Unnecessary SPAC Commentary

Special Purpose Acquisition Companies, referred to by the acronym SPAC, have emerged as the go-to vehicle for tapping equity markets in 2020. The basic SPAC exists as a non-operational publicly traded company that exists with the sole purpose of identifying a privately-held company and merging with that firm to effectively take it public.

The trend has caught on in a year that initially saw quite a freeze in IPOs as the pandemic set in the US in March. Though more recently identified with high-flying technology companies, the SPAC structure has been used as far back as 2009 to take companies public like ordinary oil & gas firms, to name just one example.

The SPAC trend has brought its champions like Chamath Palihapitiya who, in addition to being one of the more visible SPAC sponsors in taking Virgin Galactic public, has identified two businesses for SPAC takeover in 2020: OpenDoor, an online home selling platform, and a healthcare company called Clover.

It has attracted less scrupulous business operators as well. Nikola Motors, whose CEO resigned under accusations of fraud and misrepresentation, went public via SPAC merger sponsored by well-known hedge fund titan Jeff Ubben. Among the lofty representations made to investors was a claim of near vertical integration: the firm claimed it would pioneer the technology to create its own batteries but doubled back following scrutiny.

In an appropriate twist to this saga, the actual battery suppliers to Nikola Motors is itself going public. Filing for an IPO? Not in 2020 – the firm is going public via merger with RMG Acquisition Corp, a SPAC.

This is likely the beginning of long list of SPACs and inevitable tales of corporate malfeasance. The earliest criticisms of SPACs was this: they almost fundamentally suffer from an adverse selection problem since those companies best poised for the public markets do not face substantial hurdles to an IPO. So companies that have maybe not been as well-vetted as they might be if taken through an IPO process are brought to market resulting in the drama that has shaken Nikola Motors shareholders.

Yet the performance of certain SPACs has defied skepticism. Virgin Galactic, a company hoping to pioneer space travel, recorded literally no revenue in Q2 of 2020 yet its share price has held up remarkably well, up about 2x over the past 12 months.

Investors are rewarded for taking risks on companies whose near term financial prospects seem shaky but would be wise to closely inspect new SPACs offering shares. As more SPACs are formed to hunt for private companies, in a year that has seen more than double the SPAC activity from the prior year, the problem of adverse selection is likely to become more pernicious.