|The Jolly Contrarian’s Glossary |
The snippy guide to financial services lingo.™
SPAC /spæk/ (n.)
1. Playground slang: (Also “spack”) Someone who could do with slapping upside the head with a fish of some sort. One who invests in a special purpose acquisition company.
2. Finance: A special purpose acquisition company, also known as a “blank check company” is an espievie that is listed on a stock exchange — thus, being a publicly listed company — that is organised with the purpose of acquiring a private company by a type of merger, in the process making the private company public without it having to go through the traditional, painful, expensive initial public offering process.
According to the Securities and Exchange Commission — that is the competent regulator, by the way — “a SPAC is created specifically to pool funds in order to finance a merger or acquisition opportunity within a set timeframe. The opportunity usually has yet to be identified”.
All right, readers: let’s take in a bit of history. This is an extract from Charles McKay’s 1841 classic, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. It’s a bunker buster, but it is worth staying with it:
“Some of these schemes were plausible enough, and, had they been undertaken at a time when the public mind was unexcited, might have been pursued with advantage to all concerned. But they were established merely with the view of raising the shares in the market. The projectors took the first opportunity of a rise to sell out, and next morning the scheme was at an end. Maitland, in his History of London, gravely informs us, that one of the projects which received great encouragement, was for the establishment of a company “to make deal boards out of saw-dust.”
This is no doubt intended as a joke; but there is abundance of evidence to shew that dozens of schemes, hardly a whit more reasonable, lived their little day, ruining hundreds ere they fell. One of them was for a wheel for perpetual motion—capital one million; another was “for encouraging the breed of horses in England, and improving of glebe and church lands, and repairing and rebuilding parsonage and vicarage houses.”
Why the clergy, who were so mainly interested in the latter clause, should have taken so much interest in the first, is only to be explained on the supposition that the scheme was projected by a knot of the fox-hunting parsons, once so common in England. The shares of this company were rapidly subscribed for.
But the most absurd and preposterous of all, and which shewed, more completely than any other, the utter madness of the people, was one started by an unknown adventurer, entitled “A company for carrying on an undertaking of great advantage, but nobody to know what it is.” Were not the fact stated by scores of credible witnesses, it would be impossible to believe that any person could have been duped by such a project.
The man of genius who essayed this bold and successful inroad upon public credulity, merely stated in his prospectus that the required capital was half a million, in five thousand shares of 100l. each, deposit 2l. per share. Each subscriber, paying his deposit, would be entitled to 100l. per annum per share. How this immense profit was to be obtained, he did not condescend to inform them at that time, but promised that in a month full particulars should be duly announced, and a call made for the remaining 98l. of the subscription.
Next morning, at nine o’clock, this great man opened an office in Cornhill. Crowds of people beset his door, and when he shut up at three o’clock, he found that no less than one thousand shares had been subscribed for, and the deposits paid. He was thus, in five hours, the winner of 2000l. He was philosopher enough to be contented with his venture, and set off the same evening for the Continent. He was never heard of again.”
Enough said? Apparently not. Despite McKay’s certainty, there is doubt as to whether “A company for carrying on an undertaking of great advantage, but nobody to know what it is” ever really existed or whether that, too, was a joke — but, really, if this were a joke, does this not make the present phenomenon of the SPAC all the more preposterous? For that, to this old goat’s reading is exactly what a SPAC is.
It might strike you that this is a bit of an end-run around the traditionally hideous process of going public which involves not only bearing you soul to the hearts and minds of the investment banking community, and then the world at large, paying them some extraordinary fee for doing so, going through quiet periods, justifying your business credentials by reference to years of solid revenue and profit generation, and a plausible “go-forward” story.
This is not to say these target companies do not have all those things, but even if they do, the IPO process is a financial root canal. But freshly minted espievies don’t. They have no track record. They have never made any income, let alone profit, let alone three good years of the styff. They have never made a widget. They have no capital. They have nothing. So, how —?
With a healthy hand from our old friend the agency problem. that’s how.
The IPO usually prices at $10 a share and the proceeds bear interest until the SPAC sponsors finds a suitable target. If they do, and the SPAC completes an acquisition, investors can either convert into the newly merged public company or redeem their SPAC shares to get back their original investment, plus the interest accrued while that money was in trust. SPAC sponsors typically receive 20% of the common equity in the SPAC for an investment of approximately 3% to 4% of the IPO proceeds.
Now you might think a little arithmetic is in order. But if that seems too simplistic, consider this academic survey:
We find that costs built into the SPAC structure are subtle, opaque, and far higher than has been previously recognized. Although SPACs raise $10 per share from investors in their IPOs, by the time the median SPAC merges with a target, it holds just $6.67 in cash for each outstanding share. We find, first, that for a large majority of SPACs, post-merger share prices fall, and second, that these price drops are highly correlated with the extent of dilution, or cash shortfall, in a SPAC. This implies that SPAC investors are bearing the cost of the dilution built into the SPAC structure, and in effect subsidizing the companies they bring public.
Someone is getting rinsed, in other words. Could it be our old friend the ultimate client, again?
Will Granddad never learn?
- From Wikipedia, at any rate.
- A Sober Look at SPACs, Yale Journal on Regulation