View from the City: Why the change of heart over SPACs?

One of the reasons why conference panel sessions are such fun is because unlike, say, most pptx-powered speeches, panellists can be quite upfront and unrehearsed with their emotions. In fact, if you ask the right question with the right angle to the right person, you can get raw, unadulterated, almost Freudian-like responses. Last week, I was fortunate enough to be moderating a pretty intense panel with some great industry heavyweights from the buying side of the M&A table, so why not throw a curveball question: SPACs – good or bad? Standard fare so far. What was unexpected was the unambiguity in preference for the latter option. Which, coming from the target market for SPACs, raises an interesting question. Why is this a bad thing? Have we now reached peak-SPAC? Not according to the City. In fact, after just a brief lull at the beginning of the year, as we now head into half-time it seems that the SPAC market is in full frenzy. Year-to-date, there have been more than 300 globally listed SPACs generating gross proceeds in excess of $100bn. That’s already more than what was generated in the entirety of 2020, and five times that of 2019. So, if anything, SPACs are now exponentially accelerating. So, it’s not for want of any SPAC vehicles lying around. Could it possibly be that the SPACs themselves are not being utilised by the gambling industry? Again, the data doesn’t seem to suggest gambling-related SPAC interest is decreasing. We know full well that two of the largest game data providers in the industry are both in the final stages of SPAC-powered IPOs. And, according to the Sportico Sports SPAC Tracker (incidentally such a great American™ title), the list of SPAC-influenced gaming M&A is actually growing. Artemis, Ascendant and Atlas have all announced SPAC IPOs in the sports betting industries this year, each in excess of $150m. And in case you were wondering, that’s just from the first letter of the alphabet. There’s at least 20 other SPACs which have publicly disclosed intentions to focus on sports betting, casino and esports products. Just from the beginning of this year. Now the narrative starts to get interesting. If this (growing, may I add) aversion to SPACs is not for want of capital or focus, what’s the real reason for the change of heart? Part of this is due to the increasing awareness about SPACs themselves. First off, as one of the panellists rightly put it, SPACs inflate sale prices, making the whole M&A sphere a sellers’ market. This is mainly due to the structure of how (and importantly when) a SPAC needs to complete a deal. At the risk of generalisation, but a point worth making nonetheless, there usually is a 24-month deadline from funding to acquisition. Put another way, given that a SPAC has two years to find and complete a deal, from an acquisition perspective that places inflationary pressure on any potential assets for sale. You can see how this plays out in the medium term. A buyer, having external limitations placed on them due to the choice of financial instrument, start to yield to terms which in otherwise balanced markets would not otherwise have entertained. There’s also the question of ‘rounding off’ valuations too; if, say, an asset has a fair market value of $150m but the SPAC still has $180m worth of unrealised capital, guess what the final purchase price would be? Palate-cleansing time. At this point some people in the industry familiar with our business are probably wondering why an investment and M&A broker is complaining about rising sale prices. There are a few reasons for this, not least that a proper brokerage is not run like a RE/MAX franchise, but more on that later.

Quality control

Back to SPAC. Another reason why seasoned buyers are averse to such blank-cheque vehicles is that – while they indeed remove some of the red tape related to deal-making – they also lower the quality threshold for both buyer and seller. Quite a few investment banks have raised concerns that a tranche of middle-market groups which did not have the level of sophistication to orchestrate an IPO suddenly all want to talk about SPACs. While capital markets should be all about reducing friction to, well, capital, that cannot come as a compromise to due diligence. Let’s not forget that we still haven’t recovered from the last time markets lowered their guard on how and whom money was given to. This, then, is the view from the City. The main reasons behind unilateral concerns on SPACs which come from both sides of the M&A table. Improperly used SPACs will not just create an unsustainable inflation in asset prices. There is a real risk that, through a couple of poorly vetted and/or toxic acquisitions, they will wipe out an entire asset class, thereby removing liquid capital from the table and moving the risk profile of regular cautious buyers to the left. In so doing the capital markets will be plunged into an illiquid state. And at that point, as we saw most recently in 2008 and 2000, everyone stops buying. This is not a hypothetical scenario. It can, and will, happen. Economists classify it a necessary stage in the cycle of capital markets and say that it’s inevitable, but that is actually disingenuous. It is as inevitable as tulip mania or south sea bubble was. The real reason behind this is behavioural – FOMO and unchecked hubris – and is behind the same forces currently driving bitcoin and NFT markets. The weapon of choice this time is a SPAC, but before that it was an OTC derivative. And before that, it was zero-capital lending. The issues aren’t due to the instruments themselves, but the lax controls placed on them. The fact that SPACs are gradually turning away their very core customer base sends out a strong message that they need to be better gated, properly audited, more purposely defined. That way, just like IPO, there’s proper due diligence placed both before and after a transaction.