The SPAC Reversal Presses Creators to Find High Quality Mergers

Numerous companies associated with SPACs have seen their shares fall recently, including the one that is taking genetic testing company 23andMe public.

Numerous companies associated with SPACs have seen their shares fall recently, including the one that is taking genetic testing company 23andMe public.

Numerous SPAC teams are courting startups with the goal of closing deals within two years.

Competition for mergers among so-called blank-check companies is already fierce. Share price declines and a ticking clock for IPOs add to the pressure.

The new challenges for creators of special-purpose acquisition companies, or SPACs, are partly a result of the high volume of deals that raised capital in early 2021. A two-year deadline looms over these firms to complete a transaction or return cash to investors.

With the decline in the value of many SPAC-related companies, fewer startups are interested in going public via a SPAC. This mismatch is escalating competition between some blank-check firms for the same private firms, dubbed a “SPAC-off” by some on Wall Street.

SPACs are shell companies that raise capital and list on an exchange with the sole purpose of acquiring a private company and taking it public. The private company, which is frequently a startup, then acquires the SPAC’s stock market position. Blank-check mergers enable companies going public to make future business projections, which are not permitted in traditional initial public offerings. This is one of the reasons they took Wall Street by storm this winter, raising a record $105 billion this year, according to SPAC Research.

However, with SPAC shares in decline, many blank-check firms are now trading below their initial public offering price. Numerous companies have stated in recent months that multiple SPACs have approached them about mergers, a trend that has contributed to the sector’s frenzy.

The pressure to close deals at reasonable valuations may intensify in the months ahead, as nearly 260 companies with approximately $87 billion in cash face merger deadlines in the first three months of 2023, according to a Methuselah Advisors analysis of SPAC Research data.

While such deadlines can be extended, they place a strain on SPAC teams, which frequently require several months to complete deals and are now confronted with turbulent market conditions.

“There is a tremendous amount of capital that needs to find a home,” said John Chachas, co-managing principal of Methuselah, a boutique investment bank. “You’re going to see a fair number of less-than-desirable transactions completed simply because they must be completed.”

Private companies interested in SPAC mergers should first focus on their core business before pursuing blank-check opportunities next year, Mr. Chachas advised. By that time, many SPAC teams may be desperate to close deals and make generous offers.

With investors pulling back from early-stage investments in recent weeks, shares of a number of companies associated with SPACs—including those bringing genetic-testing company 23andMe Inc., electric-vehicle battery maker Microvast Inc., and flying-taxi startup Joby Aviation public—have fallen by around 30% or more since mid-February.

Signs that regulators are toughening up on the once-hot sector have also weighed on the stocks. Regulatory uncertainty has slowed the pace of merger completion and reduced new issuance of blank-check companies to a fraction of their record levels earlier this year. Only two of the 23 SPACs that announced deals in May ended the month trading above their initial public offering price, according to data provider SPAC Research.

If no deal is reached by the final date — after any extensions — the SPAC creators must refund investors’ money and forfeit the funds used to establish the shell companies, which are typically several million dollars in underwriting fees and other expenses. Additionally, they do not receive the deeply discounted shares that typically allow them to earn several times their initial investment.

These incentives help to explain why many blank-check mergers will proceed in the months ahead—even if they are completed at lower valuations or the SPAC teams are forced to give away some of the discounted shares to close the deals.

As a result of the market reversal, some analysts now anticipate that private companies and investors in SPAC mergers will have greater bargaining power when negotiating deal terms with blank-check firms. The shift demonstrates how many on Wall Street and in Silicon Valley are grappling with the unprecedented market environment created by SPACs, which were previously a rarely used alternative to traditional initial public offerings but are now evolving rapidly.

“People are becoming much more selective,” according to Kristi Marvin, founder of data and research firm SPACInsider.

Numerous investors believe that smaller SPACs will face the most pressure, while the most well-known investors, such as venture capitalist Chamath Palihapitiya, continue to churn out deals.

Because investors can typically withdraw at the low IPO price per share, plus a small amount of interest, prior to the completion of SPAC mergers, low share prices mean that many will do so to avoid taking a loss. This can leave the SPAC with significantly less cash, forcing executives to seek alternative sources of funding or renegotiate certain terms of the deal.

“They’re going to have to be more circumspect about the valuation and the terms of the transactions,” said Patrick Galley, a SPAC investor and CEO of RiverNorth Capital Management.

Investors who invest in SPAC mergers via a fundraising round known as a private investment in public equity, or PIPE, may benefit significantly. Among the largest private equity investors are funds managed by asset management behemoths BlackRock Inc. and Fidelity Investments Inc. Their capital is critical to transactions because it is combined with the cash held by the blank-check company to complete a merger several times the size of the SPAC.

In one indication that PIPE investors may now be able to obtain better terms, mobile entertainment company Jam City recently disclosed that PIPE investors invested in the company at an average price of $8.42 per share in its approximately $1.2 billion SPAC merger, including debt. This is a special price that is not available to other investors.

Nonetheless, some analysts believe the market’s momentum could quickly shift again, particularly if some compelling deals entice investors back into the space.

“Three months from now, the market may look drastically different,” Ms. Marvin stated. “It is possible that the game will resume.”

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