“Each of them has grown”

SPAC’s hot market is getting even hotter in 2021, raising concerns about rampant speculation that could leave retail investors fresh out of the GameStop bust holding the bag.

Not only do special purpose procurement companies raise a record level of capital – more than $ 30 billion so far for the largest quarter in history – pre-merger SPACs are also seeing an increase in size in the first place. trading day.

New offers this year saw an average increase of 6.5% in their debuts, an increase of almost six times their historical levels (from 2003 to 2020, the average yield on the first day of SPAC IPOs is only 1.1%), according to University of Florida Professor of Finance Jay Ritter.

“Each of them has risen in price. It’s not driven by one or two outliers,” Ritter said.

Unlike traditional IPOs in which debut pops are generally seen as a sign of the healthy appetite of investors and the market environment they make up, initial SPAC rallies are less rational in nature. These blank check companies are empty corporate shells that raise money from investors and then merge with a private business within two years, making them public.

So when investors hungry for returns bid on transaction prices by blank check, they are essentially making a leap of faith bet on something without valuation or a real deal. Many believe that rising SPAC prices could be a sign of speculative behavior in a new bull market with massive liquidity and uncontrolled animal spirits.

“There’s a lot of money coming into the market,” said JJ Kinahan, TD Ameritrade’s chief market strategist. “This is suitable for people who go outside the S&P 500 or Nasdaq 100. You’ll still see this behavior just because people look around to see what else there is besides buying the same shares that everyone else is buying. . ”

There are signs that the SPAC boom is caught in the market frenzy fueled by retailers. Bank of America’s customer flows showed that retail investors accounted for 46% of SPAC’s trading volume on its platform in January, up from about 30% two months ago. In comparison, the retail crowd occupies only about 20% of the S&P 500 trading on the Bank of America platform.

“The speculative nature of SPACs appears to be particularly attractive to retailers,” Bank of America analysts said in a statement. “We certainly don’t have to remind anyone what can happen when something speculative appears on the retail radar (ahem, GameStop).”

There is an attraction to getting a first piece out of a SPAC business for many retail investors looking at high-growth start-ups. However, since most individual investors buy SPAC common shares on the open market, they would most likely lose the pop from day one. In addition, many brokers do not offer trading SPAC mandates, which are a sweetener that offers early investors more compensation for their cash.

In fact, for buy-and-hold investors who enter only after a transaction is concluded, they almost always lose money.

For the 114 companies that went public through SPAC mergers in the last 10 years, investors lose an average of 15.6% if they buy common shares of a merged company on the first trading day and hold them for a year, according to Ritter. And they lose an average of 15.4% if they hold the shares for three years.

However, it is a different story for institutional investors. Hedge funds and other players participating in SPAC IPOs are often able to obtain bid prices of $ 10 plus the benefit of mandates. They also tend to sell shares once the merger is completed, which could have a negative impact on prices.

“Institutional buyers have realized that they are very good,” Ritter said. “SPAC IPOs are essentially convertible bonds with no default price. The worst I can do is $ 10 plus interest and no one has lost money.”

Another worrying factor is the large number of offers targeting targets right now. A record over 300 outstanding SPACs are on the hunt, giving private companies more bargaining power and allowing investors to play against each other for a better valuation.

“The assessments have, of course, become more and more competitive,” said Soumya Sharma, a corporate lawyer at Troutman Pepper. “The whole reason this will survive is that high-end targets agree to merge with SPACs because they believe they are better evaluated.”

As the valuations of the target companies increase further, it reduces the growth potential for SPAC investors. Meanwhile, sponsors could compete for lower-quality companies, many of which have not yet produced a physical product.

“The last few months have been great for SPAC investors, with very high returns, but I don’t think it will be able to continue like this,” Ritter said.

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