A Resurgence of SPACs Indicate Market Risk
By Brian Hilyard
Money and Investing Writer
Every few years, a certain market gets so optimistic that investors start to question the current sentiments and valuations. These times usually come with their unique financial products to capitalize on the euphoria. During the dot-com bubble, it was the use of EV/clicks as a valuation method, rather than EV/Revenue or EV/EBITDA. In the housing bubble, it was CDOs. Now, there is one for the tech rally. But first, some context:
A company can ultimately only raise capital in three ways. The first is through profit earned from operations. The second is through debt by either taking out loans or issuing bonds. The third way is by issuing ownership/equity of the company itself.
Traditionally, the most popular way to raise capital through the equity market is by doing an Initial Public Offering (IPO), marking their transformation from a private company to a publicly listed company. Bank fees are the largest expenditure of conducting an IPO. Investment banks charge fees to underwrite the newly public shares and sometimes purchase some shares to provide price stability during the first days or weeks of trading.
To avoid underwriting fees, a company looking to go public to raise capital can advertise its intent with Special Purpose Acquisition Companies (SPACs). However, there are inherent risks in investing in a SPAC. First, most SPACs do not disclose what its target acquisition is, meaning its intrinsic value is near impossible to calculate. Value is mostly derived from the historic success of the fund managers. Second, while a failure to conduct an acquisition results in the liquidation of the capital raised, the full amount is not refunded, as the SPACs managers can keep some of the capital raised.
We have seen a record amount of capital raised by SPACs recently. A big reason is that investors are betting on the possibility that the SPAC will acquire a valuable tech company. We’ve seen Nikola, DraftKings, and Virgin Galatic merge with SPACs. Now, Airbnb is a rumored target of Bill Ackman’s SPAC, who managed to raise a record-breaking $4 billion in its IPO. This trend could be an indicator of possible irrationality in the current market.
Contact Brian at brian.hilyard@student.shu.edu