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Too SPAC-culative? Has the SPACs bubble burst?

Stocks

Written by:

Bryan Tan

Most investors in Singapore might not have heard of SPACs until the recent news of Grab’s upcoming listing with Altimeter Capital (NYSE : AGC) on the New York Stock Exchange. If you are unfamiliar with SPACs, do read the first part of my article on Grab’s listing where I briefly explain what a SPAC is with some basic illustrations.


Most SPACs have been trading sideways for about a month since their recent fall from the February 2021 highs.

Some notable SPACs which have experienced more weakness over others during this period include:

  • Churchill Capital Corp IV (NYSE : CCIV)
  • SKILLZ Inc (NYSE : SKLZ)
  • Chargepoint Holdings Inc (NYSE : CHPT)
  • QuantumScape Corporation (NYSE : QS)

In general, the recent stock market correction has caused SPACs to fall faster than other stocks in the market.

While there are both qualitative and quantitative factors involved, I’ll be touching on the qualitative factors, namely the increased legislation from The Securities and Exchange Commission (SEC).

If you are curious about the quantitative point of view and why stocks some stocks fall faster/rise faster than others, do refer to my article on the key technical indicator, BETA (β).

Why have SPAC’s experienced more weakness than other stocks on the market?

As investors, I believe that every cent earned is due to keen senses at work. As such I take it upon myself to be as up to date as I can on the happenings in the market. It is important for us to understand why things happen so that we can deduce the repercussions of such events and subsequently decide on our desired level of exposure to such instruments.

To summarize the entire SPACs situation,

The Securities and Exchange Commission (SEC or Commission) is raising its voice on Special Purpose Acquisition Companies (SPACs), alerting sponsors, targets, and investors to regulatory risks and raising new concerns about SPAC-related disclosures.

Pillsbury Law – 16th of April 2021

I’ve decided to breakdown the above paragraph and its contents into 2 main points as follows,

1. Too SPAC-culative

By now we know that when it comes to listing, a SPAC merger has various advantages over the traditional IPO. Such advantages include faster processing, less paperwork etc.

“What paperwork?”, you may ask. Of the many listing documents, one which we are most familiar with would be the targeted company’s financial projections. These projections are of utmost importance as they can be used to predict the future valuations of the company.

To protect consumers/investors, there many laws which regulate this crucial document in a regular IPO. But in the case of SPAC mergers,

“….. such projections are generally protected by the safe harbor for forward-looking statements afforded by the Private Securities Litigation Reform Act (PSLRA), whereas projections made in connection with traditional IPOs are outside the PSLRA’s safe harbor.

Thus, compared to a traditional IPO, a SPAC acquisition presents the opportunity for an operating company to speak more directly to the market about its financial prospects.

Pillsbury Law – 15th of December 2020

This means that while there are stricter laws guiding a traditional IPO’s financial projections, these laws are not applied to SPACs.

This may allow SPACs to make financial projections at their own discretion, thus allowing more room for speculation.

For readers interested in a case study where such projections made by a SPAC were questioned, do refer to this paper on the Litigation and Enforcement Risk of SPACs.

Warrants – Equity of Liability?

On 12 April 2021, the SEC issued a “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition“. I quote:

“….. if such (SPAC) warrants should be accounted for as liabilities rather than equity and if so, whether the impact of the change in accounting treatment is material and thus require a restatement of previously issued financial statements.”

In essence, the question is:

If a SPAC were to raise capital, should the difference between share price offering and premiums earned from warrants be classified as equity or liability?

  • What this means is that if the SPAC did a share price offering of $1 and sold 100 shares, the SPAC would have raised $100.
  • On the other hands, if a premium of $0.50 was charged on each warrant and 100 shares were redeemed, the SPAC would have raised $50.

Either way the SPAC would have raised money but there’s a difference of an additional $50 in the share price offering route. So, should this $50 should be considered a liability as it was “potential gains” which the SPAC could have made but lost as a result of issuing warrants?

I attribute the massive weakness of SPACs to this very statement above.

If SPAC warrants were to be classified as liabilities, I daresay that the material impact of this legislation may indeed be significant.

I have omitted many variables in my attempt to provide a very basic understanding of this situation but for readers who would like to read more, please refer to this article.

What are Warrants?

Warrants give the owner the right to buy or sell a stock at a certain price before expiration. Alvin explained more here.

Is the SPAC season over? How can I invest in SPACs?

In my opinion, I would say that the SPAC season is definitely not over as ultimately, we are seeing companies with strong fundamentals and prospects being listed via such mergers.

In fact, there are SPACs which have experienced a higher degree of resilience over others such as DraftKings (NASDAQ:DKNG) and Paysafe (NYSE:PSFE). These two SPACs are indeed worth mentioning as unlike the other SPACs mentioned at the beginning of this article which have experienced corrections of anywhere between 50-70%, DKNG and PSFE are both less than 30% off from their recent highs. (At the time of writing, DraftKings just got an upgrade – Cowen upgrades DraftKings, says recent struggles for stock is a buying opportunity)

In addition to this, given the current weakness in the sector due to increased legislation, readers may consider a SPAC ETF over individual SPACs to help manage risk.

With some of the most popular and trending SPACs in their portfolio, the Defiance Next Gen SPAC Derived ETF (NYSE : SPAK) is one way that investors can expose themselves to this sector with caution.

Trading at a little over 28% off its recent February 2021 high, this SPAC ETF has not experienced that drastic of a sell off due to its selection of relatively resilient SPAC companies.

My Personal Thoughts – Are SPACs dead?

The classification of warrants is indeed one which has the potential to completely bring down all SPACs. Though such a drastic move from the SEC may be unlikely due to its massive repercussions, seasoned investors would know that drastic moves happens all the time in markets.

In my opinion, I see this period as a weakness for SPACs and I am continuously finding good entry points for some of my current SPAC positions such as DKNG and CHPT.

However, we can never be too careful with our positions and therefore I would recommend for readers to take a more cautious stance when it comes to SPAC positions until the SEC provides more clarification on their statements.

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