Happy Sunday Folks!
After a Boom that lasted nearly 18-month, SPACs are now finding themselves under fire. Increasing amounts of Scrutiny from regulators, A Mismatch in Incentives towards Sponsors, and Burnout in new deals by Investors have all contributed to the recent slump. A majority of the high-growth De-SPACs have already seen a sharp selloff, leading to a drop of between 40-60%.
ARK Investments which is led by Cathie Wood is a prime example of the increased sell-off seen in recent weeks. Across the Fintech, Internet & Genomic ETFs, (which includes many De-SPACs such as Opendoor, Skillz & Ginko Bioworks) ARK has seen a decline of 45%. While the selloff may intensify over the coming weeks, beaten-up De-SPACs that are reasonably valued could make for a contrarian bet.
The State of SPACs in 2022Â
SPACs were one of Wall Street’s hottest trends in the last two years, as it expedited the process of going public, enabled companies to make forward-looking assumptions & sparked a boom in retail that was previously reserved for Private Equity/Venture Capital. Upstart companies flocked to participate and were promoted by celebrities & backed by bankers. EV Makers, Space Tech Companies, Gaming companies, and whole host Biotechnology startups took advantage of the SPAC wave to go public.
However, like most investing trends that relied primarily on speculation & hype, SPACs have started to plunge. Several risks loom at large for companies going public through SPACs, including an SEC-led regulatory crackdown, companies generally missing revenue targets, and investors shifting from growth to value stocks.
Companies that have gone public through a SPAC have lost between 40-45% after a year. As a result, shareholders have been reluctant to fund deals, with redemption rates accelerating from 10% in the first quarter of 2021 to more than 90% this month.
It can be counterproductive for most companies to go public, only to raise substantially less capital if they had raised capital through a private round. Founders are now being forced to seek additional funding through backstop commitments at lower valuations and convertible debt, which could lead to riskier deals.
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SPACs are Reminiscent of the Dot-Com EraÂ
To understand the decline of SPACs, we need to only go back two decades to the rise & fall of the dot-com era. At the height of the bubble in 2000, startups could go public through an IPO and raise large sums of money, without having made a profit or material revenues. Nearly two decades later, more than 200 startups across EV/Biotechnology/Space industries have gone public through SPACs, only this time the problems could be much worse. Not only do many of these companies not have any revenues, but they also don’t expect to ship any product for the next year (such as EV Makers Nikola, Hyzon & Lordstown, Mining Startup TMC and Biotechnology firm Ensysce Biosciences).
To further compound the problems, most of these companies have substantial capital commitments over the next 2-3 years (either to scale manufacturing/production, invest in R&D or maintain growth through advertising & promotions). This could be the single biggest challenge for companies that prioritize ‘growth at all costs’.
Looking back in 2001, new internet businesses adopted a similar mentality, by offering services/products at a large discount, while spending increasingly large sums of money on advertising to maintain growth. Many of these companies hoped that they would build brand loyalty quickly to charge customers a premium at a later date.
However, as a result of an unfavorable regulatory environment (such as an Antitrust lawsuit that Microsoft lost in 2001, similar to what Big Tech Faces today), tighter fiscal policy (such as interest rate hikes) and funding drying up in the public and/or private markets (early signs today include high SPAC redemptions & lower public comps) many of these companies ran out of money & subsequently went out of business.
Tech stocks as a whole saw a 78% correction from the peak, while nearly half the companies either went bankrupt/or went private. While such a drastic market correction isn’t anticipated this time around, nearly a quarter of the current high-growth SPACs could be at risk of bankruptcy.
SPACs RebornÂ
Investors who largely swore off the markets after the last tech bubble missed out on one of the longest bull markets in history. Tech stocks that were largely written off by the press & investors such as Amazon, Alphabet & PayPal, found a way to survive and compounded capital at astronomical rates. While the recent selloff in high growth SPACs and the subsequent decline in the next few months could prompt investors to largely stay away, the smarter contrarian bet may be to find companies that are oversold (after accounting for the re-pricing due to higher rates). While many SPACs may indeed take years to get back to $10, there may be some that could do very well over the next few years.
The broader SPAC market could also see a healthy recovery, with the focus shifting from new-age businesses to companies that already make money (such as KKR’s rumored deal with PetCare retailer PetSmart). Furthermore, higher redemptions from SPAC shareholders have resulted in Sponsors reevaluating their strategy by investing capital upfront & raising higher PIPE (Private Investments in Public Equity) commitments. All of this could mean that the deals significantly improve over the next few months, with post-merger performance also improving compared to the last few years.
Bottom LineÂ
High growth stocks & SPACs have imploded over the last few weeks amongst a host of concerns ranging from regulatory challenges to a tighter fiscal & monetary policy. The selloff is expected to accelerate over the next few weeks as market participants receive clarity about the expected rate hikes in the year and earnings from most companies. De-SPACs in turn may seem like contrarian bets in 2022, providing a lucrative opportunity for investors to buy growth at a reasonable price.