October 31, 2023 — In today’s digital age, information spreads instantly and circulates the internet with viral velocity. Due to the profound implications of some information, it is increasingly important that the data be accurate and factual. However, given that sending data is effectively costless and artificial intelligence can readily create incorrect content instantly, it is more important than ever to be diligent in the consumption of data irrespective of the source.
Over the past several years there has seemingly been an explosion of fake news, alternative facts, and incorrect opinions. As the internet giants and social media have disrupted traditional media, certain previously highly-revered information sources have resorted to click-bait headlines and sensationalist articles in a feeble attempt to keep their revenue afloat, journalistic integrity be damned.
Now that large contingents of the population gather their information from potentially unscrupulous platforms such as TikTok, it is best to remain vigilant and double-check any significant claims. As they say, “Trust but verify”.
The best way to verify information or judge the validity of an opinion is to look at the facts.
When it comes to capital market disinformation, there is no asset class more misunderstood or perhaps tainted unfairly by rampant disinformation than special purpose acquisition companies.
Most often, when the lay investor thinks of a SPAC, they think:
- SPACs are dead
- SPACs are stupid/bad
Both of these statements are mostly false and readily disprovable through data.
First, while the blank check market has declined significantly from its peak, it has reverted back to where it was in early 2020.
The SPAC asset class is currently worth $20 billion. It is a niche segment of the market that went through a boom and bust cycle of new issuance from 2020 to 2022. The asset class returned to where it should have stayed, as the boom in issuance post-Covid was proven unsustainable.
Also, activity in the blank check space remains slow, however, very much not dead. For example, there were 15 SPAC mergers announced in October, worth an aggregate of nearly $5 billion. In addition, there were 2 SPAC IPOs this month, bringing the year-to-date tally to 24. Activity is not gangbusters, however, it is also not moribund.
Second, SPACs are mostly not stupid/bad. As Howard Marks says, “There are no bad assets, just bad prices”.
In fact, as an investment vehicle, SPACs have a relatively attractive risk-adjusted return profile.
We previously described the rational way to view a pre-deal SPAC in our memo, Cash Plus: The Ultimate Upgrade To Cash For Enhanced Returns:
“A pre-deal SPAC can be considered a redeemable T-bill plus an equity call option. Depending on its price, a SPAC can trade at a discount, or a premium, to its underlying net asset value. The call option aspect of the equation refers to the notion that a SPAC can trade above its redeemable NAV upon announcing a business combination that the market deems to be attractive.
A pre-deal SPAC trading at a discount to NAV is analogous to a discounted T-bill plus an equity call option. For example, a SPAC trading at $10.30 with a $10.50 NAV represents a T-bill trading at 98 cents on the dollar. This discounted T-bill offers a premium yield — what we call “cash plus”.
A cash plus investment strategy enjoys certain advantages over a plain vanilla T-bill or a high-interest savings account.
SPACs trading below NAV offer two unique advantages over cash strategies in particular:
- Higher yields: The ability to earn yields above cash given the discounted price.
- Tax efficiency: The ability to earn yield via capital gains instead of interest income.”
For example, the below graph charts the year-to-date price performance of the market’s two largest blank check companies, Gores Holding IX ($547 million market cap), and Screaming Eagle Acquisition ($787 million market cap). These return profiles look more like a cash-plus investment rather than a speculative junk stock.
Given the redeemable nature of the underlying T-bills held by blank check companies, if administered correctly, a pre-deal SPAC investment strategy is one of the lowest-risk investment allocations in the market.
However, one does not invest in a SPAC arbitrage strategy only for a T-bill-like return profile. The real torque in the strategy is its upside optionality, or exiting the investment far above the value of the underlying T-bills when a sponsor announces an attractive business combination for the SPAC.
Source: Bloomberg, Accelerate
The example above showcases how an arbitrageur could have bought shares in the black check company CF Acquisition VI at a 2% discount to its NAV, and then sold at a double-digit premium to NAV after the SPAC sponsor announced the company’s merger with private company Rumble. The ability to buy redeemable T-bills at a discount, with potentially significant upside, is why we call SPAC arbitrage a “heads we win, tails we win big” investment strategy.
However, most of the confusion and misinformation behind the asset class is mixing up two different securities: the SPAC and the deSPAC.
The difference between the two asset classes, a SPAC and a deSPAC, is analogous to the difference between a tadpole and a bullfrog.
A tadpole is an innocuous, simple creature, with limited movement and activity aside from swimming around in a pond. For a child to have one or dozens of tadpoles as pets would be relatively manageable and reasonably undemanding. However, over time, the tadpole will mature into a wild and unruly bullfrog. Suddenly, those easy tadpole pets have turned into a gang of unmanageable bullfrogs jumping out of their tank.
Just as the curious child keeps the tadpoles but never bullfrogs, a low-risk investor allocates only to SPACs, and never deSPACs.
DeSPACs occur when a blank check company completes its merger with an operating company and investors forego their redemption privilege. Historically, when talking heads say SPACs are bad, likely 100% of the time, they refer to deSPACs once they have completed their merger and the redemption floor has been eliminated. This change means the investment went from low risk to very high risk. This distinction is most important, as it distinguishes between a T-bill-like investment and a venture capital-like investment. The risk profiles could not be more different.
What a deSPAC represents is an operating company going public. It is only different from a traditional IPO via form, not function. When a private company plans to go public, it will consider a traditional IPO, a blank check company, or a direct listing, depending on its objectives.
Therefore, it is worthwhile to explore whether deSPACs are bad or is it that most new issues are bad.
Most companies lack profitability at the time of their initial public offering. Over the past four decades, the prevalence of unprofitable IPOs has surged, with the percentage of such unprofitable IPOs increasing from approximately 20% in the 1980s to 80% today. Lack of profitability is par for the course in new issues, whether they go public via traditional IPO or through a black check company.
Empirical data show that IPOs generally underperform over time. On average, 64% of new issues underperform the market average three years post IPO, while just 29% outperform.
However, we must not throw the baby out with the bath water. Averages do not describe the distribution of results around the mean. Most of the stock market’s biggest long-term winners have gone public through IPOs. Unfortunately for IPO investors, while the odd lottery ticket pays off, most are a waste of money.
Similar to how some great stocks went public via IPO, some good businesses hit the market through a SPAC, with recent winners including Willscot Mobile Mini Holdings and Archaea Energy.
Nonetheless, the average deSPAC is bad, with markedly worse performance than the average IPO. Since both indexes peaked in February 2021, the IPO index is down -61% while the deSPAC index is down -90%. Lately, whether deSPAC or IPO, new issues, on average, have delivered devastating losses to investors.
Nonetheless, it is important to discern that we are SPAC investors (T-bills + equity call options) and not deSPAC investors (speculative new issues). This distinction is the most common mistake some make while painting the two very different asset classes with the same brush.
The difference between investing in SPACs and investing in deSPACs could not be more stark. Since April 2020, the SPAC index has returned +58% while the deSPAC index has lost -85%.
Source: Accelerate, Bloomberg
The dramatically different risk profiles and investment opportunities supported by the data separate SPAC fact from deSPAC fiction.
The Accelerate AlphaRank SPAC Monitor details various metrics on the current opportunity set while offering details on every individual SPAC currently outstanding. The Accelerate AlphaRank SPAC Effective Yield tracks the average arbitrage yield offered. The Accelerate AlphaRank SPAC Index tracks the price return of the SPAC universe.
* AlphaRank is exclusively produced by Accelerate Financial Technologies Inc. (“Accelerate”). The Accelerate Arbitrage Fund may hold a number of securities discussed in this research. Visit AccelerateShares.com for more information.
Disclaimer: This research does not constitute investment, legal or tax advice. Data provided in this research should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this research is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Accelerate may have positions in securities mentioned. Past performance is not indicative of future results.