There’s a hot new trend on Wall Street right now. People have been asking me whether they’re missing the boat if they don’t invest in SPACs.
Special Purpose Acquisition Companies, or SPACs, are essentially shell companies that exist only to buy other companies. Why? To shepherd these acquisitions into public markets through an alternative pathway to an IPO.
The traditional Initial Public Offering (IPO) is famously frustrating. To join the stock market, private companies massively increase their reporting and regulatory burdens. The Wall Street investment bankers who usually manage this process are also famous for high fees and under-pricing companies to drive a Day 1 “bump”.
Since IPOs are challenging and leave a lot of money on the table, it’s no wonder that more and more private companies have been looking for alternative routes to the public market. I love that the market has found an innovative way to work around the difficulties of an IPO.
But this is only half the picture. SPACs have to raise the capital they will use for an acquisition, and this is where investors come into the picture. Until they make an acquisition deal, a SPAC is just an empty company holding cash and looking for a target. Investors in these companies have no idea what they’ll end up owning. They have to hope that the SPAC will find a good target and strike a good deal.
This points to a growing risk. The more SPACs are in the market, hunting for targets, the more leverage those target companies have to ask for higher prices, and the more likely that SPACs will get into bidding wars and overpay.
Great investors carefully optimize their risk-adjusted returns. How do we do this when we don’t know what we’re investing in? Not easily. A SPAC is basically a speculative bet that the managers or sponsors of the SPAC will close a good deal. Fees only hurt the investor ROI further. With so little information, SPACs are often more of a gamble than an investment.
Investors who are afraid of missing out should worry less. As Warren Buffet once said, there are no called strikes in investing. Investing in a SPAC is like swinging at a pitch you cannot see, simply because you like the pitcher.