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SPAC- A Free Ride or another Fiasco in the financial sector

Meaning and purpose

Special Purpose Acquisition Company or commonly known as SPAC or Blank- Cheque Company is a shell company created in order to take make acquisition or merger with another private company to take it public. This route is generally a shortcut for small companies to go public and a lot cheaper than traditional IPO route and are generally formed by Hedge Fund managers, investors, sponsors, venture capitalists or big Private equity companies. A SPAC is a company with no commercial operations and is formed to raise capital through an IPO. SPAC’s seeks underwriters and institutional investors before offering shares to the public.

The money SPAC’s raise in an IPO is placed in an interest-bearing account for a maximum time of two years or until the company finds a target to acquire or merge with. If the company fails to acquire a target in the given time period then the money will be given back to the investors and the interest earned will be used as SPAC’s working capital.

The Rise of SPAC’s

The ideology behind the creation of SPAC’s is not new but it has gained a lot of attention in the recent years and last year especially because of unique financial conditions resulting from the pandemic and ultralow interest rates making it easier to borrow at a cheaper rate. SPAC’s has created a niche for itself in the big financial markets but it is still a very small part of the overall market. It is still dominant in the U.S. market. Last year SPAC’s raised $82 billion, a figure greater than all previous year combined and nearly half of all the capital raised in U.S.-listed initial public offerings, according to Dealogic. In the year 2019 it had raised $13.6 billion, which was four times of what they had raised in 2016 via IPO’s.

How do they work?

After raising the money, the company looks for a target and once it finds the right target it announces the acquisition. The volatility is huge during these announcements but those unveiled deals in the last year on average climbed 5.4% on the day of those announcements and more than 16% after one month of the announcements according to Dow Jones Market. Investors last year had bought more SPAC’s shares and eight had more than $1 billion invested in SPAC’s at the end of third quarter last year (Data by The Wall Street Journal).

The major winner in this game are the early investors because even if the shares of the SPAC’s fall, the investors are protected by the right to withdraw. Throughout the process they can sell warrants or hold on to them, When the SPAC shares surges these warrants becomes more valuable and makes the trade a rare example of mainstream investment that has limited pitfalls.

Michael Ohlrogge, Assistant professor of law at NYU in his study of the merger of SPAC’s between Jan 2019 and June 2020 found that Hedge funds nearly sold their shares or withdrew before deal completion. The average annualized return for those that withdrew was 11.6% and he said “It’s a free lunch- there’s no way around it”.

Another big decision that the managers had to take when acquiring or merging a company is the size of the company and the stake the SPAC manager want to take. If the target company is many times expensive then the capital raise by SPAC than in this case there will be another round of fundraising commonly called PIPE (Private Investment in Public Equity) this round is more efficient than going to market and issuing shares.

The major gains are accumulated by the early investors and the major risks are bore by the stakeholders which often by shares after the acquisition, because their shares are tied to the acquiring company’s performance.

Some famous SPAC deals in the past

Billionaire Venture capitalist Chamath Palihapitiya has been a famous name behind the rise of SPAC’s in the recent years because of his company Social Capital (which is Venture Capital firm) had managed to take three companies public and the fourth one is just in the final rounds of Due Diligence. He has openly said that the IPO process is broken and the Start-ups have been waiting longer to go public and, as a result, employees are finding it harder to find liquidity for their shares. He believes this is what is contributing to a sizeable chunk of employee turnover at the best startups. These companies are:

1) Virgin Galactic

It is a commercial spaceflight company (Space Tourism Company). Chamath’s company Social Capital Hedosophia (a SPAC) had raised $800 million via an IPO and acquired 49% stake in Virgin Galactic and today the stock price of Virgin Galactic is up more than 150% since it went public in October 2019 and has a market cap of more than $6.4 billion.

2) Opendoor Technologies

It is an online real estate company which buys a property and flips it and then sells it to a profit. It was merge by another company of Chamath called Social Capital Hedosophia II.

The SPAC had raise more than $400 million via an IPO and another $600 million via PIPE offering. The market cap of Opendoor Technologies is more than $14.6 billion.

3) Clover Health

It is a next-gen Health insurance company and It will be merged with Chamath’s another SPAC called Social Capital Hedosophia III which will help clover health to gain an Enterprise value of about $3.7 billion dollars.

4) SoFi

It is an online lending start-up and it is line to go for a merger with Chamath’s another SPAC called Social Capital Hedosophia V which has raised more than $800 million but the deal is in the final stage. If the deal is secured by SoFi than it will put its value around $8.6 billion.

The world’s biggest SPAC is valued at more than $4 billion and is called Pershing Square Holdings. The Famous hedge fund manager Bill Ackmen is the promoter of this SPAC.


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