Deconstructing the SPAC frenzy: What went right and wrong?

As free money, day traders and even sports bettors piled into special purpose acquisition companies during the pandemic, the structure intended to bring small companies public began to erode, creating carnage of some unready for Wall Street scrutiny.

“There are some great examples of winners being made. Unfortunately, there’s a number of examples of losers that haven’t gotten the job done,” Vince Cubbage, CEO of Tortoise Acquisition Corp., said in a keynote at FreightWaves’ Autonomous and Electric Vehicles Summit on Wednesday.

What’s next for SPACs after the bubble burst?

Cubbage’s company brought Hyliion Holdings and Volta Charging public through reverse mergers. Tortoise raised “blank check” funds from investors to seek targets for a merger, then investors set Hyliion and Volta on their way in the public markets. Cubbage and his team took a cut in stock. Tortoise is seeking a target for a third SPAC.

“SPACs have a reputation in part because of how frequently they were used recently to bring capital to high-growth companies,” he said. “But really, SPACs are nothing more than a group of investors that are led by a sponsor. And those investors and the sponsor are out looking for opportunities to invest in sector plays.”

Tortoise Acquisition focuses on companies working on decarbonizing transportation. Hyliion is working on a heavy-duty truck powertrain that could ultimately emit zero emission. Volta is in the charging space critical to powering electric trucks.

A brief history of SPACs

In his keynote, Cubbage covered the history of SPACs that led to the frenzy of 2020 and 2021. The first iteration, dating to the 1980s, had a key difference from what Cubbage called SPAC 2.0. Early SPAC investors saw their funds used to find a merger candidate. When they voted on whether a deal should happen, they remained financially committed to the company.

A rule charge occurred in the last decade. It required that all money invested in a SPAC’s public offering remain in trust until a merger. Or the money returned to investors, usually in about two years. The SPAC sponsor spent its own money to find a merger partner to bring to investors. Investors then would vote on the deal, but they did not have to keep their money committed.

“They’ll be offered a separate choice to stay invested or to exit their investment and get all of their money back through what’s known as the right of redemption,” Cubbage said. 

Early redemptions reduced the amount of money that many SPACs received toward the end of the bubble. Some of that money was replaced by private investment in public equity, a so-called PIPE.

“The private company that was thinking about taking itself public through a SPAC would end up public with all the obligations of being public and the cost of being public but without the capital in some cases that they were expecting to receive as part of the process.”

World gone crazy

But what led to 861 SPACs and $245 billion of investment in less than two years?

“I really attribute that to the pandemic and the travel restrictions and the inability of the regular way process to play out,” Cubbage said. “If you look at the 2020 and 2021 SPAC boom and you overlay that with the March 2020 lockdown that really didn’t get released until very late in 2021, the correlation is very high.”

Zoom calls replaced in-person meetings as they did in many businesses. Government stimulus money intended to stabilize the economy found its way into SPAC deals by day traders. Even sports bettors got into the act.

“The reason that capital came is because of the lack of alternatives. The sports gambling crowd was looking for things to bet on. The amount of capital that normally flows into those channels [was] looking for an alternative way to have the same level of activity, but to find a different thing to bet on.”

Speculation on SPACs drove valuations far beyond sanity.

“When we underwrote deals, we would say to our own investors, ‘We think this is worth $12 or $13 or $15 or $18 maybe. We’re buying it at $10. It’s a good deal, long term. It certainly needs to execute. It needs to perform.’ But nowhere would we be saying to our investor group, ‘Hey, this is worth $50 or $80 or $100’ like you saw.”

Even Hyliion hit nosebleed territory, trading above $50 a share just before the completion of the business combination with Tortoise in October 2020. It closed Tuesday at $3.24.

“The prices that some of these SPACs traded at post-announcement of a deal were completely disconnected from the fundamental value of the business as underwritten by the SPAC team,” Cubbage said.

Bad actors or bad structure?

Most SPAC investors, Cubbage said, are neither good nor bad. 

“Most participants in the SPAC market are just financially motivated. And they’re very smart investors and they understand optionality in a deal,” he said.

Some SPACs never should have bailed on going through with their mergers.

“Unfortunately, there are businesses that maybe weren’t quite ready to be public or didn’t have the quality of management team they needed to kind of transition from successful private company into successful public company,” Cubbage said. “The question is, what are they going to do to work their way out of it?”

Source: freightwaves - Deconstructing the SPAC frenzy: What went right and wrong?
Editor: Alan Adler