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Speculation Mode: Local advisers say SPAC investments are risky

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A nationwide investment boom in so-called blank-check companies reached a record level last year, and it’s on an even hotter pace this year.

Special purpose acquisition companies, or SPACs, are publicly listed companies formed for the purpose of merging with or acquiring a private company to take it public. They are considered a faster and less expensive alternative to an initial public offering.

This year through mid-March, SPACs have raised $94 billion, according to analytics provider Dealogic. That’s already exceeded last year’s record of $83 billion of capital raised by 247 newly formed SPACs.

“It’s almost like an IPO in reverse,” said Don Davis, senior vice president and senior portfolio manager at Commerce Trust Co. “Typically, an IPO, they have all the fundamentals and the financials and then go through the process to raise money. This is almost backward because a lot of times they don’t have financials, so they get the money before they start creating the financials.”

American spaceflight company Virgin Galactic (NYSE: SPCE), online gambling and gaming firm DraftKings Inc. (Nasdaq: DKNG) and Bill Gates-backed electric vehicle battery maker QuantumScape (NYSE: QS) are among companies that have gone public through blank-check mergers. A Missouri company also is part of recent SPAC activity. The Securities and Exchange Commission gave its approval in late March to a deal involving a Kansas City-based SPAC, Northern Genesis Acquisition Corp. Through the deal, Quebec-based Lion Electric Co., which manufactures electric commercial trucks and other vehicles, will be combined into Northern Genesis and trade on the New York Stock Exchange under the ticker symbol NGA.

Davis and Ken Homan, senior vice president and senior portfolio manager at Central Trust Co., both said they were unaware of any Springfield-based SPACs. The financial advisers said SPACs, which have been around since the 1980s, are trendy amid the coronavirus pandemic. Retired athletes Alex Rodriguez and Shaquille O’Neal are among those getting in on the action.

“We are flush with cash and COVID plays into it,” Davis said, pointing to an increase in liquidity aided by policy actions from the Federal Reserve and legislative stimulus packages. “People are just taking more risks.”

Homan said while clients ask him about SPACs every couple of months, he has no clients invested in them.

“Our clientele isn’t ones who are generally involved in the cutting edge of investment options,” he said.

Of the roughly 300 accounts Davis manages at Commerce Trust, he said around 5% have inquired about SPACs.

“Most of it is just curiosity from all the hype,” Davis said. “I’ve discouraged a lot of my clients from getting involved in them.”

SPAC starting
A SPAC launch starts with a sponsor, which can be a management team or individual, that seeks to raise capital through a holding company in order to merge with an undetermined private company. Investors are sold units, typically at $10 each, as part of the SPAC IPO, according to New York-based CB Insights, a company that analyzes venture capital deals. At least 85% of the funds invested must remain in an escrow account and cannot be accessed until the shareholders approve the acquisition.

The SPAC then goes public and retail investors can purchase shares on the open market while sponsors look for a target company to acquire. Sponsors, who also receive 20% of the SPAC’s shares as a transaction called a “promote” fee, have up to two years to find an acquisition target. If a target isn’t found, the SPAC dissolves and shareholders get their money back. But if one is located, the SPAC negotiates acquisition terms in advance of a proxy vote from the shareholders. A yes vote allows the SPAC to buy the target with money from its IPO and additional equity funding. The acquired firm then is listed on a stock exchange.

“The very essence of a SPAC is you don’t even know what they’re investing in yet,” Davis said. “It’s the promise that the people who are sponsoring this thing are going to do something very smart with that money.”

Ron Penney, private wealth adviser with Ameriprise Financial Services Inc., said SPACs can get one rich or broke in a hurry. Like Homan and Davis, he doesn’t advocate for his clients to invest in them.

“I don’t deal with that kind of stuff,” he said, describing it as a trendy way to invest in venture capital. “Anything like that is too far on the speculative scale for me.”

As of late March, roughly 400 SPACs are searching for deals, according to data from SPAC Insider. However, SPAC sponsors are raising more capital through IPOs, allowing them to purchase larger private companies. The average SPAC IPO in 2020 was $336 million compared with $230 million in 2019. This year’s average IPO size is nearly level with 2020 at $326 million.

Attraction and concern
So what’s the attraction for companies and investors?

Davis said it’s the short SPAC process that leads to mergers – sometimes just a few months. Additionally, a lot of the companies going public are in sectors such as space, technology, science and health care.

“A lot of those companies are in need of cash and funding very quickly because their technology or sector is changing very dramatically in a short amount of time,” he said. “This is a very quick way to get money versus the traditional IPO process.”

Homan said the new retail investors that come with SPACs are concerning to veterans of the industry.

“They’re entering maybe for more speculation than they are long-term investing,” he said.

Davis said when it comes to investing in SPACs, private equity or venture capital, people need to remember the risk of inflation from basic economy class: too many dollars chasing too few goods.

“There’s only so many companies out there. If you have all of these dollars trying to find a merger partner or companies to buy, that implies the prices of these companies are going to go up,” he said. “The risk would be you’re paying too much for them and they’re never going to live up to, in many cases, what you paid for them.”

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