A SPAC-tacular year

A perspective from E*TRADE Securities 10/08/20

What do an electric-car maker, a sports-betting operator, and a space-travel company have in common? 

If you guessed that all three debuted on the US stock market within the past year, you would be correct. But it’s how they went public that has been generating a lot of buzz.

Instead of the initial public offering (IPO)—the traditional route to the stock market for most US businesses—these companies used something called a special-purpose acquisition company (SPAC) to make the transition from private to public.

SPACs have made their way into a fair number of headlines lately as a method for bringing private companies to market. And with some high-profile names like Nikola, DraftKings, and Virgin Galactic recently partnering with SPACs, investors may be curious about how this alternative differs from an IPO.

What is a SPAC, anyway?

A SPAC's sole purpose is to raise money (which it does through an IPO) to buy another business (think private company) in the future. They are often referred to as “blank-check companies” because they typically don’t have a specific company in mind when they are formed, although they might target a particular industry. (Deals in tech—particularly biotech—and transportation have been popular recently.) SPACs generally have 24 months to identify and complete an acquisition. Once a SPAC completes the purchase of its target, that company becomes publicly traded by virtue of the SPAC’s already-listed shares. 

Private companies looking to go public are increasingly partnering with SPACs as an alternative route to a traditional IPO. Merging with a SPAC is typically quicker than the IPO process, and a SPAC merger is privately negotiated, meaning market volatility may be less of a factor.

While the management team of a blank-check company may solicit institutional investors (e.g., funds, money managers, banks, or trusts) to take a position in a SPAC before it announces an acquisition, many retail investors likely wouldn’t be eyeing them until the target was confirmed or the business combination was complete.

Record numbers so far this year

SPAC activity is at an all-time high: 86 blank-check companies have raised $31.4 billion so far in 2020, and SPACs are on track to raise more money this year than the previous 10 combined.1 

Source: Renaissance Capital, data as of 9/4/20

It’s worth mentioning that the broader IPO market is on fire this year as well, with a roster that includes tech unicorns Snowflake and Unity, Rocket Companies, and GoodRX, among others. According to Renaissance Capital, which tracks IPO activity, 2020 is shaping up to be the biggest IPO market by capital raised since 2014, with 50–70 more deals expected by year-end.1 More than 80% of the money raised by IPOs this year has been in healthcare, technology, and—surprise—SPACs.2 

How do SPACs typically perform?

Since 2015, shares of SPACs that have completed mergers and taken a company public have delivered an average loss of -9.6%, compared to the average aftermarket return of 37.2% for traditional IPOs within the same time period.3 Less than a third of the SPACs in this group had positive returns as of September 30.3 

There are some bright spots, however. Recent SPAC mergers have fared better than the larger group, with deals completed in 2019–2020 outperforming those in 2016–2018. Healthcare and tech-focused SPACs have outperformed among the sectors, with the exception of communication services, whose performance has been solely due to DraftKings.3

Target sector identified at time of IPO; may differ from sector of acquired company. *Number of SPACs that have completed mergers and taken a company public, 2015–10/1/20. Source: Renaissance Capital

Investing considerations

Investing in new-to-market companies—whether SPAC, IPO, or even direct listing—comes with significant risk. Shares of these companies can be extremely volatile, especially when they first start trading. Investors considering these stocks should make sure they understand the landscape. A few important things to keep in mind:

  • Beware “hot” new issues: Despite their significant appeal, hot new issues are no sure thing, regardless of whether it's a regular IPO or SPAC. Investors run the risk of buying at pumped up prices when everyone is trying to get in on the action.
  • Consider broad exposure: Exchange-traded funds (ETFs) can provide an ancillary way to access new-to-market companies without the single-stock risk. ETFs that invest in IPOs and SPACs can offer exposure to a basket of these stocks. But do your homework—each fund’s methodology varies, and these ETFs aren’t for the faint of heart.
  • Look for public-company investors: Well-established public companies may take positions in start-ups that eventually go public. Investing in these stakeholder firms may allow investors to indirectly participate in potential profits, with the benefit of owning a mature stock.

Bottom line: Any investing decisions should ultimately reflect individual goals and risk tolerance, and fit in with investors’ longer-term strategy. 

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  1. Renaissance Capital, “Fall 2020 US IPO Preview,” 9/4/2020, https://ipopro.renaissancecapital.com/reviews/US_Fall_Preview_2020_Pro.pdf
  2. The Wall Street Journal, “IPO Market Parties Like It’s 1999,” 9/25/20, https://www.wsj.com/articles/ipo-market-parties-like-its-1999-11601052419
  3. Renaissance Capital, “SPAC returns fall short of traditional IPO returns on average,” 10/1/20, https://ipopro.renaissancecapital.com/News/71815/Updated-SPAC-returns-fall-short-of-traditional-IPO-returns-on-average

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