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E-MailMichael Klausner is the Nancy and Charles Munger Professor of Business and Professor of Law at Stanford Law School; Michael Ohlrogge is Assistant Professor of Law at NYU School of Law; and Emily Ruan of Stanford University. This post is based on their recent paper.
1. Introduction
SPACs, or special purpose acquisition companies, have experienced a frenzy of activity and attention over the past year. In 2020, SPACs have already raised as much cash as they did over the entire preceding decade, with two-thirds of this cash raised in just the past three months. Press reports and blog commentary present SPACs as a clever financial innovation that provide a cheaper, faster, and more certain path to becoming a public company than does an IPO. Those reports, however, misunderstand the economics of SPACs. We have just posted a study of all 47 SPACs that merged between January 2019 and June 2020. That study addresses each of those claims. In this blog we focus on our findings regarding the cost of SPACs, which are very much at odds with the commentary one sees on nearly a daily basis.
In a nutshell, we find:
- Although SPACs issue shares for roughly $10 and value their shares at $10 when they merge, by the time of the merger the median SPAC holds cash of just $6.67 per share.
- The dilution embedded in SPACs constitutes a cost roughly twice as high as the cost generally attributed to SPACs, even by SPAC skeptics.
- When commentators say SPACs are a cheap way to go public, they are right, but only because SPAC investors are bearing the cost, which is an unsustainable situation.
- Although some SPACs with high-quality sponsors do better than others, SPAC investors that hold shares at the time of a SPAC’s merger see post-merger share prices drop on average by a third or more.
- Since the end of our study period, Pershing Square issued a SPAC with substantial improvements in the uniform structure of other SPACs. We propose, however, that more fundamental improvement is possible.
2. The SPAC Structure
SPACs raise cash in an IPO and then have two years to search for a private company with which to merge and thereby bring public. Their shares are redeemable at the time a merger is proposed, so if SPAC investors don’t like a proposed merger, they get back their full investment, plus a very high return.
The primary source of SPACs’ high cost and poor post-merger performance is dilution built into the circuitous two-year route they take to bringing a company public. Along the way, SPACs give shares, warrants, and rights to parties that do not contribute cash to the eventual merger. Those essentially free securities dilute the value of shares that SPAC investors purchase. We illustrate this circuitous route in Figure 1: (a) a SPAC issues units consisting of redeemable shares and warrants in an IPO and at the same time the sponsor makes an investment to cover the SPAC’s costs between the IPO and its merger; (b) within two years, the SPAC’s sponsor proposes a merger by which a private company would go public; (c) typically about three quarters of the SPAC’s shares are redeemed; (d) contemporaneously with the merger, the SPAC issues new shares to the sponsor and/or third parties in private placements (PIPEs) to replenish some of the cash the SPAC paid out to redeem its shares; (e) the merger proceeds; (f) the SPAC’s remaining public shareholders, PIPE investors, and sponsor each own a small slice of the post-merger company’s equity.
Figure 1: The SPAC Merger Process
3. Dilution Inherent in the SPAC Structure
There are three sources of dilution inherent in the SPAC structure. First, SPAC sponsors compensate themselves with a “promote” consisting of shares equal to 25% of the SPAC’s IPO proceeds, or equivalently, 20% of post-IPO equity. Second, in order to attract IPO investors, SPACs promise a very attractive return for simply allowing the SPAC to hold their cash for two years. SPAC shareholders that redeem their shares receive the full price of the units sold in the IPO with interest—plus the right to keep the warrants included in the units for free. For SPACs in our study, that has amounted to an average annualized return of 11.6% for redeeming investors, with essentially no downside risk. Third, at the time of their IPO, SPACs pay an underwriting fee based on IPO proceeds, despite the fact that most shares sold in the IPO will be redeemed at the time of the merger. These three elements of SPACs dilute share value at the time of the SPAC’s merger, and impose a steep cost on either the shareholders of the SPAC or the shareholders of the company the SPAC takes public. We address below who bears that cost.
Redemptions also magnify the dilution initially caused by the promote and the warrants. Consider a hypothetical SPAC that sells 80 shares to the public and gives 20 shares to the sponsor for a nominal fee. That is, 80% of the shares are backed by cash, and 20% are not. If 50% of the SPAC’s 80 public shares are redeemed, the sponsor’s 20-share promote, initially equal to 25% of publicly owned shares, will equal 50% of the 40 remaining publicly owned shares. Equivalently, of the 60 shares remaining after redemptions, 67% have cash behind them, and 33% do not.
Redemption actually tends to be much higher than 50%. Mean and median redemptions for SPACs that merged between January 2019 and June 2020 were 58% and 73%, respectively. Over a third of those SPACs had redemptions of over 90%. To some extent, SPACs replenish the cash they lose to redemptions by selling new shares through private placements contemporaneously with their merger, but for most SPACs, the replacement is only partial.
4. The Cost of SPAC Dilution
When a SPAC merges, the value of a SPAC share is stated to be $10. This is necessary because the redemption price of a SPAC share is approximately $10 and therefore the pre-merger trading value of a SPAC share is no less than $10. Because of the dilution outlined above, however, SPACs do not have $10 of cash for each share outstanding. In Table 1, we show SPAC dilution as a percentage of cash that a SPAC delivers—that is, IPO proceeds, minus redemptions, plus new money raised in PIPEs. The median SPAC’s dilution amounts to a staggering 50.4% of cash delivered in a merger. This means that a SPAC with median dilution that delivers $1,000 in cash from selling 100 shares would have the equivalent of roughly 150 shares outstanding (treating warrants as fractions of shares based on their value). Another way to say this is that for each share purportedly worth $10, there is $6.67 in cash and $3.33 in dilution overhanging the merger. At the 75th percentile, there are the equivalent of 2.6 shares outstanding with no cash behind them for each share with cash.
Table 1: SPAC Costs as a % of Cash Delivered in Mergers (Including PIPEs)
| Median | 25th Percentile | 75th Percentile | |
|---|---|---|---|
| Net Promote | 31.3% | 14% | 140% |
| Underwriting Fee | 7.2% | 4% | 34% |
| Warrant + Right Cost | 16.6% | 9% | 77% |
| Total Costs | 50.4% | 29% | 261% |
Table 2 shows the same dilution shown in Table 1 above, but this time as a percentage of SPACs’ post-merger equity. At the median, the surplus that must be created for SPAC and target shareholders to break even is 14.1% of the post-merger company’s value. To the extent this does not occur, either the SPAC shareholders or the target, or both, will bear the cost.
Table 2: SPAC Costs as % Post-Merger Equity
| Median | 25th Percentile | 75th Percentile | |
|---|---|---|---|
| Net Promote | 7.7% | 5% | 12% |
| Underwriting Fee | 2.3% | 1% | 3% |
| Warrant + Right Cost | 4% | 3% | 7% |
| Total Costs | 14.1% | 10% | 21% |
5. Who Bears the Costs?
When a SPAC merges, SPAC shareholders must believe they will receive about $10 per share in value to justify giving up their option to redeem at about $10. Target shareholders, however, will not agree to a merger unless they receive shares in the post-merger company at least equal to their estimation of the pre-merger value of their shares. Therefore, if target shareholders value SPAC shares only at their cash value, and negotiate a deal based on that value, SPAC shareholders will see their shares fall in price following the merger. For example, for the median SPAC with $6.67 in cash per share before the merger, shares would drop to $6.67 after the merger. This would mean the target has gotten an even deal and the SPAC shareholders have borne the cost of the SPAC’s dilution. If both target and SPAC shareholders are to break even or come out ahead, the merger must create sufficient surplus to fill the hole created by the SPAC’s dilution. That surplus, if it exists, would consist of the value of the target becoming a public company plus value the sponsor creates by remaining engaged with the post-merger company.
In order to analyze who bears the cost of SPAC dilution, we look at post-merger price performance. Table 3 presents three-, six-, and twelve-month post-merger returns for SPACs that merged between January 2019 and June 2020. By three months following a SPAC’s merger, median returns were negative 14.5% and median returns in excess of the Russell 2000 or the IPO index were even lower. Six-month returns were worse and twelve-month returns (for those SPACs with that much post-merger performance history) are worse still. A reasonable inference is that targets negotiated prices or share exchanges based on the cash value of SPAC shares, and that SPAC shareholders bore the cost of SPACs’ dilution.
We find further support for this inference in Figure 2, which shows a high correlation between stock drops and the amount of dilution in a SPAC at the time of its merger. SPACs with low cash per share see large post-merger price declines from the roughly $10 pre-merger share price. This relationship strongly implies that poor post-merger SPAC performance reflects the cost of the dilution embedded in SPACs—and that SPAC shareholders have generally borne that cost.
Commentators often highlight SPACs that have done well. These are generally SPACs sponsored by high-profile private equity firms, former CEOs of Fortune 500 companies, and others with high visibility. To explore the possibility that there is an identifiable subset of SPACs that have consistently done well, Figure 2 identifies SPACs with sponsors that are (a) private equity funds listed in Pitchbook as having assets under management of $1 billion or more or (b) former CEOs or senior officers of Fortune 500 companies. We label those SPACs as “high quality” or “HQ” (with apologies to high quality sponsors that do not meet this admittedly imperfect definition). SPACs with high quality sponsors tend to do better than other SPACs in two respects. First, their dilution is lower—although most still had $7 or less in cash per $10 share. Second, they produced higher six-month post-merger returns for SPAC shareholders—though many still lost value. The lower dilution is primarily due to fewer redemptions. The higher returns are presumably a function of value these sponsors created by promising to remain engaged in the post-merger company, or perhaps their ability to drive a harder bargain with targets. Figure 2 visually depicts returns for high quality and non-high-quality sponsors, and Table 3 presents additional details.
Figure 2: SPAC Dilution and 6-Month Post-Merger Returns
Table 3: Post-Merger SPAC Returns
6. SPAC Cost vs. IPO Cost
Some commentators have touted SPACs as a cheaper way to go public than IPOs. As the analysis above shows, however, the story is more complicated than that. If indeed SPACs are a cheaper way to go public than IPOs, it is only because SPAC shareholders are bearing the cost of SPACs and thereby subsidizing targets going public. It is difficult to believe that this will continue. Nonetheless, on the assumption that the market will before long force SPAC targets to bear the costs embedded in SPACs, we can compare SPAC and IPO costs.
The direct cost of an IPO is the underwriting fee, which is generally between 5% and 7%. In addition, however, some consider the “IPO pop” to be an additional and much larger cost of an IPO. If an IPO is offered at $10 per share and “pops” to $13 per share on the first day of trading, many consider this to be a 30% cost of the IPO. The assumption, which is contested, is that the issuer could have sold all its shares at $13. According to Jay Ritter’s data, from 2000 to 2019, the average pop on the first day of trading has been 14.8% of cash raised. Thus, total IPO costs, including the pop, are roughly 20% to 22% of cash raised in in an IPO. This is far less than the 50.4% median cost of a SPAC. So, if target shareholders were to bear the full brunt of the dilution inherent in SPACs’ structure, their cost of raising funds through a SPAC would be far greater than the cost of an IPO.
7. Capturing SPAC Benefits Without the High Costs
In addition to being touted as a cheaper route to the public markets than IPOs, SPACs are often viewed as providing other benefits over IPOs. These include better communication of a target’s story to investors through the work of the sponsor and through raising equity in PIPEs at the time of a SPAC’s merger. Relatedly, they are said to provide greater deal and price certainty. Even if these benefits are present—and we question many of them—the same benefits can be achieved without the high cost of a SPAC. Pershing Square has sponsored a SPAC with a very different and less dilutive structure, and a few other SPACs have gone public with no warrants and hence less dilution. Yet these remain the exceptions, not the rule. Furthermore, we wonder whether sponsors could help bring companies public at even lower cost without the SPAC structure. We propose that a sponsor identify a company first, negotiate a fee, commit to make an investment, attract third-party private placement investors, and either approach an underwriter for an IPO or assist in a direct listing.
The complete paper is available for download here.
60 Comments
Given the relative & rapid increase in SPAC-quality during 2020 primarily due to both target & sponsor acceptance, as well as the fact that 2019 SPACs occurred prior to this full “SPAC renaissance” in acceptance, I wonder how this analysis will look by mid 2021? I suspect the return results will improve, perhaps strongly.
Your study is interesting and suggests that investors may be better off waiting post merger to purchase shares of new companies on the market via spacs when their share price drops.
Well, so far I have made money on warrants and most likely will take those profits pre merger. Besides, the warrants are not exercisable for 30 days post merger, and that is too much time to lose their profits.
Thank you for the study. You confirmed my suspicions.
seems to me you would talk about the quality of the target when discussing post-merger returns the merger’s Target is the first thing I look at
This is not true: “SPAC sponsors compensate themselves with a “promote” consisting of shares equal to 25% of the SPAC’s IPO proceeds.”
SPACs can structure themselves with any promote they’d like. And many, such as HAAC and AJAX, most recently have promotes that are only a fraction of that.
Describing the quality of SPACs in this manner, as an undifferentiated whole, has little more value than the same exercise with common stocks.
Fantastic study. After this initial wave of SPACs I expect to see less dilutive, more shareholder/company friendly SPAC structures begin to become the standard.
Does anyone else think it’s clickbait-ey to couch this entirely on data from the last 12-24 months since that time period represents some of the most abnormal market events in the last century?
I get that people are more likely to read your stuff if you follow the trends of whatever people are chattering about today and maybe people think you are “smarter” if you take a “contrarian” view, or try to show that you know who the greater fool is.
But this isn’t really useful due to the constraints that you put on your own data, or perhaps due to the constraints that your background put on your ability to draw useful conclusions from it that could be applied outsiders a blog post.
Nice analysis. However, all these potential dilutive effects should have been disclosed to 424B, and usually post IPO buyers of stocks should value these dilution properly. And the dilution benefits goes to SPAC investors. So that it is natural and appropriate for SPAC investors to bear the dilution cost. The only impact is post IPO investors should not buy these type of stock if it is just IPO, for the sake of avoiding to share the dilution cost from the SPAC investors.
Here are responses to the comments on our post. I will number them to correspond to the number on the comment:
1. I too will be interested to see what happens to spacs in the next year. One thing I know for sure is that nearly all of the currently outstanding spacs have the basic structure we have described. So the quality of the sponsor and target will have to be such that they can dig their way out of that hole.
2. Waiting until several months after the IPO may be best unless there is good visibility into the post-merger company that has to absorb the dilution. In our sample, that took a few months in some cases and far less in others.
3. Interesting. I assume you bought the warrants on the market as opposed to getting them for free in units. We have not looked at the pricing of the warrants pre and post merger. Certainly better to get them for free, but if you are making money by purchasing them and redeeming before the merger, terrific.
4. Quality fo the target is important, though opaque to the outside observer. More importantly, a bad deal with a good target is a bad deal; and a good deal with a bad target is a good deal. The logic of our analysis implies that it is that there is a bias in the structure of a spac toward bad deals, regardless of target quality.
5. Every spac that merged between January 2019 and June 2020 had a 20% promote. Since that time, we are aware of just a few that do not have a 20% promote, including Pershing Square Tontine Holdings, which we discuss. One reads that SPACs are evolving, but we see little evidence that, in terms of structure at the outset, that this evolution is proceeding at any significant pace. On the other hand, I would not be surprised if market pressure requires sponsors to give up more of their promote at the time of the merger. I hear anecdotally that this is happening.
6. Thank you. I agree that if spacs survive they will have to restructure themselves to be less diluting and less misaligned in incentives.
7. Mr. or Ms. SPACy McSPACerton: Happy to respond if you offer a substantive comment. What sample period would you like me to use if not the past 24 months. As we say in the paper, we also looked at SPACs with IPOs in 2015 and their performance on the whole was horrible.
Here are some responses to comments posted above:
SPAC-ey-McSpacface: I will be interested as well. One thing that has not changed much is dilution. There will still be large holes to fill with value created by the mergers.
Saleem: Our performance results suggest waiting several months. For some SPACs, share price drop quickly after the merger but for others, it happens over several months. In both cases, however, there is a close correlation between eventual share value and dilution at the time of the merger.
Slay: I have not looked at pre-merger warrant prices vs post-merger. I would not be surprised if the pre-merger price is often over-optimistic given that some pot-merger prices take a while to decline in value.
Kurt Boehm: Target quality is certainly relevant, but a good deal with a bad target is a good deal, and a bad deal with a good target is a bad deal. Our analysis suggests that there is a bias toward making bad deals from the perspective of SPAC shareholders.
Christopher Hampton: For SPACs that merged between January 2019 and June 2020, what you say is incorrect. All SPACs had 20% promotes, though as we say in the full article, some canceled a few percent at the time of the merger. A few SPACs since June 2020 have different structures but the vast majority do not.
Donald Blanchflower: I agree. If SPACs survive, the basic structure will have to change. There has been very little change so far.
SPACy McSPACerton: Aside from the self-expression, I gather you think a different sample period would yield different results. In addition to January 2019 to June 2020, we also reported data on SPACs that went public in 2015. The results were even worse. What sample period do you propose?
Warren: Not sure I follow but I agree that much of the dilution is disclosed, as are historical performance for SPACs. So it is a mystery why investors gamble on post-merger performance.
Thanks for the study! It would be interesting to see this updated in a year or two since it occurs in the midst of unusual market conditions. Also, I wonder if the performance by sector could be broken out. When buying SPACs, I typically base my buys on the quality/expertise of the directors, major investor and institutional involvement, and the intent to sell pre-merger after buying as close to NAV as possible. I have also noticed that pre-merger performance is often sympathetic to sector performance or prior SPACs–such as the EV SPAC surges (after TSLA success) as well as online betting (after DKNG success). Finally, it does seem from the stats here (not sure of the quality of their data) that pre-merger preformance is often good, especially if you can be selective for a SPAC that will likely identify an acquisition (https://spacinsider.com/stats/).
Also, this site suggests that US vs. International performance varies greatly, Forward Purchase Agreements hinder performance, and SPACs with an energy focus did well–that would be interesting to see broken out in the future! Again, thanks for making this available. https://spacalpha.com/insights/spac_performance/
Can you comment on the Twelve Seas case study in the paper? Given how highly dilutive it was, you might expect significantly negative returns for shareholders. In fact though, despite a crash in mid-March (presumably COVID-induced), the stock traded as high as $12.50 and recovered after the crash to trade around $11-12 before graduall trending lower.
What explains the near-term returns of this spac, which one might expect to be the poster child for the negative returns coming from a highly dilutive transaction?
I have not followed Twelve Seas since we posted the paper. For all of these post-merger companies, even though they start out underwater due to dilution, something good (or bad) can happen in the months that follow. I expect that something positive happened to Twelve Seas.
I’ve thoroughly read this paper. It is a very disappointing and intentional collection of misleading statements. The funds/share of $6.67 is intentionally trying to imply redemption funds, when in fact it includes shares that have no such rights (founder shares). It describes redemption rates that are completely unrealistic at this time. It also blatantly misleads on dilution. Of all the filings I’ve read, the promo shares are increased/decreased (adjusted) to represents a 20% of the final outstanding share count, yet their entire dilution premise is based on this not being true. I almost wonder if the authors have read any filings in detail. Further their depiction of warrants as free is incredibly naive. In order to get “free” warrants they must split units, and give up the market value of the units. The market value of the common + warrant generally comes close to market value of the unit, so in doing so, they are actually paying nearly market rates for that “free” warrant. So the only way the warrants are free is if the warrants are worthless. If they bought pre-ipo, then they are technically free, but only if you dismiss any gain from the market itself. In the end, the gains they get are a fraction of the gains they would get by involvement in any traditional IPO historically speaking. So in many ways, the authors have misled the readers to such a degree it strains all credibility and even casts doubt on the qualifications of a Harvard Education and their faculty.
I am sorry about your disappointment. I can assure you that we reported facts based on the sample period we covered–mergers from January 2019 through June 2020. If you have looked at SPACs outside that period, you could well have found something different.
I don’t understand what you are saying about the $6.67, but what it is is the amount of cash per share in a SPAC after redemptions and taking into account the value of the warrants at the time of the merger–in effect, treating a warrant as a fraction of a share.
I also don’t follow what you are trying to say about the 20% promote, but this is straightforward. It starts at 20% of post IPO shares and then is often negotiated down at the time of the merger. But the post-negotiation, post-redemption, post-PIPE percentage is often greater that 20%.
As for free warrants, they are described as such because when an IPO investor buys units for $10 each, it gets a share and a warrant. The IPO investor can then redeem or sell the shares for $10 plus interest and keep the warrant. So the result is the investor gets its money back and still has a warrant in its brokerage account. I call that a free warrant.
As for a Harvard education, none of us went to Harvard. You?
Hey there, I loved the insight in the paper. About the dilution, how would you explain the Diamond Eagle Acquisition Corp situation in which they acquired DraftKings and the day the merger went through, Draftkings stock was at 19 I think, beginning at 10 with no sign of dilution. Can this be explained under the pretense of your argument? Thank you.
Michael Klausner: Helpful research for someone starting to get their feet wet with SPACs and I’ve enjoyed the banter in the Comments section here.
SPACs seem to me to be another form of financial leverage for deal guys to get a piece of a big company without spending their own money, so this feels a little like the early days of junk bonds or PE funds.
What everyone had to relearn in each of those instances was that its all about a deal that creates value. That’s where I’d be interested to see more research if you plan to expand on this.
I’d love to know – for example – if SPACs that rolled up several smaller companies outperformed SPACs that just bought one or two larger companies. Or, similarly, SPAC performance by acquisition strategy.
I also appreciated your thoughts on more efficient deal structures than “standard” SPACs. Any more insights on creating more efficient structures that bring more value to acquisition targets would be interesting for the practitioners out there like me.
Just my two cents. Go Stanford!
Brandon and Matt,
Your comments are closely related, so I will respond to both at once. As Matt says, it’s all a matter the how much value the deal creates. The analogy to early PE is good. If a deal creates a lot of surplus–the whole is greater than the sum of the parts–then there is room for the sponsor and IPO investors to extract value and still leave the parties to the deal (the SPAC and target shareholders) coming out ahead.
That may well have happened in DraftKings and other companies with which SPACs have merged. We will only know with time whether, for example, the DraftKings $19 price reflected the future earnings of the company or excess optimism. Or, especially today, whether a rising stock price just reflect traders’ hope for a still-rising stock price. That game ends eventually. Regarding DraftKings, the dilution was certainly present. The promote and the value taken by IPO investors through warrants has to come from somewhere. But perhaps there was a lot of surplus created I am doubtful, however, that these bounces reflect real earnings potential. If they did, it would mean that the target shareholders, who should know their company’s potential, sold shares to the SPAC way to cheaply. Why would they do that?
As for more efficient structures, if SPACs survive, they will need to reduce dilution–by reducing the promote and the warrants and perhaps paying underwriters only for shares that are not redeemed. But I have still never heard a good answer to the following question: Why collect equity first and find a merger target later–especially when all the equity holders can, and often will, redeem their shares? You will have to find new equity anyway once you know who you are merging with. So to me, the best solution is to take elements of SPACs, such as PIPEs and perhaps the role of the sponsor, and integrate those with IPOs or direct listings.
Doesn’t the cashless exercise take all of this info account to reduce the total dilution from warrants once the stock exceeds a threshold. If more SPACs adapt this wouldn’t it solve the issue you propose here.
In my view, SPAC is more fair than IPO. In current IPO allocation process, majority of shares go to large institution-“ investors and retail investors are eliminated from the party,
In our democratic country, IPO just makes rich people richer and working class harder to grow wealth. SPAC is true innovation to make the capital market more fair to everyone.
Andrew: What you say sounds interesting. Can you explain more. What problem does cashless exercise solve?
Jason: You may well be right that IPOs are unfair. But SPACs are also unfair. A buyer of a SPAC unit in an IPO makes an 11.5% annual return during the sample period of my study. Individuals cannot buy in a SPAC IPO either. Until recently, at least, individuals bought around the time of the merger, and on average lost on their investment. One reason they lost is that the IPO investors and the sponsors had already taken a lot of the value out of the SPAC (though the promote and the warrants). The market environment today is different. I expect that a lot of shareholders will be disappointed since the same dilution exists in SPACs and yet share prices are rising. But from a gambling point of view, it certainly is a game that individual investors are playing and some will win.
Great analysis. The math on dilution speaks for itself. The 50% dilution or $6.67 ultimate cash value is a huge hinderance to long term SPAC value.
The only counter argument is the different public market environment today vs. 1) prior public market environments and 2) current private markets.
Apple’s PE historically was ~15. Now it’s close to 40. Tesla, Shopify, Disney, etc. are all trading at massive PEs.
Public markets are simply awash in cash and investors are willing to pay a premium. For example, while solid fundamental analysis might value a SPAC target at $2B (which is the IPO, SPAC merger, or private investment round valuation), the public markets might be willing to support a $4B or $8B valuation in today’s environment. Even taking into account the dilution, SPAC investors would still see a great short- or medium-term return. With that said, target companies are catching on and now have industry/competitor comps trading at $4B or $8B and are demanding similar valuations to go public.
There’s also a current disregard to a “good vs bad” deal. If the target company is sexy, it’s a buy. If it’s not, it’s a sell. No matter the deal fundamentals.
Of course, fundamentals eventually matter. Either this market sentiment turns negative and post-merger SPACs tank to $<10 (e.g. close to $6.67). Or, this market stays where it is (but stops expanding PEs) and these SPACs essentially trade water (if investors don't get bored and jump ship) for multiple years before "earnings" catch up.
A sobering paper nonetheless. Thank you!
I do, however, think that retail investors can – just like the institutional investors – make money on the nature of the SPACs structure.
Albeit it is rare, sometimes SPACs are trading close to – or even more rarely – below NAV. In these instances, one would be able to SPAC-arb by 1) buying the units. 2) Wait for the split. 3) Redeem if price per share < NAV, otherwise sell the shares in the market. 4) Hold the warrants and thus make a decent (virtually risk-free) return. Especially because the warrant's pricing is quite good to be fair.
Again, yes it is rare – but it is possible – also for retail.
QUESTION:
Do you think SPACs will be a spreading phenomenon – i.e. spreading to Europe or other markets? And why dont you think that Europe has caught on to this trend yet, given the intense rise in popularity in the US?
Thank you for your most interesting article. Although mathematically correct, there is an intrinsic value missing from your analysis.
Given today’s market place where stocks are selling at multiples beyond traditional earnings per share, more so at multiples of gross sales and revenues, quality spacs, (I accentuate the word quality) are an interesting way, post merger, for individual investors to gain entrance to potentially profitable ends.
Your presentation negates the very nature of today’s equity market place where equity returns are measured on a broad scale basis, from pure financial basis to outright animal instinct. Thanks much.
I’m just dropping by to thank you, Professor Michael Klausner, Associate Professor Michael Ohlrogge, and Emily Ruan for your work in this.
I do not understand everything yet, for example, why is it important the amount of cash per share the SPAC contributes to the merged company. I presume it means $10 a share is already factored in a 50% (3.33 out of 6.67) premium paid to invest in the merged company. Most people will just look at the current market capital/valuation overall.
Nonetheless, I was already surprised at the amount of amateurs explaining how many SPACs are undervalued, as though the target company will accept deals unfair to them.
Insightful analysis – very much appreciated.
In your math calculating median dilution of 50.4% in table 1, it seems that ‘redemption’ is missing as a component of total dilution. My understanding is that redemption leaves empty shares at the SPAC, further magnifying dilution. Any reason why you excluded it as a contributor here? Am I thinking about this wrong?
Dan: I largely agree with your analysis. Today’s market seems irrational to me–with SPAC shares jumping on rumors of mergers with no hint at terms. The only thing I can say for sure is that all SPACs have a dilution hole that post-merger companies have to climb out of. Some will, but a reasonable prediction is that many will not. Even apart from the hole, SPACs may be overpaying for future cash flows. We will see. As you say, fundamentals eventually matter. When they do, I expect SPACs looking for targets will get resistance from their shareholders, redemptions will increase and PIPEs will dry up.
Tobias: Yes, the trade you suggest would work. I have not followed unit pricing in the past few months in any detail, but my understanding is that, for the first time in ten years, units are trading up substantially after the IPO. So the opportunity you describe is not what it was during my sample period–up to June 2020. Unit prices started rising when Forbes ran a cover story about hedge funds buying in SPAC IPOs and making 20% annualized returns. I assume that included leverage, since they relied on our finding that the return was 11.6%. (I have no idea why I did not buy units myself after finding this.)
Tobias: Sorry, I did not answer your final question about whether SPACs will spread. My understanding is that they have spread to Singapore or at least the Singapore regulator is looking favorably on them. I think they are in Europe too. Barring regulatory barriers, I assume they will spread until bubble bursts.
Harvey: I agree that animal instinct drives stock prices, but eventually fundamentals matter. What you are saying is similar to what we heard during the tech bubble. That did go on for quite a while and the SPAC bubble could as well. We are in a game of musical chairs and the music continues to play. Until it stops, one can make money. But it will stop at some point.
Thank you for such an informative article and for taking the time to respond to the posts!
I have been following closely the CCIV SPAC which is rumored to be merging with Lucid Motors. I can’t understand why anyone would pay $60/share (6x IPO price) for this SPAC? It seems to me that if the merger value for Lucid is, for example, $12 billion the market is assigning a value of approximately 6x that on day one. Maybe I am missing something here…
Also, I understand the 20% promote to the sponsor, but this SPAC seems to have a provision where the sponsor Class B common stock conversion ration (into Class A common) will be adjusted such that the sponsor will also own 20% of the total common stock AFTER the merger. Have you seen this provision in the SPACs that you researched?
Thanks again!
David: Regarding CCIV and Lucid, I agree. It seems clear that SPACs are in a bubble. The share price of CCIV, and other SPACs, jump on rumors of mergers regardless of the fact that the terms of the merger are not part of even the rumor. And the terms do matter. No matter how good Lucid may be, if CCIV enters into a deal that pays Lucid shareholders more than their company’s value, then that’s a bad deal for SPAC shareholders (though not for the sponsor). A price jump like this implies the opposite: That the market thinks Lucid shareholders will enter into such a bad deal with CCIV that the SPAC shareholders will walk away with a larger share of the company than they pay for. Perhaps. But I see no reason why Lucid shareholders would do that.
I have not heard of a promote as you describe it. But I have heard of promotes being 20% of total equity including later-raised PIPEs. That is not common (I don’t believe there were any in the SPACs we covered), but I suspect that is what the CCIV promote is.
The article is fantastic. Reminds me of the PE Buyer + strategic buyer tag-teams of almost a decade ago where the PE buyer would own shares in the strategic buyer it teamed up with and in the target company. The tag-team would then announce their intention to purchase the target. The tag-team would then abandon their pursuit of the target and the PE buyer would make millions off of the stock prices of both the strategic buyer and the target skyrocketing. The only work done to “unlock” this “value” would be leaking stories to the press. (I swear these guys are like a hemorrhoid on the market’s ass that just won’t go away.)
Thank you for this excellent analysis and for working on the posts!
Excellent study. Wonder if you could clarify one statement which confuses me. You say “Redemption actually tends to be much higher than 50%. Mean and median redemptions for SPACs that merged between January 2019 and June 2020 were 58% and 73%, respectively. Over a third of those SPACs had redemptions of over 90%.” When I look at press releases for shareholder votes on merger approval the press release generally states “minimal redemptions”. What am I missing? Thanks!
Alp, Bernhard and Bob: First, thanks for the kind words about our article (and the humor). Regarding redemptions, they are down a lot since June 2020, which was the end of our study period. Beginning sometime in the fall, many SPACs’ pre-merger share prices started rising and for some, they “popped” when a merger was announced. If the share price is above the redemption price of $10 plus interest, there will be no redemptions. IPO investors will sell their shares rather than redeem them. This happened in a significant number of SPACs during our study period, but not nearly as much as today.
Thank you for posting the most helpful explanation of SPACs which I have seen to date. Nevertheless, I have several questions which I believe are not covered above.
1. Am I correct in understanding that if a SPAC has $200 M in cash to contribute to a merger and the operating company (target) has an agreed-on valuation of $800 M, the post-merger shares which would be allocated to the SPAC shareholders would represent 20% of the total float?
2. In the same example, if the agreed-on valuation of the target company is $1.8 B, the post-merger shares which would be allocated to the SPAC shareholders would represent 10% of the total float?
3. If, in my example, 50% of the shareholders redeem, will the proportion of the post-merger shares going to the SPAC shareholders decrease by the same amount? In my example, 100x shares for the non-redeeming SPAC shareholders and 800x shares for the operating company owners (assuming no PIPE transactions).
4. If the SPAC shareholders buy their shares in the SPAC for $10 and the SPAC stock, post-announcement and pre-merger increases to $20 or $30, why would any SPAC shareholder redeem their stock rather than simply selling to members of the general public willing to pay two or three times that amount?
5. Do SPAC shareholders exchange their SPAC shares on a one for one basis with target company stock?
6. If I understand things correctly, Gores Metropoulos stock (a SPAC) closed at $19.51 on December 2, 2020, LAZR stock closed at $22.98 on December 3 and has ranged between approximately $42 and $23 since that time. It is currently at $29.50. While we don’t know what the LAZR stock price will be in six or twelve months, these numbers would make it an exception to your observation that most SPAC mergers result in post-merger price declines, right? (I’m using this as an example to confirm that my understanding of this process is correct.)
7. Do you believe that the electric vehicle / automated driving / battery technology / EV charging sector is so hot these days that the general rule of post-merger stock price declines may not be applicable to companies in this market segment?
8. Are you aware of any SPAC transactions in the EV etc. market segment which have, in fact, resulted in a post-merger stock decline along the lines which you have illustrated?
Cal,
Thanks for these questions. One response will cover a few of your questions: Since sometime last fall, after our study was posted on SSRN and this blog post was published, SPAC prices started rising–especially when a merger was announced or even when a rumor of a merger was publicized. I have not looked at a lot of individual SPACs but I expect this is true of all SPACs look to merger with the types of companies you list (and plenty more). Our study covered a period that ended in June 2020. During that period this sort of price “pop” was rare. Far more common was a post-merger drop. In my view and that of many others, current SPAC pricing reflects a bubble. Why would a rumor of a merger cause a SPAC share price to rise when the market has no idea of the price or share exchange terms of the rumored deal?
Regarding your questions about the share exchange, this is purely a matter of negotiation. The parties agree on a valuation of the target and they treat the SPAC has being valued at $10 per share (which is far more than cash per share). Those two valuations yield a share exchange ratio. If there are redemptions, they will scale back the percentage of the combined company that the SPAC shareholders will own, but they will not affect the share exchange (despite the fact that they reduce cash per share).
If the SPAC share price is above the ~$10 redemption price, then shareholders will not redeem, as you suggest. Those that choose to exit will sell on the market.
statiscally – are you better off buying into a spac before a merger is announced; buying just after an announcement; or waiting until the merged company stock begins trading?
Thx
Once an investor redeems at the initial Business Contribution voting stage, how long does it take for investors to actually be paid?
Can you share the backup data for the individual SPACs included in Figure 10 (“Returns to SPAC Sponsors”)? I’m trying to drill down on SPACs where sponsors have made strong returns while other investors have lost money.
Rob: The answer to your question is different today than it was during the period of my study, which ended June 30, 2020. During that period, on average, post-merger share prices dropped for at least a year. Some dropped immediately and stayed low and some dropped more gradually. So, on average, I’d say the later one bought the better. And even better, buy something else. But that is just on average. Today, SPAC prices seem to be rising no matter what. So if one wants to bet on the bubble, then investing earlier is better. Just hope to get out before the music stops.
KT: I don’t know how long it takes to get your check once you redeem. I assume fairly quickly.
Hi again – and thanks for the prompt response!
Since my last comment, I have become more interested in researching this myself with the hopes of creating a database which updates the quantitative findings on a daily basis.
Are you open to share how/where you scraped the data for your analysis? Thank you!
Excellent clear writing, especially for a lawyer. (We have read too many mind-numbing M,D & A’s which we assume are written by lawyers.) You have saved us lots of heartache searching for answers to our many suspicions about spacs, not to mention money not lost by being legally ripped off.
Questions: Is the 11.6% return from redemption paid like bond interest? Who pays for it, especially at 90% redemption rates? We assume it’s remaining and public shareholders.
Love your even-handed approach to commenters both good and bad. You get nothing for taking the time to answer except for your decision to make the world a better place. That’s the most gratifying part of reading this post.
Tobias: We did not scrape the data. We did it all by hand. It was a nightmare. SPAC SEC filings tend to be poorly written and trying to find consistency in numbers across filings and sometimes within a single filing is maddening. There is also a lack of consistency in where information appears across SPACs. Maybe it is possible to scrape but I am doubtful. I would be happy to give you whatever advice I have to give. You can find my email address on the Stanford website.
Paul and Nicole: I feel your pain! (I had written my response to Tobias regarding reading what I said about MD&As.) The vast bulk of the 11.6% annualized return to IPO investors is the warrant they get for free by buying units and redeeming shares. There is a small interest payment as well but it is small. For purposes of this calculation, we use the trading price of the warrants on the day of the merger. As for how the shareholders get their money back (plus interest) the proceeds of the IPO are placed in trust and cannot be touched until the point of redemption/merger or liquidation.
Thanks for the kind words. I have enjoyed this–though I seem to spend several hours a day on SPAC-related calls, presentations, podcasts, emails, etc. One of my biggest surprises is that I have gotten no negative substantive critiques here or elsewhere (though I don’t do twitter and who knows what’s there). And I have gotten very few nonsubstantive comments. I have been surprised because people certainly have a lot of money at stake in SPACs and I am not exactly delivering good news.
周瑜: I am sorry. I missed your question two weeks ago. Cash per share is important because when you pay $10 for a share that is the amount you will be investing in the company going public. So if there is $7 of cash per share, when you buy a share for $10 you are investing $7 in the target company and you are giving $3 to the sponsor and to the warrant holders. You could think this is worth doing, but you have to believe that, compared to investing a full $10 in another company, a $7 investment at a cost of $10 in this company is better.
Chis W: Sorry, I missed your question too. My coauthor is the keeper of our data. I suggest that you contact him directly.
Excellent study.
What I understand simplistically is the sponsors take the risk of initiating a SPAC and then getting a 20% promote., it may or may not end up as 20% of the whole. Do the authors think that the sponsors who spend 2 years looking at targets deserve that promote.
I agree, Target quality is certainly relevant, and someone said in this forum “a good deal with a bad target is a good deal, and a bad deal with a good target is a bad deal” . So a High quality (HQ) target is important!
What happens when there is a flood of SPACs and not enough decent targets?
I think startups will become the new targets, and small boutique SPACs will bloom.
Also, perhaps there may be a opportunity of hybrids-
Can authors predict what new structures could come into play. Do you for-see merger of SPACs? I apologize to the authors if I am making any incorrect , remarks or inferences. I am an inventor and I see opportunity on focusing on creating startups to become HQ targets! I also see opportunity for small boutique SPACs specialized in consumer health, autonomous vehicles concepts, cyber security and fintech.
Appreciate all the comments!
Dr Raj:
You make a few points. Here are some responses:
1. If SPACs continue to exist in significant numbers, I think their structure will change to reduce dilution. Pershing Square’s SPAC is a start.
2. A flood of SPACs, as you put it, will give targets excellent bargaining power whether or not the targets are high quality. So this is good news for targets and bad news for SPAC shareholders. Perhaps small startups will go public via SPACs, but being a public company is not easy, so for many this would be a bad idea.
3. I too have wondered about SPACs merging and then having the ability to make a substantial cash contribution to a large target. I am not aware of an impediment to that.
4. Do sponsors deserve the promote? Sellers of services deserve whatever a fully informed buyer will pay them. One of my concerns about SPACs is that disclosure could be better–regarding the amount the sponsor will get out of a merger and the amount of cash in the SPAC at the time of the merger.
Thank you for this.
I dont understand how the nominal investment of $25000, equal to 25% of IPO proceeds, is equivalent to 20% of shares outstanding after the IPO
“First, SPAC sponsors compensate themselves with a “promote” consisting of shares equal to 25% of the SPAC’s IPO proceeds, or equivalently, 20% of post-IPO equity.”
How do you arrive at this result?
Hamza: For example, if the IPO is for 1000 shares, the sponsor takes 25%, or 250 shares. After the IPO, there are 1250 shares outstanding (1000 + 250) and the sponsor owns 250, which comes to 20% of the total.
One of my phd students told me I had to read this paper. I am happy I did.
I want to use your example on twelve seas in my lectures, but I cant arrive at the same dilution %.
The combined company receives $32.760.000 and the total cost to underwriters is $15.135.000.
Founder shares is equal to 4.140.000 shares, or $41.400.000 assuming share price of $10.
What did you do from here to arrive at $36 millon for warrants’ value and subsequently the 254% dilution?
And what about the rights included in the units?
The last summary misses one of the significant value creations of SPAC. There is enormous publicity that comes along with doing things publicly in a pre-packaged manner. That is of significant value for the target company.
You have given the most comprehensive description of the entire space process. Thanks for writing the paper Emily Ruan, Michael Klausner and Michael Ohlrogge
Hi Bryan, I think the way it is calculated in the paper is as follows: since the redemption rate is 82%, resulting in only 3.7M shares remaining, sponsor’s shares of 4.1M would amount to 113% (4.1M/3.7M). Further, since each right could be exercised for 0.1 share, 20.7M (initial shares) would result in 2M additional shares, priced at $10 ($20M). Adding this number to the value of warrants, which is given as $0.8*20.7M, we get ~$16.5M for warrants, thus ~37.26M for warrants and rights combined (which is 101% – $37.26M/$37M). Finally, the underwriting fees are taken at 5.5% of the initial IPO proceeds + 375k additional shares, valued at $10 ($15.1M), which after redemption would amount to 41% ($15.1M/$37M). Adding all the percentage figures we arrive at roughly 254% dilution as mentioned in the paper.
Hi Ali.
Thats how I did it as well. However, it amounted to approx 251% which made me wonder why my results differed from that of the authors’.
With that said, I think it is incorrect to include the warrants, in and of itself, as being dilutive in their calculations. The warrants are only dilutive if they are exercised. Thus, one cannot just calculate the dilutive effect of warrants as:
warrants trading price x number of warrants issued
This is what they did in the paper. Keep in mind: just a few pages prior to this calculation, they mention that most shares trade under the initial offering price. Hence, warrants would expire worthless.
I genuinely like the paper for what it is, but it is coming from a biased perspective. Another thing is to consider the effects of the additional capital invested in the business as a result of the rights and warrants (for the few who, according to the authors, actually happen to be exercised), which is obviously difficult to measure, but nonetheless deserves to be mentioned.
Bryan and Ali,
I have not had a chance to go back and do the calculation for Twelve Seas, but what Ali says looks correct to me.
Regarding dilution, Bryan, consider the following security: If common shares of ABC Co, which trade at $15 today ever reach $16, then this security will give the holder the right to one free ABC Co share. And let’s say that for every share of ABC Co outstanding, there is one of these securities. You could say that this security is not dilutive because ABC Co shares are not worth $16 (yet). But the prospect of ABC shares rising coupled with the prospect of ABC issuing lots of free shares, will have an impact today on ABC’s share price. The same is true of a warrant, which allows a holder to buy shares cheap, but not free. The price of a warrant today reflects the likelihood that the warrants will be in the money and by how much. It therefore is a measure of dilution as of now. If the warrants go into the money the dilution will be far greater. As I recall, SPAC warrants averaged about $1.50, which reflected a fairly low likelihood during our sample period that SPAC share prices would rise above the warrants’ strike price of $11.50.
Regarding bias, if you mean my coauthors and I reached a conclusion that SPACs are problematic, that is correct. But bias implies that we started with a negative view of SPACs. That is not correct. So if you have read anything in our paper, or elsewhere, that leads you to that view, please let me know. In fact, my coauthors and I had never heard of SPACs–nor had most of the world–until shortly before we started researching them three years ago. We had no reason to develop a bias one way or another back then.
It occurs to me that even where SPAC costs are borne by SPAC shareholders, these costs can be seen as an imputed cost for target shareholders, if you assume that SPAC shareholders consider the merger price of target shares to be discounted to the degree necessary to compensate them for the dilution they suffer – otherwise, they’d presumably redeem. The corollary is that they would pay a higher price in the absence of the dilution.
Thanks for publishing your analysis – really interesting results.
Stuart: I think the mystery is why SPAC shareholders do not redeem much more than they do. They have a choice of investing $6.40 (median) in a target company that, as you say, is fully able to negotiate a merger price based on the cash it will receive–or redeeming for $10 in cash instead. The only reason for a SPAC shareholder to do the former is if it believes that either (a) the target credited the SPAC for the $10 it claims to be worth in the merger agreement and/or (b) the SPAC sponsor will work its magic after the merger to enhance the value of the combined company sufficiently to make up the difference between cash and $10.