The luster of SPACs is beginning to fadeJune 10th, 2021 | Posted in Investing
Are SPACs Losing Their Appeal?
2021 has seen a wave of enthusiasm for risk assets in general (to date), but particularly for new categories like SPACs and cryptocurrencies. As ever, investors are usually interested in the ‘next big thing,’ and chasing heat comes with the territory. But for SPACs, the strong run – which may have only lasted six months or so – could be coming to an end.
Before we discuss the fizzling appeal of SPACs, we will explain exactly what SPACs are for readers who may not be familiar.
SPACs are often called “blank check companies,” as they are essentially shell companies formed to raise enormous amounts of cash. SPACs go public with no assets – usually attracting investors by the acumen and/or pedigree of the SPACs managers – and merge with a private company to then take it public. The companies that SPACs try to take public are often start-ups with flashy new products and growth profiles, though many still lack actual earnings.1
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The appeal of SPACs is the same type of appeal that draws investors to the IPO markets: the possibility of fast, outsized returns gained from investing in a small start-up or a company with major growth potential. But on the other side of the SPAC coin is what investors should expect to find – high risk.
For one, start-ups and other companies that go public via SPACs don’t face the same constraints as traditional IPOs, particularly in the realm of financial disclosures and projections. For instance, companies that go public via SPACs often tout wildly positive growth expectations, but traditional IPOs would be sued by the federal government for doing the same thing.
One recent, noteworthy deal involved an electric vehicle maker named Fisker Inc, which went public in October via a SPAC with a $4 billion market capitalization. The company projected it would make over $13 billion in revenue by 2025. These are huge numbers, but guess what – to date, Fisker hasn’t generated a penny of revenue. Many SPAC companies fit a similar profile – of the companies that completed a public listing via SPAC in 2020, approximately 50% missed their revenue forecasts and 42% saw revenue decline. These deals represent the antithesis of what we look for at Zacks.
SPACs do not have a good track record of returns, either – of 44 tech startups that finished a SPAC deal from 2020 through April 2021, share prices have declined an average of 12.6%. These returns should make sense. Investors often end up paying a premium for future cash flows that are not there, and may never arrive.
The SPAC surge that just a few months ago had the market buzzing is starting to lose its appeal. What’s more, the SEC is starting to take a closer look, and just recently announced new accounting mandates. The market has also seen an increase in litigation from investors, accusing SPAC managers of misleading financial statements, breaches in fiduciary responsibilities, and so on down the line. More regulation could be on the way.
Bottom Line for Investors
This piece focused on SPACs, but the bigger picture story here is to remind investors to be cautious around any trend-setting investment idea or asset class. Don’t get lured into the ‘get rich quick’ ideas of the moment. In our view, investors can reach long-term goals by focusing on quality and adhering to a disciplined, research-driven approach like we do here at Zacks Advantage. That’s how we approach managing money.
We manage client portfolios based on investment goals, and we drive our decision-making process based on research. The equity market is strong today, but there are pockets of froth building up in some areas and certainly in some ‘alternative’ asset classes, in our view. That makes it a good time to redouble focus on fundamentals and quality.
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1 Wall Street Journal. May 23, 2021.
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