Tech SPACs crushed all records in the first quarter of 2021, completing 182 IPOs with $60B raised and announcing another 73 acquisitions with an aggregate deal value of $201B. These IPO numbers are not annualized, and for good reason, because they will never be repeated again in a single quarter. Completed SPAC IPOs dropped to 28 in Q2 and announced deals fell to 43. Wall Street did what Wall Street does and went overboard, and PIPE investors responded in April by temporarily shutting their purses before slowly cracking them open again in June and July. They are no longer saying yes to everything (as I do with my 2 year old granddaughter, Emma) and have grown far more skeptical and selective on what SPACs they deem worthy of de-SPACing. June and July are on track for an annualized rate of 240 SPAC IPOs and 240 acquisitions, which would amount to a whopping $72B in IPO proceeds and $432B in annualized M&A value, equal to 2/3 of an entire year of typical Tech M&A deal flow.How plausible is it that, overnight, this old Wall Street product repackaged can supercharge the IPO and M&A market by nearly two-fold? The U.S. government's near-zero interest rates and massive deficit spending, coupled with insatiable appetite for PE returns, has pushed trillions upon trillions into equities. Sponsors are making an immediate 5x return on their money for literally just closing the deal. The investment banks (yes, my art and trade) put up their best quarter ever in Q2 fueled by SPACs. Those are some powerful forces driving a phenomenon that, in and of itself, does not legitimize the quality of these investments.The SPACs announced in 2020, with far less competition, have delivered 23 of the 27 best performing closed deals. On the good news front, those top 27 closed SPACs are up a median of 53% since IPO. So in the early days of the SPAC revival, we had better priced and possibly better quality companies. The last 40 SPACs to close are down a median of 8%, driving home the concern of overheated competition and low deal quality.The fundamental thesis behind SPACs makes a lot of sense: savvy deal makers raise public funds to buy a private company like DraftKings at a discount to the market, unlocking enormous value for both the private and public company shareholders. So let's back up the truck and do as many SPACs as possible, right? Here is why that strategy is not working as planned:
In June, there were 20 SPAC acquisitions at $30B in enterprise value. Annualized, that amounts to $360B, an enormous capital markets new public listing and M&A product category. Banks and sponsors are making lots of money, and sellers who are generally not taking out any cash are getting sky-high public listing valuations that no strategic would pay. So who loses out in this case? If the stock goes up, everybody does well, but if the stock goes down, the recent PIPE investors get hurt dollar for dollar, and the selling company's shareholders start getting hurt when the price falls far enough to where they could have transacted on a private market driven valuation. As an M&A advisor, it does not hurt to have all these public companies coming to market searching for targets to backfill their bloated valuations. For traditional IPO investors, SPACs are pushing up their IPO pricings. The banks, sponsors, and sky-high paper valuations will keep SPACs IPOing and announcing deals until a market correction or predictable underperformance ushers them out. While there is some chance that self discipline and healthier sponsor incentives will bring about a more sustainable SPAC ecosystem, I am not betting on it!So, what would be a well-executed SPAC in today's market? A solid tech company with strong long-term fundamentals, ready to be a public company, but a little early or not quite sexy enough for Goldman and Morgan in a traditional IPO. The company has IPO aspirations and would like to engage in acquisition sooner than later. In other words, it's a solid company that can predictably perform well over the long-term with a substantial revenue base, e.g. over $75M. That said, you need to execute the acquisition and de-SPACing, unlike all the other SPACs getting done lately. The new PIPE investors should be coming in with at least 50% of the proceeds of the IPO investors with no sharing of the promote or the warrants. You want a PIPE investor that is a pure third party advocate of the company and the deal with meaningful skin in the game. The acquisition has to be priced at a level that is going to give the new PIPE investors a pop in the market, just like an IPO. Sponsors should get their risk capital back as free shares, so that their capital is returned to them in shares for successfully getting the deal done. The entire promote should be locked up for a minimum of one year, after which half of the promote can be sold if the stock trades above $10 for 60 days, and the other half can be freed up if the stock trades over $12.50 for 60 days, with no early acceleration on the one year requirement. The sponsor should not make a profit on their risk capital, time, and effort until the company stock price exceeds its original $10 acquisition price. If you want PE-quality companies and returns, then you need the incentive structure to be closer to a traditional PE deal. A SPAC deal ecosystem as described above could make for a vibrant, sustainable pubic marketplace for both solid but not perfect larger companies, as well as fast-growing but young early companies.