SPACs have had a bumper run. In 2020 SPACs raised more cash than they did in the prior decade, making up about half of total IPO funding. Heading into 2021, the trend isn’t stopping. However, despite the influx of cash, have post-merger SPACs delivered for investors?
Researchers at Michael Klausner and Michael Ohlrogge at Stanford and New York University examined 47 SPACs that merged between January 2019 and June 2020. This is a relatively recent cohort of SPACs. They found that SPACs tended, on average to lose a third of their value post-merger, though some notable exceptions did produce positive returns.
In the researchers’ view, the problem is essentially the high fees associated with SPACs. First off, there is the promote fee, which is the most well known and typically the largest component. However, there are other considerations. The initial underwriting fee for the SPAC is typically around 5% and the implicit cost of warrant issuance can add up too.
Importantly, if some shares are redeemed during the merger process (i.e. returned for cash) as typically occurs, then many of these SPAC’s costs don’t change and high redemption rates can therefore lead to greater costs being borne by the smaller number of remaining shareholders. The researchers find that the size of these costs then create a significant headwinds for the ability of post-merger SPACs to deliver meaningful shareholder returns, on average.
That said, cost drags aren’t unique to SPACs. IPOs have direct and indirect costs too, the researchers point out. There is no free way to bring a company to market. However, the costs of SPACs do tend to be higher, on average.
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The Twelve Seas Example
For example, Twelve Seas Investment Company is given as an example, where the researchers argue that given an 82% redemption rate, dilution was estimated to be 254% of the cash delivered into the merger. That’s definitely on the high side, but shows how the costs of SPACs can increase for remaining shareholders if there are high redemption rates.
The Quality Filter
However, despite the generally dire numbers, quality filters can help SPAC investors somewhat. If the sponsor is affiliated with a well-regarded fund with over $1 billion in assets, and the sponsor (or SPAC manager) is a former officer, such as a CEO or President, of a Fortune 500 firm, then SPAC post-merger returns look better and the researchers called these mergers “high quality”.
About half of the 47 SPACs analyzed met this definition and returns for this group were materially higher over 3-, 6- and 12-month periods post-merger, though still about half of this more exclusive group did, in fact, lose money for investors.
Furthermore, even the mergers in this ‘high quality’ group seeing relatively better performance still lost money over a 12 month window in absolute terms in terms of mean and median performance and relative to an IPO index. The one saving grace is the mean return did exceed the Russell 2000 for this group. Though of the firms examined, not all had made it to the 12 month mark yet, so the data could change over time. The implication is not so much that the returns for the so-called high quality group were unambiguously good, but that they were definitely less bad than for the other SPACs.
These research findings are not encouraging for SPAC investors. It does show that being a more discriminating SPAC investor in high-quality SPACs may help your returns, though that said, the costs associated with SPACs can be hard to overcome even with a strong merger candidate.
As the number of SPACs continues to grow it will be interesting to see if even so-called high quality SPACs can offer meaningful returns as the market becomes potentially more competitive.