SPAC named as Special Purpose Acquisition Companies was developed to avoid the old lengthy and costly way of moving with a traditional IPO process. But now it is getting misused to bring up incompetent companies to go public which do not have the necessary requirements to become public under any circumstances. The goal is to bring in capital and deposit into an interest-bearing trust account, the SPAC aims to buy an established privately owned corporation through a “business combination.” After a SPAC raises funds, it usually has two years to make an investment, with the possibility of an extension if enough SPAC stockholders vote to do so. If the SPAC is unable to reach an agreement within that time frame, it is required to refund the money to its investors, and the SPAC’s sponsor forfeits any initial investment. The investors have no clue about the company getting acquired.

Now let us take a moment back and think, will you ever give a blank check to someone without knowing where is it getting spent. How many of us will do that? hopefully none. This is exactly what is done in SPAC and that is why it is called blank check companies. The investors pay without knowing and analyzing as there is almost no way to perform a distinctive calculation to understand the acquisition as there is no prior announcement of the acquisition.

Risk from an Investor’s Perspective

Under securities law, only past financial statements can be disclosed in standard IPOs. SPACs, on the other hand, will use forward-looking forecasts to market the business mix. For fast-growing but not yet profitable businesses, being able to present forecasts will help them tell their story to investors. If you are an investor, then you know what happens when a bubble bursts.

Let us take a basic example and understand, if you could buy SPAC shares for $10 and then get approximately $10 back, what you’ve lost is the chance to put the money to better use elsewhere. If you as an investor, on the other hand, do not participate in the SPAC IPO. Instead, if you purchase stock on the open market, let’s take SPAC shares that have been trading 50 percent to 75 percent above their IPO prices in recent months, even before they name an acquisition target. You won’t get your $15 back in liquidation if you buy a SPAC for $15 per share and it never makes a deal. You’ll get $10, which is a 33% loss. Akazoo, an AI music streaming company that was expected to merge with Modern Media Acquisition Corp in 2019, maybe the most unfortunate of the failed SPACs. Instead, it was revealed that Akazoo’s previous management had falsified the books and records to a significant degree, effectively nullifying their claimed 5.5 Million subscribers.

This is not new in the case of SPACs. Despite this let us go through the celebrity industry involvement in SPAC making it even more popular sports figures Alex Rodriguez and Shaquille O’Neal, former house speaker Paul Ryan and the list is goes on. The count moves to 474 SPACs raising $156 Billion. After investing your hard-earned wealth what you get is Ambiguous valuations, questionable disclosures, and misalignment of interests. SPAC is making the people minting SPACs rich and giving hope to the investors to get rich later without a basis but a promise of a gamble. It is often seen that the SPAC sponsor tends to wash off their hands by selling off their part of shares, as an investor what do you think is the confidence level that is getting reflected where the SPAC Sponsor sells off his part leaving others in dismay. The actual purpose of SPAC is getting diluted and is becoming a tool to just skipping the IPO process and going public with litigation risk is present as recent cases have demonstrated.

See, for example, Bogart v Israel Aerospace Indus., Ltd. (standing of SPAC sponsor to bring a claim for breach of duty to act in good faith); Rufford v. Transtech Serv. Partners, Inc. (challenge to fees being paid to SPAC sponsor); Welch v. Meaux (alleged securities fraud in connection with SPAC business combination); and Olivera v. Quartet Merger.Corp. (SPAC shareholder suing SPAC for failure to honor his redemption right). CEC Entertainment (owner of Chuck E. Cheese and Peter Piper Pizza) and Leo Holdings declined to combine in 2019. CEC executives gave no specific reason for the termination, but they did lose out on a $1.4 Billion contract. Since then, the company has applied for Chapter 11 bankruptcy protection.

Performance of SPACs: The Numbers Game

Now let’s bring in numbers which is the ultimate factor for investors from August 2020, the 56 SPACs studied outperformed the S&P 500 by an average of 11 percentage points in the first three months following an acquisition but lagged the broader market in the 12 months following the transaction. According to a separate study, SPACs under consideration that went public since 2015 have lost an average of 18.5 percent, with median returns of -36.1% compared to a 37.2 percent increase for typical IPOs.

It is not surprising as a bubble when it grows beyond a limit it will burst. It might sound like a normal fact when I say Dozens of SPACs are trading below $10 at which the shares were sold assuming they are yet to announce their deals, but surprisingly many SPACs started trading at a large premium to their cash holding, like Churchill Capital Corp.IV traded at $64 even before its deal with Lucid Motors Inc, which is a highly unlikely behavior but its shares have fallen by 60% since then. To continue the discussion let us look into the former financial disappointments by SPACs, one of the prominent examples that comes to mind is the case of Nikola Corp. so-called rival of Tesla, which was targeted by Hindenburg announced that it would produce fewer than 20% of the electric trucks it has planned.

Based on our analysis all the forecasts made were turned into scraps, a complete financial disappointment. If that was not enough let’s see the case of Quantumscape Corp. and Hyliion Holdings Corp., former SPACs, which have already lost 2/3rd of their value after attaining peak last year. The performance of SPAC post-merger is often disappointing.

Investors Beware

Let us see the upcoming facts in the world of SPAC, there were nearly 250 special purpose acquisition companies, or SPACS, that raised more than $83 billion in 2020, with an average size of $334 million. So far this year, 75 people have been counting. Walmart Inc.’s Flipkart is reportedly exploring going public in the U.S. through a merger with a SPAC as it aims to fasten the listing process, also E-commerce players like Grofers also are exploring ways to go public through SPAC. Now see the example and look from a investor’s perspective, it has a revenue of around 34 million USD, showing an increase of 54% in income but also has a 74.4% year-on-year increase in loss. Its revenue is no way even near to 100 million but is going public with presenting a forecast of growth in future. Would you Invest in it?

It is an obvious fact that it can no way follow the traditional IPO method so coming in through the SPAC. Don’t you think SPAC is increasingly becoming a loophole rather than an effective tool of reducing the tedious process of traditional IPO? It should be conclusive of the fact that investors shall be beware and should examine and analyze whenever it comes to the point of investing in a SPAC before thinking it to be a highly profitable investment in the near future, otherwise you may end up losing money. The fate of a bubble on growing beyond the threshold is inevitable.

This article has been co-authored by Sayan Mitra, who is in the Research and Insights team of Torre Capital.

For exclusive information about additional research and insights by our Analysts, kindly subscribe to Torre Capital’s Blog.

If you are an investor or shareholder and want more advice about the Pre-IPO secondary markets, please feel free to reach out at [email protected] for investment advice, or register for an account at Torre Capital.

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