SPACs may still be new to Singapore investors, but have been popular in the US stock market for years. In 2020, US SPACs raised more than $80 billion, surpassing traditional IPOs for the first time, and became one of the mainstream ways to go public. The total SPAC IPO proceeds in 2021 were more than $160 billion, and the rapid growth continued.
What is a SPAC?
Many investors may not yet understand what a SPAC is? It is an acronym for Special Purpose Acquisition Company.
SPACs work this way: Firstly, sponsors establish a SPAC, a shell company. Then the company raises capital through an initial public offering (IPO), but without any actual business or assets. After that, the SPAC searches for and acquires another company of interest, known as a target company, but the acquisition needs to be approved by more than half of its shareholders and independent directors. Finally, the target company can be helped to achieve a rapid listing by merging with the SPAC, using the cash raised earlier.
If the SPAC cannot successfully merge a target company within the specified time frame (usually two years), the SPAC will be liquidated, and the money raised will also be directly returned to the investors.
Features of SPACs
The rapid rise of SPAC is mainly due to its great advantages for all stakeholders, including sponsors, target companies, and investors.
Firstly, from the sponsor or management team's perspective, a SPAC offers the opportunity for potential permanent capital for them to fund large acquisitions. Sponsors usually retain approximately 20% of the SPAC's shares post-IPO.
Secondly, for the target company, going public through a merger with the SPAC shell company can greatly increase the chance of getting listed, shorten the IPO time, and use funds raised by the SPAC.
Thirdly, for the investors. The issue price for SPACs on the US stock market is generally US$10, and it's S$5 in Singapore. A SPAC IPO offers investors a unit of securities that includes one share of common stock and a fraction of a warrant (generally 1/2 or 1/3 of a warrant). Warrants resemble forward call options, which are contracts giving holders the right to buy a certain number of shares of common stock at a fixed price before a predetermined date. Shares of common stock and Warrants can be traded in combination or separately.
When the SPAC is said to acquire an attractive operating company, the stock price may rise. But the quality of the target company cannot be guaranteed, and the sponsors may make decisions that do not benefit investors.
Fourthly, redeemable merger. If investors disagree with the decision approved by the general meeting of shareholders, they can choose to redeem their shares at the issue price. In addition, if the merger cannot be completed within the specified time, funds raised initially will be liquidated.
Potential investment opportunities for SPACs
The first is to subscribe or buy a SPAC and wait for the merger news, as the stock price may soar. Generally, there will often be related news before the merger, and an announcement if the merger is confirmed. The proposed merger may lead to a surge in the SPAC's share price if the company has great potential. Conversely, if the merged company does not go well, the SPAC stock price may not respond.
A typical case here is Digital World Acquisition Corp (DWAC). DWAC went public at the end of September 2021, and its shares have been trading at around US$10 since then. On October 21 that year, Trump's social media company said it was merging with DWAC, sending DWAC's stock price to rise by more than 16 times in two days at most. However, if you buy at the high point, there would be a great risk of falling back for this kind of trend.
Source: moomoo app
The second is to subscribe or buy a SPAC and wait for a possible share price increase after the merger. When a SPAC successfully merges with a target company, it becomes a regular listed company. Therefore, its price rises and falls are determined by its development prospects and market supply and demand.
A typical example is Social Capital Hedosophia, which merged with the famous spaceship company Virgin Galactic on October 29, 2019. Before the merger, the share price was around the issue price most of the time. After the merger, it temporarily fell below the issue price, but has risen five times in three months since December 2019. The stock price fluctuated drastically in the following two years.
Source: moomoo app
The third is to buy a SPAC when it falls on debut and redeem it at the issue price on the redemption day. It is arbitrage, in essence. A few days before the specific date specified in the prospectus, such as the date of the shareholders' meeting of the SPAC merger, ordinary investors can choose to redeem their shares, and the redemption price is generally not lower than the issue price. Investors who buy below the issue price can profit from the difference between the purchase price and the issue price. Although it takes several months to two years, the risk is relatively low.