Just when I thought I knew about every kind of investment in the stock market, up pops another thing I’d never heard of. For someone with twenty years of investment experience, the lesson is to expect the unexpected. In this case, the unexpected is a SPAC (pronounced “spack”).
What the heck is a SPAC?
It’s a Special Purpose Acquisition Company. It exists for pretty much one reason: to acquire at least one other company. The SPAC raises money in an IPO from the public with the intent to purchase other companies.
A SPAC is essentially a blind pool in which the managers get a blank check to buy something — something you won’t be told anything about. If a SPAC sounds like a scam, then you have the right skeptical frame of mind to keep reading. After all, what’s stopping SPACs from just taking the money and running?
How SPACs Work
A bunch of safeguards are in place with SPACs. First 98% of IPO proceeds get dropped into escrow. SPAC management gets 20% of the units in exchange for a flat $25,000 payment. They get nothing else. No management fees. No free candy bars. All they get are 20% of the shares, so they have a vested interest in making those shares more valuable via acquisition.
The acquisition must be approved by a majority of the shareholders, and if more than 20% of shareholders choose instead to cash out because they hate the acquisition, the deal doesn’t go through. That’s right — you can bail completely and get your money back if you don’t like the deal.
There’s a kicker. In addition to investors getting shares in the SPAC, they also get warrants. That allows them to purchase additional shares at a pre-determined price, often a bit higher than the IPO price. The idea here is that if the acquisition is a winner, then the SPAC’s share price should increase, giving shareholders a chance to buy additional shares at or below where it trades post-acquisition.
The acquisition must also be made within two years or the SPAC returns everyone’s money.
So the next question is: Should you get involved in SPACs?
Their track record is not stellar. This comprehensive report shows that not very many SPACs deliver blockbuster returns. Some of them do, but overall the ones that made acquisitions have returned negative 14% vs. a 5.9% positive return for the Russell 3000.
Evaluating a Potential SPAC Investment
First, who are the people involved in the SPAC? What is their track record? What areas of expertise do they have? Are they planning to purchase something in their wheelhouse of expertise? Have they launched other SPACs and how did those perform?
Most importantly, only select a SPAC that wants an acquisition in an area you understand. It’s no different than buying a stock in a business you understand.
If you feel like management and sector pass muster, then you can buy in.
The next step is to evaluate the potential acquisition once it is announced. While you should read everything the SPAC provides, you should then set it aside and do your own due diligence as if you were buying the company yourself. Remember, once you approve the acquisition, you’re stuck with the company. If it craters, so does your investment. You don’t have to approve the acquisition. You have the option to cash out and get your money back.
One last thing — if a SPAC is headed for an acquisition, then abruptly changes course, get out. It means management didn’t get the deal it wanted, was running out of time to make a deal, and is probably grasping at straws.
Some SPACs worth looking at right now are Capitol Acquisition Corp. II (CLAC), which is looking at real estate and already has one successful SPAC behind it, and Boulevard Acquisition Corp. (BLVD) which is buying a unit of Dow Chemical (DOW).
Lawrence Meyers has no position in any SPACs.
