Market Lemonade
You may have heard the popular saying, “When life gives you lemons, make lemonade, and as 2020 is coming to an end we can look back and say that 2020 has provided us with plenty of lemons… an entire Amazon fufillment center of lemons at that. The same cannot be said for the (speculative) financial markets as global equities are trading around their all time highs, and up 67.40% YTD (MSCI). This performance can be attributed to the central bank liquidity dynamics and rate policies further extrapolated in growing-deflationary-risks-within-the-economy. Alongside with these risk friendly dynamics derived from central banks, the propensity to invest has been amplified as global equites trading volume has jumped up to a 61.8% rate of change. Due to the increased volume and liquidity in the equity markets, even a blind man can assess that this market environment is very IPO friendly (IPO volume at 5 year highs).
Out with the old, In with the new… eh?
To further accelerate the funding fad amidst the age of shareholder primacy and the age of instant gratification, the financial sector aimed to fulfill these inducements with the integration of SPACs (Special Purpose Acquisition Company) to supplement the traditional IPO.
Tale of the tape: (IPO): An IPO is a stock market launch where shares of a company are valued and sold to institutional and retail investors. IPOs are used to raise funding/equity for the company and to create exit liquidity for private investors. How do SPACs differentiate ? Unlike IPOs, SPACS carry a discount structure where 2% of the total proceeds are paid, and an additional 3.5% that is deposited in payables to the underwriters (Total *average* cost: 5.5%) in contrast to the 6% (Total Average) for the IPO. SPACs also differentiate in which they have the ability to defer the SEC review process. SPACs also require a smaller due diligence “squad” which attributes SPACs to move faster and become “cheaper” than traditional IPOs (SPACs usually take 3.5 months compared to the IPO 7 month timeline). SPACs can also “mitigate risk” by offering redeemable shares at the time the merger is proposed. It is also important to note that the dilutive nature of the SPACs, caused by the share and warrant offerings which do not supply cash to the impending merger and subsequently dilute the valuation of the SPAC shares offered to investors, can contribute to higher costs (see figure 1) and accentuate risks associated with M&A’s (see below).
M&A Risks:
- Takeovers unambiguously bring positive short term returns for shareholders of target firms, but the long run benefit to investors is “more” questionable
- Only 35-45% of acquirers achieve positive returns in the 2-3 year period following acquisition.
- Acquisition outcomes are highly dependent on the integration process
- Execs are undertaking acquisitions driven by non-value maximizing motives
- Workers’ social and cultural contrasting must mix well or the internal integrity, base model, and or “bottom line” of the newfound organization is at risk.
Tale of the tape:
Just like any investment you can make, due diligence and research is vital. Sure the amount of research and information available for the average retail investor is limited in regards to IPOs; this is why it is vital to assess the intangibles and be weary of the financial parameters when considering investing in SPACs. The evasive branding surrounding SPACs can create a falsified “risk-free” (less than an IPO) sentiment, but as anything in life, “all that glitters is not gold,” watch out for underlying cost risks, merger implications, and the executive sentiment along the lifeline of the SPAC process.
