What an 18th-Century Stock Market Bubble Can Teach Us About the SPAC Frenzy
Grab broke records with a $40 billion SPAC value. Is investing in blank-check companies a good idea?
Grab Holdings Inc., the “Uber” of Southeast Asia, is the latest and largest announced SPAC deal that values the firm at almost $40 billion, through a merger with a blank-check company in the form of a Special Purpose Acquisition Company. It’s time to pay attention to SPACs to see why all the fuss. I’ll explain what SPACs are, and I’ll describe the pros and cons for investors and other stakeholders, but first I’ll share a cautionary tale from 18th century England, in what may have been the world’s first blank-check company (not literally, but you’ll see what I mean).
The Blank-Check Swindle of 1720
In 1711, the South Sea company, a joint-stock company (the precursor to today’s publicly-traded companies), was incorporated by an act of Britain’s Parliament to reduce the cost of the national debt in return for providing monopoly trade in and around South America. Despite dubious prospects of profitability, the stock rose from £128 per share in January 1720 to almost £1,000 in August of that year, before retreating to around £100 later that year — not unlike some of the recent stock gyrations in stocks like GameStop.
During the frenzied South Sea price ascension, nearly 200 other joint-stock companies were formed, and were collectively denoted as Bubbles-Companies — not referring to the inflated asset price “bubble” connotation commonly used today, but to con artists. Most that made it to the market flamed out in short order, although a few emerged as successful firms, including an insurance company. In response to the hype, the Bubble Act was passed in 1720 to ensure that joint-stock companies could only be incorporated through acts of Parliament. According to Charles Mackay’s 1841 classic Extraordinary Popular Delusions and the Madness of Crowds, some of the companies were declared to be illegal and abolished, including ones for trading in hair, insuring horses, improving the art of making soap, increasing children’s fortunes, improving malt liquors, a hospital for taking in and maintaining illegitimate children, fitting ships to suppress pirates, extracting silver from lead, and a wheel for perpetual motion.
Mackay also documents the most infamous prospective company of the era — and what I’m calling the world’s first blank-check company — described in 18th century lingo as “A company for carrying on an undertaking of great advantage, but nobody to know what it is.” The prospectus stated that the required capital was £500,000 issued in 5,000 shares of £100 each with a required deposit of £2. The promoter promised that in one month the full details of how the company would make money would be revealed. The next morning at nine o’clock the promoter opened his office in Cornhill to crowds of people at his door. By the time he closed at three o’clock in the afternoon, he had more than 1,000 subscribers, having collected over £2,000 in 5 hours, close to $600,000 in today’s money. He was philosophical enough to be content with that amount and set off for continental Europe that evening, never to be heard from again.
Maybe it isn’t fair to SPAC sponsors to compare today’s SPACs with the infamous swindle, but I think there are some lessons and parallels. The major similarity is that for both the swindle and today’s SPACs, investors provided the upfront capital without knowing how that capital was going to be deployed. Another similarity is the optimism and leap of faith of investors. SPACs are the only type of investment I can think of where you don’t really know what you’re getting at the time of the investment. But of course, there are major differences. First and foremost, today’s SPACs certainly aren’t swindles, although just like the eager investors in 1720, expectations may be excessive and actual returns may not meet expectations.
How SPACs Work
Developed in 1993 by investment bankers David Nussbaum and David Miller, SPACs are companies formed through initial public offerings (IPOs), for the sole purpose of combining with private companies, typically start-ups. They have no assets beyond the cash they take in and no business plan. Companies have two years to merge or make an acquisition (I’ll use “merge” and “acquire” interchangeably) — otherwise they need to return the money to investors. If 20 percent or more of investors disapprove of a proposed acquisition, it won’t go forward. An underwriting commission of 5.5 percent is typical, with 2 percent paid upfront and the remainder at the anticipated subsequent merger. At least 85 percent of money raised is placed in a trust and can only be used for an acquisition. When the acquisition is completed, the acquired firm essentially trades places with the placeholder SPAC as a now publicly traded firm. SPACs are typically issued at unit prices of $10, with each unit a combination of a common share and a derivate security like a warrant, allowing the holders to buy fractions of common shares, typically at an exercise price of $11.50, up to five years after a completed merger. While that’s been typical and appealing to investors, more recent deal structures have become somewhat less attractive to investors and more attractive to merging companies.
Let’s look at the pros and cons of SPACs from the perspective of three key stakeholders: target start-ups, investors, and SPAC sponsors and promoters. The SPAC route can be attractive for the targeted company as a quicker and surer route to going public and raising capital rather than the traditional IPO, although not necessarily cheaper. SPACs are in a good position to tell growth stories, complete with forecasted revenue. From a retail investor perspective, getting in on the ground floor of hot unicorns (private companies valued at more than $1 billion) is often impossible, so the SPAC route offers a great access point compared with being locked-out of private investments and traditional IPOs. Warrants provide considerably more upside potential compared with simply owning a stock, but rosy forecasts don’t always pan out. As for the wealthy individuals who create the SPACs along with well-known celebrities, its usually a case of the rich getting richer since they earn upfront fees and usually participate through warrants, limiting their downside risk.
There are three key stages in the life of a SPAC. The first is around the IPO. Since the only assets are cash, SPACs typically trade around the initial $10 per unit value unless there is any news related to a potential merger. The second is around the announcement of an actual pending merger, like the April 13, 2021 announced merger between Grab and Altimeter Growth Corp. (which had reportedly been in talks since at least March 11, 2021). The SPAC price is then driven by the anticipation of successful merger and what investors perceive the prospects to be, so there is typically a bump in the stock price (particularly if it is a surprise to investors), but it depends on the implied valuation and the prospects of a completed deal. The third life is when the merger is completed, at which point the stock price is driven by the merged firm’s fundamentals such as growth prospects and perception of risk, just like any other stock.
SPAC investing is essentially betting on the jockey — the sponsors who formed the company — because there isn’t any horse. The sponsors often include high-profile names to attract investors, such as tennis star Serena Williams, basketball star Shaquille O’Neil, skateboard star Tony Hawk, former football quarterback Colin Kaepernick, and former Cosmopolitan editor Joanna Coles. Some well-known SPAC mergers include Richard Branson’s space-tourism Virgin Galactic Holdings Inc., sports-betting firm DraftKings Inc., electric-car battery company QuantumScape Corp., and a planned merger by flexible workspace company WeWork.
While firms that go the traditional IPO route are prohibited from making public projections of revenue, that’s not the case for SPACs. For example, 3D-printing company Velo3D Inc. that plans to merge with Jaws Spitfire Acquisition Corp., a SPAC associated with Serena Williams, projected that revenue would grow from $26 million in 2020 to $162 million in 2023. At least 15 firms in 2021 that have merged with SPACs or plan to, have no revenue. Some that have raised over $1 billion are in unproven markets such as future flying taxi services — which sounds to me like it’s right out of The Jetsons.
Is Now a Good Time to Invest in SPACs?
Some market observers have warned of a SPAC bubble. Even the original SPAC developers recently acknowledged that the current pace of SPAC growth isn’t sustainable. SPAC interest may be partly related to the current low interest rate environment, with investors chasing yield. Whenever supply increases considerably, it’s a sign that less desirable companies and perhaps more naïve investors are coming to the table. It’s important to note that with SPACs there is no guarantee of a completed merger, and even if there is, there isn’t a guarantee that the merger will be successful in terms of the subsequent stock performance.
So, how have SPACs performed? A recent comprehensive study (also a good primer on SPACs) by Minmo Gahng, Jay Ritter, and Donghang Zhang examined the returns of SPACs. The authors find that, since 2010, SPACs have tended to provide decent returns to investors up until the SPAC is merged, on average 9.3 percent annually. Subsequently, over the deSPAC period, on average returns are negative. Of course, past performance isn’t a guarantee of future returns, and with the recent proliferation of SPACs, lower returns compared with the past are almost inevitable. So far this year over 300 SPACs have raised nearly $100 billion — way more than in all of 2020 and up from only $13 billion in 2019 — and accounted for more than 70 percent of IPOs. There are over 430 SPACs and more than a hundred that came to market in 2020 and 2021 have been sports-related.
It’s true that with a SPAC there is relatively little downside, as most money — after initial costs, that include paying promoters — is returned if no suitable acquisition is identified in two years. But don’t overlook the opportunity cost. Based on history, a low-cost index fund might easily return 10 to 20 percent over two years. Are you thinking of a SPACs investment? The Wall Street Journal’s Laura Forman had an unflattering description of typical SPAC investors: “SPACs appeal to those with short attention spans, offering immediate gratification.” Perhaps that’s too harsh, but if you are considering a SPAC investment, take a hard look in the mirror first — are you tired of boring long-term buy-and-hold index investing (not that there’s anything wrong with that, in my opinion!) and just looking for a quick gain? Be clear as to what your motivation and expectations are, and always think before you invest, especially in something that “nobody to know what it is.”
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Stephen Foerster is a co-author, with Andrew Lo, of In Pursuit of the Perfect Portfolio: The Stories, Voices, and Key Insights of the Pioneers Who Shaped the Way We Invest, Princeton University Press (August 17, 2021).