Bubble warning: even college kids are touting Spacs

So far this year 133 Spacs have been floated in the US, raising $51.1bn, nearly four times last year's volume. 123rf

OPINION:

When the shoeshine boy starts sharing stock tips, it is time to get out of equities; or so Joseph Kennedy Sr is said to have remarked as he exited the market ahead of the 1929 crash.

So what should investors do when college students start promoting special purpose acquisition companies, or Spacs? This week it emerged that University of Pennsylvania students have created a so-called "Penn Spac" club to celebrate these new equity vehicles. Known as blank-cheque companies, Spacs raise money from investors, via a public listing, and then merge with a private company, in effect taking it public while avoiding a traditional initial public offering.

For the students, this is probably a smart move — at least if they want to find internships with finance companies that are profiting from this trend. For everyone else, though, it is a worrying sign of froth.

The current statistics around Spacs are startling: so far this year 133 Spacs have been floated in the US, raising $51.1bn, nearly four times last year's volume. A further 67 are waiting in the wings, according to Spac Research.

The list of Spac managers is swelling so fast that it now includes Billy Beane, the US baseball executive depicted by Brad Pitt in the film Moneyball, and Paul Ryan, former Speaker of the US House of Representatives.

Meanwhile, the London Stock Exchange is jumping aboard, as it explores how to lure Spacs to the UK, and a fund that has jokingly been dubbed a "Spac of Spacs" has just emerged. Easterly Alternatives is raising a $100m vehicle to invest in up to 15 other Spacs. Anyone older than a college kid may well hear echoes of the last credit boom. Back then, collateralised debt obligations, backed by tranches of loans, were so hot that financiers started creating CDOs backed by tranches of CDOs, known as CDO squareds.

Before it all ended in the 2008 financial crisis, some financiers reportedly launched a CDO cubed. If a Spac cubed materialises, keep that in mind.

Inevitably, this mania is also producing investor losses. Nikola, the electric truckmaker that merged with a Spac and is now being investigated by US officials, is a case in point. A Financial Times analysis in August showed that the majority of Spacs organised between 2015 and 2019 are trading below the $10 standard Spac listing price.

So is this a bubble that is about to pop? Don't bet on that happening soon. There are now at least three factors driving investor enthusiasm for Spacs — and all could run for some time.

One of these is obvious: asset managers are sitting on mountains of cash that they need to invest — and are terrified that they cannot find decent returns now that the US Federal Reserve has signalled that rates will stay rock-bottom low until at least the end of 2023.

Smart financiers have also realised that the Spac route to a public listing is more "efficient" — that is to say, lucrative for them — than a traditional IPO, given the extensive rules around such listings.

A Spac merger lets a company go public quickly. The method can sometimes allow founders or sponsors to sell more of their holdings quicker than an IPO, which may include a lock-up period. A Spac deal can be especially attractive for a company struggling to show profits. Spac disclosures put more emphasis on putative future revenues, while IPO prospectuses require audited past financial statements.

Finally, the relative availability of public and private financing is shifting. In the past decade, so much money poured into private companies that it produced huge numbers of billion-dollar privately held companies, which used to be so rare that they were known as "unicorns". Now the private equity and venture capital players behind that money, along with company executives, want to tap public markets too.

It would be nice to think this reflects a newfound passion for democratic capitalism and retail investors. I suspect that a more likely explanation would be that financiers and founders are getting nervous that the current market boom is going to fade. The woes at SoftBank, which was a huge source of private investment, are also cutting into the availability of private funds.

That does not mean Spacs are going to crash tomorrow. But if they do eventually, some investors will get hurt — although there thankfully may be fewer systemic implications than with CDOs. Members of the Penn Spac club should read their history books, as well as financial engineering manuals, and remember this: the smart money is good at passing risks on to mainstream investors when they want to leave. Spacs are not so "new".

Written by: Gillian Tett

© Financial Times