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SPACs market re-groups under closer scrutiny

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By A Paris – Following a year of high exuberance, the market for special purpose acquisition companies (SPACs) has slowed since peaking in mid-February 2021. Now, with the US Securities and Exchange Commission (SEC) changing accounting rules and vowing to keep a close eye on the market, the momentum behind these vehicles has reduced. But despite the market cooling off, the space remains attractive as the increased scrutiny can lead to better quality structures with more robust due diligence on behalf of sponsors, to the benefit of the investors.

“Since the beginning of 2020, SPACs have raised a collective USD167 billion in new capital from investors. Just three months into 2021, SPACs have already exceeded the amount raised in the entirety of last year. January–March saw 258 SPACs raised, with an aggregate value of just over USD83.3 billion,” outline Winna Brown, EY Americas Financial Accounting Advisory Services and Private Equity Leader and Pete Witte, EY Global Private Equity Lead Analyst.

This searing pace of growth may have been dampened by the announcement by the SEC regarding accounting and reporting considerations for warrants issued by SPACs. The new guidance suggests that warrants issued to investors are liabilities rather than equity, for accounting purposes. This is a significant change.

“SPACs warrants have always been treated as equity. It has been the accepted practice for eight years across around 600 SPACs. Now that it’s changed, those companies need to restate their financial statements which is a huge headache,” says Zac McGinnis, managing director, Riveron.

However, despite this, signs suggest the market will continue to be attractive. “With recent IPOs trading above USD10, it suggests investors are likely ready to allocate again once the warrants-as-liability situation is settled,” writes SPAC Research in its late April newsletter.

According to Brown and Witte: “Whether or not new SPAC issuance continues this blistering pace is, at this point, effectively immaterial. With more than USD166 billion in trust (and another USD59 billion that is pre-IPO, according to SPAC Research), SPACs have a tremendous amount of assets that must be deployed over the next two years.”

Advantages to investors

There are several benefits to investors considering allocation to a SPAC. Duncan Lamont, Head of Research and Analytics, Schroders comments: “Because investors in a SPAC IPO have the option to redeem their shares for what they paid for them plus interest, they essentially have a money back guarantee. In addition, they have a warrant, which may turn out to be worth a lot if the SPAC is a success. The warrant is akin to a risk-free bet on the success of the SPAC.”

A paper by Michael Klausner and Michael Ohlrogge at the New York University School of Law notes: “Commentators have described SPACs as ‘poor man’s private equity,’ suggesting that retail investors invest in SPACs as bets on the sponsors’ skills in identifying and merging with attractive private companies to brings public.”

However, the authors claim this characterisation of SPACs is off the mark. “SPAC shareholders are overwhelmingly large funds, rather than retail investors,” they write. The industry has seen a number of large well-known hedge funds throw their weight behind SPACs – names like Falcon Edge Capital, Pershing Square Asset Management and Millennium Management.

However, not all agree retail investors play a small role in the SPACs space. Earlier in 2021, the Americans for Financial Reform and the Consumer Federation of America outlined concerns regarding retail participation in the SPACs market.

The letter, addressed to Maxine Waters, chair of the House Financial Services Committee said the boom in SPACs is: “fuelled by conflicts of interest and compensation to corporate insiders at the expense of retail investors.” The think tanks gave recommendations on how to better protect retail interests.

Interest in SPACs continues to be considerable. The letter to Waters notes: “This is likely due to the attention drawn by the relatively few SPAC mergers that have earned outsized returns. The widely touted performance of shares of SPAC-launched companies such as Virgin Galactic and Draft Kings helps feed the myth that SPAC investing provides a route for ordinary investors to profit from access to high-tech investments that are typically limited to venture capitalists hedge funds, and other institutional investors.”

Lamont draws attention to this popularity: “Celebrities such as NBA star, Shaquille O’Neal, MLB star Alex Rodriguez, and popstar Ciara, have all launched SPACs. This is where the risk lies. So much so that the SEC has even put out an alert, warning investors: “It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.”

One consequence of the earlier market sell-off and potential slow down encouraged by the SEC scrutiny has arguably been a flight to quality.

Strong outlook for company roll-ups

Another change expected is the rise in several companies banding together.

In the view of Cindy McLoughlin, Managing Partner, CohnReznick, this is a key element in the future of SPACs. She explains the reasons driving this development: “There are only so many companies which are of the necessary size to go into a SPAC. There is however, another tier of companies which are in growth mode but are too small to do an IPO or a SPAC on their own. Therefore, I expect there to be opportunity of some roll-ups which can help companies get to the magnitude which warrants going into a SPAC.” 

One recent example of this is the Greenrose Acquisition Group, which De-SPACed in March 2021, making deals to buy four cannabis firms in March 2021.

“The companies we are bringing to market fully align with Greenrose’s core objectives,” CEO Mickey Harley said in a statement. “We are targeting strategic assets in several key states that present opportunities for further consolidation as we seek to deepen our presence, particularly in the West.”

Another high-profile SPAC called Power Brands was created to build a global conglomerate of sustainable and digitally focused beauty brands. The company states its objective “to create a next-generation consumer holding company by combining exceptional brands and leadership teams in beauty, wellness, and consumer-related industries to create long-term value for our shareholders.”

This is one of the few SPACs founded by women. It got off to a strong start in the de-SPAC stage with a USD276 million IPO. 

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