Two minute explainer: The “SPAC Sea Bubble”

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The phrase “a company for carrying on an undertaking of great advantage but nobody to know what it is” is a hangover from the South Sea Bubble of 1720.

In some respects, it applies to Special Purpose Acquisition Companies (SPACs) 300 years later, although hopefully without the very unhappy ending associated with the South Sea Bubble investment craze.

With a SPAC, investors effectively give a blank cheque to a cash shell company that then lists on a stock market.

The SPAC then wanders off and finds a company and arranges for that company to merge with it or to effect a reverse takeover. The SPAC is under no obligation to give shareholders any clue as to what sort of companies it is looking at buying into before the shareholders stump up their money.

Funds channelled into SPACS over the last year have hit US$70bn, according to Goldman Sachs; other sources put the amount at more than US$83bn.

It’s largely been a US phenomenon, with examples of companies that have joined the market via SPACs including space tourism company Virgin Galactic Holdings Inc (NYSE:SPCE), online betting outfit Draftkings Inc (NASDAQ:DKNG) and electric battery developer QuantumScape Corp (NYSE:QS).

There have been attempts to get SPACs off the ground in Europe but not nearly so many as there has been in the US and the cash amounts involved are normally much smaller.

The rules are also slightly different for UK SPACs compared to US ones and the differences are mainly ones UK investors should feel uncomfortable about.

For instance, in the UK, there is no requirement for the funds raised in the flotation to be placed into a ring-fenced trust account. Neither is there a requirement for shareholders to vote in favour of the “undertaking of great advantage” that the company’s board plumps for; in theory, the company could splash the whole lot on the whelk stall run by the chief executive’s brother, Barry.

The success of a SPAC in raising capital depends very much on the reputation of the management team but bear in mind that past performance is not a reliable indicator of future performance. For instance, five years ago, maybe, Neil Woodford would have had little trouble raising plenty of cash for a SPAC but now? Not so much …

The supposed appeal of SPACs for the private investor is the chance to get involved second-hand in what is in effect a private equity style takeover carried out by a public company.

As always in investment, however, it is wise to remember that if a thing looks too good to be true, it probably is.

Oh, and remember the South Sea Bubble.

 

 

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