The SPAC market may be getting frothy.
Just like in entertainment, when network executives copycat a hit show format until the market is saturated, investors are flooding the market with special purpose acquisition companies, or SPACs, to scout private companies to take them public.
The boom started earlier this year, when companies such as electric vehicle company Nikola and DraftKings saw their valuations soar once they became public through SPACs. The reaction was eye-opening for investment professionals, who suddenly viewed SPACs as a viable option for growth companies.
“Historically, growth companies wouldn’t have been thought of as SPAC candidates,” said Bennett Schachter, Morgan Stanley’s global head of alternative capital solutions. “What Draftkings and Nikola did, I think they showed the market that there’s a new application of SPACs.”
Still, while DraftKings’ decision to reverse-merge into a SPAC led to the company’s valuation ballooning from about $3 billion in April to more than $13 billion Friday, investors and companies should be wary about the surge of available SPACs. Not all of them will be good fits, said DraftKings CEO Jason Robins in a CNBC interview.
“Hopefully the market settles down a little bit there,” Robins told CNBC’s A View from the Top. “I think there are a lot of SPACs now. Some will do well and some won’t. For the right companies, SPACs are great vehicles, but it’s not a fit for everybody. It’s not a fit for every company.”
SPACs: Not a fit for everyone
A SPAC typically scouts and acquires its target within two years. Companies that use SPACs skip the initial public offering process, including company roadshows. SPACs are up 145% from a year ago, according to a recent note from Goldman Sachs.
There are several different factors to consider for companies deciding if they want to merge into SPACs, said Schachter. The most important is finding the right fit between the investor base that has put money into the blank-check company and the company, itself. SPAC owners should have a track record taking companies from the private market to the public market, either financially or operationally, Schachter said. The number of individuals putting money into SPACs without this expertise is a sign the market is getting overheated, Schachter said.
“Just because you’ve made money doesn’t mean you’re going to be a successful SPAC issuer,” Schachter said. “LeBron James or Michael Jordan might be the best basketball player, but if you gave them ice skates, I’m not sure they’d be Wayne Gretzky. Just because you’ve been successful doing one thing doesn’t mean you will be successful doing something else.”
While most SPACs are targeted, the focus of the investment vehicle is less important than the actual track records of the individuals operating the shell company who will continue to invest in the company moving forward. In recent weeks, hedge fund manager Bill Ackman, Oakland Athletics general manger Billy Beane, former Trump administration economic adviser Gary Cohn and former speaker of the United States House of Representatives Paul Ryan are among the notable names to back SPACs.
“If you move LeBron James from one basketball team to another — from the Cleveland Cavaliers to the Los Angeles Lakers — there’s a good chance he’ll still do well,” Schachter said. “You need to leverage the skill set that the particular SPAC has.”
The burgeoning number of SPACs is leading to “lower quality” shell companies that don’t offer the same knowledge or track record of success with public companies, said Schachter. Still, the beauty of SPACs is that investors do have some protection. That’s because investors in a SPAC can typically walk away with all of their money if they don’t like the company targeted to be acquired.
That protection will likely lead to a continued surge in SPACs — as long as the market continues to reward them.