slaughter the new lamb if its first quarterly numbers don’t meet expectations. This is the genesis of the fall for many of the newly minted SPAC mergers. The following chart clearly depicts why the public gets screwed as usual.

Essentially everyone except the individual investor is playing with house money. The sponsor or celebrity endorser can get upwards of 20% of the float of the new company for putting the deal together. Standard underwriting fees are around 5.5% of the proceeds from the IPO sale. However, as we’ve seen with the majority of SPACs this year, the value has dropped precipitously since the IPO. Shares of half of the companies that finished deals in the last two years are down 40% or more from the $10 price where SPACs typically begin trading, erasing tens of billions of dollars in startup market value. Have no fear, the regulators haven’t lost sight of this. As with other domestic equities, the Securities and Exchange Commission regulates the comings and goings of the SPAC introduced IPO’s. On March 10, 2021, the SEC’s Office of Investor Education issued a statement cautioning investors not to make investment decisions related to SPACs based solely on celebrity involvement. According to the SEC, “It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.”

You get the picture now. If it is too good to be true it probably is. SPACs are actually more convoluted and complex than the average investor can understand, with structures that essentially hide their embedded costs and can ensnare unknowledgeable investors. Even for the seasoned investor a SPAC investment is hard, as it is difficult to fully assess the value of a previously private company. If you are so inclined to pursue a SPAC, make it a sliver of your portfolio that is put into the category of high risk.


Investment StrategyWealth Mgmnt