Rising bond yields are not just bad for overvalued stocks, they’ve had a far more brutal impact on SPACs – the IPOX index fell 20 percent last week since its February peak. Even the king of SPACs, Chamath Palihapitiya, conceded on Saturday. “The SPAC market has taken a real beating,” he said on his podcast.
A lot of people had sounded the alarm well in advance. Charlie Munger, Buffet’s 93-year-old right hand, had said: “The world is better off without SPACs.”
SPACs are shell companies with no operations, and they raise capital through IPOs. They then use those funds to merge with companies wanting to go public.
SPACs had become a red-hot asset in 2020-21 after being recessive for years following the global financial crisis. To give you a perspective: the market saw a listing of 91 SPACs in January 2021. These companies have raised over $38 billion YTD – double of what traditional IPOs made. But it seems like the red-hot asset rally is cooling down.
The IPOX SPAC index has nosedived 20 percent in the last few days. As the treasury yields rose, investors’ sentiment for growth stocks has soured. We saw a fresh example of this sourness, with Nasdaq diving as much as 3 percent. And now the SPACs.
And, many had expected this. SPAC valuations were moving up faster than what fundamentals could justify.
Assets breaching their fundamentals have become a norm in the past few months. We saw this in the GameStop mania and the silver price hike. As with all these assets, SPACs, too, did not take a lot of time to hit the ground.
“When the price is moving up way faster than fundamentals can justify, that screams risk to us, and people who have those exposures are experiencing that risk today,” Matt Stucky of Northwestern Mutual Wealth Management told Bloomberg. “It’s an awfully risky proposition to have a lot of capital invested in an exposure that is pretty volatile.”
In January and February, over 175 SPAC deals were closed, as per the data by Goldman Sachs. It didn’t take the investment bank long to slate this pace unsustainable. No, it only took them a dozen months and 100 or so billion dollars.
So, what happened?
Many analysts have slated its meteoric rise to speculation. With rising interest from executives to celebrities, investors had rushed to make profits. The stocks were trading at a large premium to their cash holdings, and hedge fund managers wanting to earn a quick profit dipped their feet in. The NAV premiums have now declined from 27 to 7 percent.
Now, according to data by Bain & Co., some 60 percent SPACs are lagging behind S&P, with 50 percent of it trading down post-merger. The other 40 percent are trading below the $10 IPO price. And that’s how things should be, according to Chris Bryant of Bloomberg.
Despite the crash, SPACs have been able to raise capital. The only difference is, IPO allocations went from less than 5 percent to 100 percent. Bryant believes this bust will make the hedge fund managers more judgemental when picking a stock. Till then, falling prices will make life harder for SPACs trying to conclude mergers.
“If you have one or two more months of this where bonds look better, you’ll have a bunch of busted IPOs or mergers,” Palihapitiya had said.
There is another factor at play: SPAC sponsors have become a little aggressive. Before, they offered stocks at $10 with a fraction of a warrant. (The warrant gave holders the right to buy another share for $11.50.) Now, they have withdrawn warrants, reducing the risk of future dilution. And allowing the merging company to hold a greater percentage of stock in the combined entity.
The absence of this incentive proved to be a dealbreaker for the hedge fund managers. And it’s not just outsiders; insiders don’t seem too happy either. Last week, Palihapitiya sold a large portion of Virgin Galactic Holdings.
However, this is not the first time when SPACs have been hit hard. They had died out after the global financial crisis. But, for now, the party is over.
First Published: Mar 9, 2021 6:29 PM IST
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