UAE: Are SPACs the next tech boom in the making? Know what are they and how do they work
Why has the burgeoning deal-making instrument suddenly spiked interest among investors
Dubai: In the past many months, almost since 2021 began, there have been several mentions of the word ‘SPAC’ in the world of business and investments. So there is a need to de-jargonise what it means to an average stock market investor.
With the recent developments surrounding SPACs, it is now commonly referred to among analysts as ‘a 2020s echo of the dot-com mania of the 1990s’ – making it a concept that sparks investor attention and drives a need to know about it in detail as a possible investment opportunity. But first, what is a SPAC?
What is a SPAC?
A special purpose acquisition company, or a ‘SPAC’, is a company that is formed strictly to raise money through an initial public offering (IPO) for the purpose of acquiring an existing company.
Also known as ‘blank cheque’ firms, SPACs have been around for decades and have no commercial operations. So, simply put, they are non-operating publicly-listed companies whose purpose is to identify and purchase a private company.
When a SPAC or other publicly-traded company purchases a private company, it is called a reverse merger. A traditional merger is when a private company takes a public company private.
So, in other words, SPACs raise money in an IPO, and then place it in a trust while the SPAC owner (sponsor) searches for a business or businesses to acquire, usually within a two-year period. The companies then complete a merger and the target becomes a listed stock.
It’s essentially considered a back door to going public, predominently in the US currently, and avoiding scrutiny. Although regulatory scrutiny is tightening, a more crucial fact to keep in mind is that apart from a handful of companies that have performed well, the average return is negative in this space.
What is the basis for this investment craze now?
Although SPACs have been around since the 1980s, they have become a force to reckon with this year amid high levels of liquidity and a strong appetite for new growth companies.
About 300 SPACs, or special purpose acquisition companies, launched this quarter on US stock exchanges, raising almost a mammoth $100 billion (Dh367) - more than all of last year.
In 2020, 247 newly formed SPACs raised $83 billion (Dh304 billion) in capital through initial public offerings. In 2019 and 2020, more SPACs were created in those two years than in the prior 18 years combined.
Not only are the number of SPACs increasing, but each SPAC is raising more capital through IPOs to allow them to purchase larger private companies. The average SPAC IPO in 2020 was $336 million (Dh 1.2 billion) compared to $230 million (Dh844 million) in 2019.
Why the need for a SPAC?
Private companies look to be acquired by SPACs because it is more easy and less taxing and cumbersome than going public through an initial public offering (IPO).
Investor appetite for new public offerings is dependent on numerous unquantifiable conditions, and this in turn affects the share price of the new company – posing the threat of being undervalued.
A SPAC is already public, so a reverse merger allows a private company to become public when the IPO window is closed.
SPAC acquisitions are also attractive to private companies because their founders and other major shareholders can sell a higher percentage of their ownership in a reverse merger than they would with an initial public offering.
The owners of the private company can also avoid the lock-up periods for selling newly public shares that are generally a mandatory requirement for initial public offerings.
Understanding how SPACs work
SPACs raise capital to make an acquisition through an initial public offering. A typical SPAC IPO structure consists of a common stock share combined with a warrant. A warrant gives the holder the right to buy more stock at a fixed price at a later date.
Investors who take part in a SPAC IPO are enticed by the chance to exercise the warrants so they can get more common stock shares once the acquisition is identified and the transaction closes.
The typical IPO list price for a SPAC common stock is $10 (Dh36) per share. The exercise price (price the stock can be either bought or sold for) for the warrants is typically set about 15 per cent or higher than the IPO price. A few weeks after the IPO is completed the warrant is spun off and trades separately from the SPAC stock.
Some upsides to SPACs
Speed: The typical IPO process can take 2 to 3 years from start to finish, while a SPAC only takes 3 to 4 months. For private companies looking to go public quickly, a SPAC is an attractive option.
Additional profit opportunities: Once a target company is identified, institutional investors like hedge funds, pensions, or banks can purchase additional shares at a fixed price through warrants, making the SPAC structure very attractive for big investors.
Significant upside for sponsors: The sponsor, or the team responsible for creating the SPAC and taking it public, can stand to make hundreds of millions of dollars regardless of how well the acquired company does after its public. This is because they own a lot of the shares from the start.
Private investors or PE investment fund investors may want to be SPAC sponsors to benefit from potential gains and returns on the day of the IPO, and also during and after the later acquisitions of a SPAC.
Criticisms SPAs face
A key criticism of SPACs is the large stock allocation the SPAC sponsors receive as part of the SPAC IPO.
The shares and warrants belonging to the owners of the SPAC are purchased for a nominal amount but entitle the management to up to 20 per cent of the total stock shares outstanding following the IPO.
This further leads to a conflict of interest as the sponsors have significant upside if they close a transaction even if the particular opportunity is not overly compelling.
Changing approach
However, some recent SPAC IPOs have sought to reduce the conflict of interest and shareholder dilution.
For instance, US-based Pershing Square Tontine Holdings, led by US billionaire hedge fund manager Bill Ackman structured its IPO so that the sponsors purchased $1 billion (Dh3.6 billion) of stock along with some warrants. The firm expects the dilution to stockholders to be only 6 per cent compared to the typical 20 per cent.
How UAE stock markets handling this rush?
UAE firms have been trying to fast-track listings in US through mergers with special purpose acquisition companies (SPACs).
Analysts weighed in how this posed a fresh challenge to stock exchanges in the region, which have already been witnessing a waning in the IPO market.
Although SPACs allow the target to list more quickly on share markets than via traditional initial public offerings, such lightly regulated vehicles are currently not permitted on UAE bourses.
However, stock market experts evaluate how companies seeking out alternative venues are putting local stock markets under pressure to change regulations to cash in on the trend.
After a strong run of acquisitions in the US, analysts are of the view that SPACs are looking at companies in emerging markets which they would like to merge with to go public, with a focus on Asia, potential targets in the UAE and elsewhere in the GCC.
Why UAE may look attractive for SPACs?
An added benefit for SPACs is the Gulf states' dollar peg, implying limited currency risk for US listings.
The UAE's equity markets have not seen sizeable IPOs over the past few years. Dubai logistics firm Tristar recently announced an intention to float on the Dubai bourse, which would be the bourse's first big-ticket listing since Emaar Development in 2017.
Abu Dhabi-headquartered Anghami, the Middle East's rival to Spotify, recently announced it was merging with a SPAC, with a planned listing on the US-based Nasdaq exchange, after achieving the valuation it was looking for.
Abu Dhabi's Brooge Petroleum and Gas Investment Co (BPGIC), which operates an oil storage and service business, listed in 2019 on the US-based Nasdaq after a merger with a SPAC to establish a global presence and access liquid markets.
Total traded value in the UAE has slumped by 74 per cent since 2014 to Dh127.5 billion last year. The Dubai Financial Market (DFM) is consulting market participants about inviting SPACs to list in Dubai, Reuters reported this week, citing a source familiar with the matter.
In Netherlands, the stock exchange in Amsterdam is turning into a hotspot for such listings, while Britain has also said it will modernise its listing rules to attract more ‘blank cheque’ flotations on the London exchange.
Is a SPAC a good investment?
Historically, SPAC investing has been less profitable for individual investors. Most SPACs underperform the stock market and eventually fall below the IPO price.
Given SPAC's poor track record, veteran investors and market analysts are widely of the opinion that investors should be wary of investing in them, unless they focus their investing on pre-acquisition SPACs when the listed prices are low.
However, while among those analysts that believe profitably investing in SPACs is possible, they reiterate that manually selecting them is essential, as compared to selecting the SPAC through robo-advisors.
As with any investment decision, there are perks and risks to investing in a SPAC. Investing in a SPAC IPO amounts to a bet on the sponsors or the SPAC owners, their reputation and whether a successful deal will happen within two years.
Rather than researching a company’s financials, as you should when investing in an individual stock, you will need to instead research who is behind the SPAC and what industry they may be targeting for an acquisition.
Experienced investors may use their industry expertise to back the most skilled sponsors, who are likely to have the highest probability of success.
How do I invest in SPACs?
As they are public companies listed on major exchanges, you can invest in SPACs like you can any other publicly traded stock – through your online brokerage account. You can also take a diversified approach and invest in a basket of SPACs by buying an exchange-traded fund (ETF) focused on SPACs.
Selecting individual SPACs allows investors to focus on the opportunities that seem most promising. If you can't access a SPAC's pre-IPO stock, you can still invest in pre-deal SPAC stock after it goes public. SPAC stocks often soar after they announce a deal to merge with a private company. Once a SPAC debuts on the US-based stock exchanges (or any other) you can buy it through your regular broker.
What to keep in mind if investing in a SPAC?
While SPACs do offer a guaranteed return of your investment if they don’t acquire or merge with a company within two years, they aren’t without risk.
First, though most SPACs start out with share prices of around $10 (Dh36), this price can rise substantially due to the fame of those behind them or the announcement of their target acquisitions.
If you end up paying more than the initial offering price of a SPAC, you could stand to lose more than your initial investment if no deal materialises since you would only recover the $10 (Dh36) per share price, after deducting expenses.
And if your SPAC does successfully acquire a company, it becomes just as risky as any other single stock, if not riskier. Keep in mind that while some startups offer incredible returns on investment, most fail or offer sub-par returns.
However, it is about 24 per cent worse than the US key stock market benchmark S&P 500 during the same period.
In the year following the acquisition, when SPACs no longer has a guarantee of return, the lower declines persist. In their first year, SPAC-acquired stocks still underperform the broader stock market by 24 per cent on the whole, according to Goldman Sachs.
What’s driving interest to SPACs now?
Recent research has shown that the recent crop of SPAC mergers have performed better than a broader group of companies.
In the US, the common shares of the 21 SPAC mergers completed in the period from January 1 to July 2020 are averaging a return of 13.1 per cent from their offer price, but that’s mostly due to the two highest performers — DraftKings and Nikola.
US-based sports betting operator DraftKings went public via a merger with SPAC Diamond Eagle Acquisition Corp. and SBTech Global Ltd last year. Electric vehicle maker Nikola merged with VectolQ Acquisition in June. Both firms gained over 200 per cent last year.