Andy Gordon

The Real Problem with SPACs

I’ve never hidden my disdain of special purpose acquisition companies (SPACs). As a refresher, SPACs are shell companies that attract investors and then go public in order to merge with a specific startup, thereby taking the startup public. I laid into them back in January in this article and again in February in this article. On Monday, Congress took its turn. 

The House of Representatives heard how SPACs are allowed to make overly optimistic statements on their growth prospects without penalty. Companies launching traditional IPOs enter a quiet period, during which time they’re severely constrained from making forward-looking statements of any kind. These constraints prevent companies from driving up interest — or their share prices — by promising things they may not actually deliver on. But SPACs don’t have to play by those rules.

The SEC also has SPACs in its crosshairs. In late March, it issued a statement expressing concerns over their governance and disclosures. The SEC added that it was tightening accounting standards.

But neither Congress nor the SEC called out the real problem with SPACs — preferential treatment toward institutional investors. They actually get a money-back guarantee. If an institutional investor doesn’t like the company the SPAC is acquiring, they can ask for their entire stake back, no questions asked. Everyday investors do not get this privilege. If the SEC is so concerned about protecting everyday investors, I think this is what they should be focusing on. 

Even with these big advantages, it’s telling that many institutional investors are unimpressed with the current SPACs market. The valuations of many of the companies set to merge with SPACs have soared in recent months. As a result, institutional investors are no longer rushing into SPACs at the rate they were earlier this year. And many are leaving them soon after the mergers are announced. About 60% of the 146 SPAC mergers announced since the start of the year are currently trading below their initial public offering price. 

And it could get worse. Shorting SPACs has become more popular, according to data from S3 Partners.

SPACs have entered a full-blown downturn. The main SPAC exchange traded fund — the Defiance Next Gen SPAC Derived ETF (SPAK) — hit a peak of $35.08 per share in February. Since then, it’s dropped more than 28%. The IPOX SPAC index shows a loss of around 20% since February. By comparison, the S&P 500 has gone up 11.5% this year.

SPACs haven’t even come close to living up to their hype. They’ve underperformed the Russell 2000 by 10% or worse every year since 2010. But SPACs aren’t going away anytime soon. They appeal to founders seeking a quick public listing. They appeal to institutional investors who like the built-in “satisfaction or money back” guarantee. They appeal to everyday investors who get to invest in so-called hot companies. 

It’ll take more than new SEC-mandated restrictions and continuing market underperformance to make SPACs less popular. What’s going on now is more a pause in the action — a temporary cooling-off period.

The closer I look at SPACs, the less I like them. I hope more everyday stock investors will look past the hype and frenzy to see SPACs for what they really are — an asset class that puts them last. Everyday stock investors enthusiastically followed institutional investors into the SPAC space. My hope is that they’ll now follow them out. And stay out.