If someone mentioned the term ‘SPAC’ weeks before the pandemic struck, a processed meat product might have come to mind.
Of course special purpose acquisition corporations — or SPACs — aren’t at all like Spam.
But these highly speculative investments were for months among the hottest corners of the stock market.
Colloquially called ‘blank cheque companies,’ SPACs have been around since the 1990s but caught fire last year as an alternative to initial public offerings (IPOs) to bring new companies to market.
Certainly, there have been dozens of high-profile examples of IPOs lately, including Canadian business-to-business financial firm Nuvei, which started trading on the Toronto Stock Exchange last fall for $26 a share, and now trades at more than $120.
Yet IPOs are costly, time-consuming and typically involve road-show meetings where new businesses seek to drum up money and interest.
Those became challenging with COVID-19. Yet investors still had a desire for new companies involved in technology, space travel, biotech and renewable energy.
Enter SPACs.
"SPACs are supposed to be a more efficient way to bring companies public than initial public offerings," says Mark Yamada, president of PUR Investing Inc. in Toronto.
Certainly SPACs have advantages. Chiefly, they are less costly, less regulated and a faster path to going public than IPOs. SPACs are also promoted as a way for small investors to gain access to private companies on the ground floor just before they list on a stock exchange.
And demand was unquenchable from March 2020 until February this year. In 2020 alone, US$83 billion poured into SPAC deals on the U.S. stock market and in the first six months of 2021, more than US$121 billion worth of SPACs listed, according to SPACinsider.com.
The previous high, by the way, was US$13 billion in 2019. Even Canada’s stock market saw SPAC deals worth hundreds of millions last year, according to an analyst from CPE Analytics.
Yet SPACs have fallen out of favour, down collectively about 20 per cent year to date as investor appetite for risk has waned.
One might think this is an opportunity to buy into a down-trodden segment that could again heat up. Indeed, younger investors continue to be curious, says Claudio Chisani, an investment adviser with Chisani Wealth Group at BlueShore Financial in North Vancouver.
"We hear questions about SPACs typically from 30-something clients who might already invest in cryptocurrencies," says the portfolio manager with the B.C.-based credit union.
Chisani’s answer involves explaining what SPACs are and, in turn, what makes them so risky.
"With SPACs, you’re buying a pool of capital looking for a business to purchase rather than buying into a company looking for money to grow its business."
So a SPAC’s job is to find a private company that has developed a promising product or service — but likely not generating much cash if any — to merge with.
"You’re really investing in competence of a SPAC manager to pick the right company to acquire," says Josh Olfert, an investment adviser with Haven Wealth Management in Winnipeg.
Another quirk is, when SPACs list on a stock exchange and are still looking to merge (buy into) with a private company, their share price trades around $10.
Investors also receive warrants along with stock, which offer an opportunity to buy more shares after the merger with the target company is complete. The idea being that once the merger is done, and the SPAC begins trading under the company name it merged with, the share price could skyrocket. In turn, the warrants allow SPAC investors to buy shares in the newly formed company at a lower price than market value (i.e. $11.50 versus $15).
In fact, experienced SPAC investors often sell SPAC stocks pre-merger — trading around $10 a share — and keep the warrants, Yamada says.
"If the post-merger company does well, the warrants are where the real value is," he says.
"You get all your money back (invested in the SPAC stocks); you get the warrants for free, and the warrants might make you the money — that’s the way to play SPACs."
Yet many investors hold the shares, based on the promise of the companies with which SPACs merge.
Indeed these companies can be intriguing: fantasy pool provider DraftKings (ticker: DKNG), Nikola (NKLA), an electric semi-truck manufacturer, QuantumScape (QS), a solid-state lithium battery manufacturer, and Virgin Galactic Holdings (SPCE) in commercial spacecraft.
All experienced incredible price growth — from $10 a share to $65, for instance. Yet all saw their share price drop significantly afterward.
One reason is SPACs merge with risky companies.
"If a company has gone public by SPAC, it almost inherently means its leadership was looking for a less scrutinized way to list than the IPO process," Olfert says.
Nikola is a good example. It’s now under investigation for allegedly powering its electric trucks by secretly plugging the vehicles into an electrical outlet while rolling them downhill in proof-of-concept demonstrations.
With this in mind, understand that if you invest in SPACs, you’re not really investing, Olfert says.
You’re speculating because it’s more likely the newly formed, post-merger company may never be profitable.
So if you want to scratch this itch, do so with a very small portion of the portfolio. And it’s best to buy them via exchange-trade funds (ETFs) that invest in a handful of SPACs or post-merger companies.
"This is an easier, more risk-adjusted way to gain access," Chisani says, pointing to offerings like Defiance Next Gen SPAC Derived ETF. "That way an investor, for about $25 (per share), can get a piece of the action."
Just remember: You might end up wishing you’d bought Spam instead.