2020 is the year of the SPAC — a record 82 special purpose acquisition companies went public this year to raise $31 billion and more are on the way. That’s a big jump from 2019 when they raised a total of $13.6 billion. It’s as if everyone is starting their own SPACs as a side hustle, but what are these companies really, and why have they become so popular? Are they actually worth investing in?🤔 Investing in SPACs or not, you definitely need to know how to find the best stocks out there. Learn how to find them here.👀
SPAC or special purpose acquisition company or blank-check or shell company, all describe exactly the same thing — a company with no real operations.
How do They Work Exactly?
SPACs are formed strictly to raise capital through a traditional initial public offering (IPO) for the purpose of acquiring an existing private company. Pretty much anyone who can persuade shareholders to buy its shares can start one — ok, I know what you’re thinking…
SPAC’ing has become a serious sport for some entrepreneurs. Chamath Palihapitiya who has famously brought space company Virgin Galactic to markets, through his first SPAC Social Capital Hedosophia, has started five other blank-check companies so far!🔥 His Social Capital Hedosophia II has recently announced that it will merge with real estate startup Opendoor. The four newer SPACs Social Capital Hedosophia Corp. III, IV, V, and VI will start looking for acquisition targets soon.
SPACs typically have about two years to find a target company. If they fail, they return the money to shareholders.
After the SPAC raises capital through an IPO, the money is moved into a blind trust. Until the management team decides which company wants to acquire. Share prices don’t really move much during this period as no investors know what the target company will be yet.
SPACs usually sell their units/shares at $10 apiece, just for easier accounting or tradition.
Why are so Many Companies Suddenly Going Public through a SPAC?
Going public through the traditional route is a difficult and lengthy process. And the COVID-19 pandemic may have slowed down the process even more. SPACs provide startups a relatively frictionless way to get out of the door. Chosen companies get to forgo the roadshow, the part of a traditional IPO. Where they have to present their business to an endless array of possible investors. This has already been done by the blank-check company. Also, the merger automatically takes the company public, allowing it to avoid much of the usual disclosure paperwork.
Should you Invest in SPACs?
SPACs may be trading like common stocks but there are some big differences. It’s important to know the risks and the rewards involved 👀 so you can make your own decisions with confidence.
There are typically 3 phases in the lifecycle of a SPAC, let me explain:
- The pure-SPAC phase: This is the period when a SPAC’s shares don’t move much, as investors wait for the company to announce a deal.
- The deal announcement phase: This is a pretty tricky period for a SPAC. When managers announce that they’ve found a target company, the previously quiet stock is a past. If investors believe that the target company is interesting, has great potential, and is fairly disruptive the stock can surge. But the opposite can also happen if the target company fails to impress investors.
- The after-SPAC phase: This is the period when the deal closes, the target company goes public and the stock ticker changes to reflect the name of the new company. If you keep your shares after a deal closes, you now own a part of the acquired company, so the stock performance depends on the company’s fundamentals. The SPAC has done its job.👌
You may be surprised to learn that the blank-check company that brought Virgin Galactic to public markets had actually performed poorly after the deal was announced.
Investors didn’t initially believe that Virgin Galactic’s plans could become reality, so they rushed to sell their shares in the SPAC and the stock fell more than 30%, following the deal announcement. However, after analysts started covering the stock and supporting its story, this negative sentiment quickly changed. The Virgin Galactic case is a great reminder that investing in a SPAC is pretty much like flipping a coin.
If I were to invest in a SPAC, I’d definitely choose one that is managed by a high-profile investor or entrepreneur — the likelihood of making a deal with a promising private company is much higher.
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