G REAT FLOODS are supposed to wash away the world's ills. Facing a divine deluge, Noah built an ark in which to escape. In "Metamorphoses" Ovid, a Roman poet, describes how Jove, king of the gods, unleashes a flood to wipe out a degenerate humanity: "now seas and Earth were in confusion, lost; a world of waters, and without a coast."
Whether a flood has wiped out the unworthy is a critical question for investors in special purpose acquisition companies ( SPAC s). These are blank-cheque vehicles that raise capital through initial public offerings, after which their sponsors hunt for private firms to take public via mergers. Although SPAC s have been around for decades, they were once niche affairs. Their structure was costly for investors, and companies mostly avoided them.
Their popularity surged in 2020. Between June 2020 and November 2021 more than 700 SPAC s were created, almost eight times as many as in the preceding 16 months. SPAC s have raised $235bn since the start of 2020, a staggering $97bn of it in the first quarter of 2021 alone. Everyone who's anyone has sponsored a SPAC , from Shaquille O'Neal, a former basketball player, and Serena Williams, a tennis player, to Gary Cohn, a former banker at Goldman Sachs, and Bob Diamond, erstwhile boss of Barclays. Because they are listed pots of cash, shares in pre-merger SPAC s tend to trade near their IPO price, usually $10. But prices climbed late last year, peaking at a premium of 15% this spring.
The hysteria ended in April after regulators began to grumble. Prices of pre-merger SPAC s tumbled and the pace of SPAC creation slowed. Mr Diamond posits that this helped clear out the muck. "Oh my goodness, has there been a washout. The days of the celebrity SPAC are gone," he says. The next phase, he argues, will be about sponsors who have proven track records and who can attract extra capital from institutional investors keen to gain exposure to newly listed firms. The idea that SPAC s have been cleaned up is widely held. But do the data support it?
The phase immediately preceding the frenzy seems to have proved a poor bet for investors. In October 2020 Michael Klausner and Emily Ruan of Stanford and Michael Ohlrogge of New York University published a draft paper evaluating investors' returns. For SPAC s that merged between January 2019 and June 2020, these were dismal. The problems were structural. Investors who buy a SPAC' s shares during its IPO are often given free "warrants", the right to buy more stock in the future. Around 5.5% of investors' money is eaten up in underwriting fees. Punters can claim their stake back at any time, but that leaves the costs to be borne by the rest. And when a deal is struck, the sponsor typically takes 20% of the shares issued. From every $10 raised, a median of only $5.70 was available for the merged entity to spend.
As sponsors are only paid if they arrange a merger, their incentive is to do a deal, even at a high price. The fatter the slice taken by sponsors and early investors, the worse the stock performance of the merged company. Firms that went public via a SPAC between January 2019 and June 2020 underperformed the Nasdaq composite, an index of American stocks, by 64.1 percentage points in the period to November 1st 2021.
The paper caused much consternation among SPAC fans. "We have received countless responses to our research," the authors noted in a postscript published online on November 15th. "Most of which amounted to 'your study is out of date'." So they reran their analysis.
The authors found that there were indeed some differences between the original cohort and SPAC s created in the six months after September 2020. The second group experienced far fewer redemptions, tended to issue fewer warrants and attracted more capital from institutional investors. As a result, cash available for merged firms rose to $6.60, per each $10 share. Still, SPAC s that closed deals in the six months from October 2020 have underperformed the Nasdaq by around 20 percentage points: an improvement, but hardly stellar.
Crucially, there is little evidence of lasting change. "It's remarkable how little innovation in structure there's been," says Mr Klausner. Sponsor shares, warrants and underwriting fees are still present in much the same form. Redemptions and warrants offered are on the up again, and institutional investment has begun to fall. The havoc of 2021 has not wiped away all of SPAC s' ills. If anything, it has left a lot of muck behind.
Read more from Buttonwood, our columnist on financial markets: Why the bond market has become jumpier (Nov 27th 2021) Baillie Gifford and the three quandaries of fund management (Nov 20th 2021) Cash is a low-yielding asset but has other virtues (Nov 13th 2021)
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This article appeared in the Finance & economics section of the print edition under the headline “After the flood”
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