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When a house party gets a little too rowdy, it’s only a matter of time before the police take notice. And when that party’s happening down on Wall Street, it’s the Securities and Exchange Commission that gets the call.
That appears to be the case for special-purpose acquisition companies, or SPACs. So far in 2021, SPACs have raised $99.9 billion in initial public offerings — more than the amount SPAC IPOs raised from 2003 to 2019 combined. That’s the kind of explosive growth that gets the attention of regulators, and indeed, the SEC has intervened.
Also see: 5 things to watch out for before you invest in SPACs
Now, with the SPAC market sputtering, you may be wondering if you missed out. But it’s possible that if you sat out the SPAC frenzy, it was for the better — the surge in SPACs might just go down in the annals of the investing world as a seismic event with a short run, alongside GameStop,
GME,
boom-and-bust cryptocurrencies and other hot investing trends.
So what did the SEC do? In a statement released earlier this month, the regulator presented new accounting guidance for SPACs. And while that may sound minor, it’s already having a profound impact.
The change will put additional stress on accountants working on SPAC deals and lead to a slowdown in the market, says Yelena Dunaevsky, managing editor of the American Bar Association’s Business Law Today and vice president of transactional insurance at insurance and consulting firm Woodruff Sawyer.
And perhaps, she says, a slowdown is exactly what the SEC wanted, considering how big the market had become.
More: With SPACs down as much as 90%, there are finally some good buys
What’s a SPAC anyway?
A SPAC is a company that doesn’t actually do anything — it has no operations and is referred to as a “shell” company. The SPAC is formed by a management team known as the “sponsor,” which then sells shares of the company in an IPO. Once the SPAC is a public company, it usually has two years to use the cash it raised to find and merge with a private company (the “target” company) that actually does have operations.
Why did SPACs surge?
According to Iliya Rybchin, a partner at global management consulting firm Elixirr, a confluence of events from the past few years, including deregulation, excess available capital and a volatile stock market, likely contributed to the surge. But what can’t be overlooked is that for the sponsors, SPACs can be a really, really sweet deal, Rybchin says.
If the SPAC finds and acquires a target company, the sponsors often get to own 20% of the merged company for a much lower price than the average investor would have to pay for the same equity. Considering this, alongside the other factors, it’s not hard to see why the number of SPACs went parabolic.
Did I miss the boat on SPACs?
With the inevitable slowdown coming, you may be having a bit of regret you didn’t have the chance to add SPACs to your portfolio. But if you look at the data, missing out may have been fortuitous.
In the short term, SPACs are attractive. According to data compiled by Elixirr, investing in SPACs outperformed investing in the S&P 500
SPX,
in the latter half of 2020, and by December, the outperformance was significant. But this is looking at the earliest stages of a SPAC — the post-IPO period. From there, the SPAC still must find a target to acquire, merge successfully and start operating as a real company. And that, Rybchin says, is where the rubber really meets the road.
“In theory, yeah, SPACs are doing well. Everyone’s like ‘yeah, you guys are gonna go buy a clothing company!’ Then in reality, they go buy that clothing company, and they can’t deliver the efficiencies, the synergies, the cost savings, the growth,” he says. “You can no longer hide behind the veil of your thesis.”
Also see: These are the hidden dangers lurking inside SPACs that can hurt you
Elixirr data show that between 2010 and 2019, average one-year postmerger returns for earlier SPACs consistently underperformed the Russell 2000 index.
RUT,
“The explanation for this phenomenon is simple. Investors rush into a SPAC on the promise of big returns from famous SPAC founders,” Rybchin says. “However, we have found many of these SPAC leaders are not as hands-on as they once were, do not have support to operate the acquired businesses and many of the promised benefits are never realized.”
So, if you’re kicking yourself for not buying into the SPAC hype, maybe a change of attitude is in order. It’s more likely you avoided jumping on a bubble that was bound to burst. Looking ahead to a world that isn’t dominated by SPACs, you may want to follow the tried-and-true advice of financial experts: Put your money away in highly diversified, low-cost index funds, make regular contributions through a dollar-cost averaging strategy and focus on the long term, rather than chasing the types of investments making headlines.
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Chris Davis writes for NerdWallet. Email: cdavis@nerdwallet.com.
