“Everyone’s raising a zillion SPACs,” a Manhattan billionaire tells me, referring to special purpose acquisition companies, the latest craze on Wall Street. He doesn’t want to be seen biting the hand that feeds him (and many others), and so he asks for—and receives—anonymity. “Every day there’s a SPAC merger,” he continues, amazed. “There’s a rumored SPAC merger. There’s another SPAC.”
The SPAC business is “kind of like kissing a lot of frogs,” he suggests, although perhaps a slot machine would be a better analogy. “You don’t want to be a $400, $300, $200, $500, $700 million SPAC. They’re just a dime a dozen, unless you have something special.”
It’s true that the field has become very crowded of late. While much of the financial media has been consumed by Reddit, Robinhood, and the retail euphoria fueling booms and busts in shares of GameStop and AMC, an equally significant (if somewhat less sexy) story has been playing out in SPAC land.
Originally invented 25 years ago as a way for smaller companies to get access to capital they would otherwise have difficulty obtaining, SPACs have recently become popular among retail investors seeking higher risk and a little excitement by investing alongside celebrities and proven entrepreneurs; SPAC sponsors, who can extract as much as 20% of the equity of the SPAC in compensation for setting it up, are more than happy to oblige.
In 2020, more than 200 new SPACs raised $73 billion. Another $38 billion was raised by SPACs in January, the single biggest month of SPAC issuance ever and about double what companies raised in January through traditional IPOs. In February there were a record 50 SPAC mergers, the most of all time, worth an estimated $108.6 billion.
The rules of the SPAC confidence game go something like this: A small group of investors, usually with a proven track record of sorts, join together to “sponsor” a SPAC—that is, to pay the millions of dollars in fees to Wall Street bankers, lawyers and accountants necessary to help them raise gobs of money in a publicly traded company. The publicly traded company itself is an empty shell, containing nothing but the cash that is raised for the sole purpose of trying to find a private company with which to merge.
There’s a catch: SPAC sponsors have only two years to find a merger partner. If they don’t, all the money put up by investors must be returned, including the non-refundable fees paid by the sponsors to the bankers, lawyers, and accountants. That is the “risk” in the SPAC for the sponsors—find a company to buy within two years or you’ll not only be out of business, you’ll also have to eat the millions in fees already paid. If they do find a company to buy, the sponsors are off the hook and can get up to 20% of the equity of the newly public company virtually for free. No wonder the SPAC space is broiling.
The ticking SPAC clock creates a number of perverse incentives, the worst of which is that SPAC sponsors may end up competing for increasingly immature companies to take public. More than $150 billion in equity capital has been raised since the start of 2020, according to SPAC Insider, an industry data source, much of it in desperate need of spending. With the expectation of three-to-one leverage from other private investors, who often put money into the deal as the merger is coming together, that’s something like $500 billion of capital looking for companies to buy before the money has to be returned.
The financial press has responded with astonishment and alarm: Andrew Ross Sorkin, the business columnist at The New York Times and CNBC anchor, wrote a column decrying SPAC excess as “rife with misaligned incentives between the sponsor and other investors, particularly those who come after a merger.” He also repeated a bad joke making the rounds on Squawk Box that more people on Wall Street have SPACs than have COVID-19—and Bloomberg Opinion recently ran a series of columns devoted to the froth in the SPAC market.
Perhaps more important, the sirens are ringing among Wall Street practitioners too. One senior banker tells me that SPAC bankers have become infected with Masters of the Universe Syndrome—think junk bonds in 1987, the dot-com bubble in 2000, or mortgage-backed securities in 2008—and he worries the market will crash and burn in similarly spectacular fashion. “Trouble is coming,” he says.
Even David Solomon, the CEO of Goldman Sachs, which was the third-largest underwriter of SPACs in 2020 (and is the second largest so far in 2021), has spoken publicly about the dangers of the new hot asset class. In January, Solomon wondered if SPAC issuance had “gone too far” and said he didn’t think such issuance “was sustainable” in the medium term. The ecosystem, he added, “is not without flaws.” In an interview with Yahoo News, no less a respected investor than Charlie Munger—Warren Buffett’s longtime sidekick—criticized the proliferation of SPACs in unusually colorful language: “The investment banking profession will sell shit as long as shit can be sold.”
Consider the case of Churchill Capital IV (CCIV), the latest SPAC sponsored by Michael Klein, the former top investment banker at Citigroup. In early January, rumors that CCIV might be merging with electric car company Lucid Motors caused shares of Klein’s SPAC to soar nearly 600% in a month. Lucid’s flagship sedan, the Lucid Air, drew comparisons to Tesla, another stock that seems to defy gravity. But when the dust settled last week, after the actual merger agreement was announced, shares of the SPAC collapsed some 50%.
Who got burned? Not Michael Klein, I can assure you of that. As for Citigroup, Klein’s former firm, it has reaped some $100 million in fees from taking CCIV public and then advising on its “de-SPAC-ification,” or the merger with Lucid. Talk about Masters of the Universe Syndrome.
Indeed, the jury is very much out on the wisdom of SPAC mania. Sure, in recent months nearly every SPAC, filled with nothing but some cash and some hope, has traded up after its public listing. But according to a study by University of Florida professor Jay Ritter, of 114 SPACs issued between 2012 and 2020, investors who bought shares of a merged company on day one and held for a year lost about 15% of their money on average. Their returns were just as bad two years later.
My billionaire friend points out that SPACs can operate like “venture capital in the public markets,” which on the surface may appeal to retail investors searching for their inner Elon Musk. But it rarely works out well for the retail crowd, even those on a mission like the YOLO bros on Reddit that bid up the price of GameStop. In the old days, startups had to solicit private markets to raise capital, excluding retail investors from the biggest gains. Now, increasingly, startups and companies previously denied access to capital can simply merge with a SPAC. “I think it’s going to have a profound effect on business formation,” he continues. “But I think the results are going to be as scattered as the results from venture capital.”
These newer SPACs increasingly feel like an inside joke for the super-rich.”
It’s the nature of a gold rush to attract grifters and dilettantes alongside more seasoned professionals, and there is a wide variety of players getting in. Some of them have been unsurprising. There is Gary Cohn, the former chief operating office of Goldman Sachs and Trump’s first national economic advisor; Doug Braunstein, my onetime boss and the former chief financial officer of JPMorganChase during the infamous London Whale episode; David Cote, the former enormously successful CEO of Honeywell; and Tidjane Thiam, the former CEO of Credit Suisse.
There are tech billionaires like Michael Dell, Reid Hoffman, and Mark Pincus; and regular billionaires like Bernard Arnault, the world’s fourth-richest person. And of course there are the hedge fund managers and activist investors, like Bill Ackman, Dan Loeb, and Chamath Palihapitiya, who already make deals for a living and see SPACs as just another avenue to do so.
And then there are the SPAC players who might give us pause. There are the former athletes, such as Shaquille O’Neal, Colin Kaepernick, and Alex Rodriguez (whose Slam Corp. just raised $500 million). There are current professional athletes Steph Curry and Serena Williams. There’s Billy Beane, the baseball executive behind Moneyball. There’s the former Speaker of the House Paul Ryan, who just joined Mitt Romney’s son’s buyout firm. There’s the former astronaut Scott Kelly, who spent a year living in the International Space Station. There’s Joanna Coles, the former editor of Cosmopolitan, and Ciara, the Grammy-award-winning singer.
These are all good people, to be sure, but what are they doing advising SPACs or investing other people’s money? “These newer SPACs increasingly feel like an inside joke for the super-rich and a way for celebrities to monetize their reputations,” CNBC’s Jim Cramer has observed.
Scott Galloway, the NYU business-school professor, entrepreneur and pundit—he does not have a SPAC—is among those sounding the alarm. “The market arc is curved and jagged and violent, but it bends towards valuations reattaching to fundamentals and I worry we’re kind of due for the mother of all that,” he says. Galloway, who began his career at Morgan Stanley, notes that with all that money chasing deals on a tight schedule, SPAC sponsors will have no choice but to merge with private companies of lesser and lesser quality—the ones that Goldman Sachs or Morgan Stanley declined to underwrite in a more traditional IPO.
In the end, he warns, it will be unsophisticated investors left holding the bag. “The returns in SPACs will go down,” he continues. “I think it is an indicator of the canary in the coal mine because you have now 300 SPACs with about $90 billion in cash”—more like $150 billion these days, but OK Scott— “that needs to be de-SPAC’ed. In other words, they’ve got a gun to their head.”
There are benefits to a sellers’ market, of course, as long as you’re the one selling. “It’s a great time to be a decent, maybe even a good company that typically wouldn’t get underwritten in the public markets or that wouldn’t get past the investment committee of Goldman Sachs,” Galloway observes. He compares some of the high-profile companies to go public via SPAC—Virgin Galactic, SoFi, Fisker, Nikola, and so on—as akin to walk-on college athletes.
“Occasionally a walk-on ends up being a great player,” he says. Virgin Galactic, which merged with one of Palihapitiya’s SPACs in October 2019, has practically sextupled in value since. But for the most part, Galloway argues, the traditional Wall Street scouting and recruitment system works: there’s a reason most walk-ons don’t make the team. “If the NFL all of a sudden expanded from 28 teams to 280, a lot of people would find themselves in the NFL.”
For another perspective I called up Chris Terrill, the co-chairman of Z-Work (along with Doug Atkin), a new SPAC that raised $230 million from investors with the goal of finding a gig-economy or work-from-home company to take public. Terrill, the former CEO of what became HomeAdvisor, was a SPAC skeptic at first. But the more he learned, the more excited he became. The biggest risk, he decided, is reputational. “A lot of SPACs are looking at that near-term and trying to count the money,” he says. “We just don’t think that way. We’re in this to help the company. And if we do a good job, pick the right company and help them, yeah, then it will all be worthwhile.” He thinks the inevitable “blowout” of SPACs led by opportunists will be good for Z-Work and others who know what they’re doing.
All legitimate arguments, perhaps, but critics still worry that amateur stock pickers—who might as well be throwing darts—are getting screwed. The Bloomberg editorial board found that retail investors end up paying $10 for $7 worth of SPAC shares after subtracting for the value that is absorbed by sponsors, bankers, and hedge funds before the real work of effecting a merger begins. They cite a recent study by Stanford and NYU law professors (“A Sober Look at SPACs”) that concluded 30% of money invested in SPACs gets diluted by fees and other benefits, such as cheap stock and free warrants for the sponsors.
“Not so tempting when you put it like that,” Bloomberg opined. The editorial suggested that the SEC step in and force more disclosure on SPACs so investors know just what they are buying: “Shed light, then let the market decide.”
Just like GameStop, the SPAC rollercoaster will stop soon enough. When the tide goes out, as Buffett likes to say, we’ll see who was wearing a bathing suit.
William D. Cohan is a journalist and author of six books, including his latest, Four Friends: Promising Lives Cut Short.