Where SPACs Pay Off — And Where They Don’t

Investors typically lose money after SPAC mergers, researchers found.

Kiyoshi Ota/Bloomberg

Kiyoshi Ota/Bloomberg

Investors seeking to profit from the boom in special purpose acquisitions companies may want to pick their investments carefully, as SPAC mergers typically result in losses for common shares in the first year, according to a study from the University of Florida and University of South Carolina.

While investors in the initial public offering of SPACs gained an average 9.3 percent annually in the study, performance later in the lifecycle of a blank-check company is more perilous, University of Florida PhD students Minmo Gahng and Jay Ritter and University of South Carolina finance professor Donghang Zhang said in a recent paper. They found that common shareholders lost money in the first year of SPAC mergers with a business.

“Between the SPAC IPO and the business combination or liquidation, we find lucrative risk-adjusted returns considering the downside protected nature of the investment,” the researchers said in the paper. “There are reasons to believe that deSPAC period returns may be still disappointing.”

SPACS — or blank-check companies that raise money through IPOs and then seek a merger partner within two years — have surged in popularity with investors. The “deSPAC” phase comes when the blank-check company combines with a business, taking it public.

The study spanned 114 SPACs that completed a merger with an operating company from January 2012 to September 2020. While investors in common shares lost 4 percent to 15.6 percent in the first year of their mergers, depending on weighting methods, warrant holders fared surprisingly better, according to the paper.

The average one-year buy-and-hold return of the merged companies’ warrants is 44.3 percent based on an equal weighting, the paper shows. Over a three-year period, the gains increased to 52.8 percent.

“Warrant investors have persistently outperformed common share investors, increasing the gap even more in 2020,” the researchers said. “The warrants, out-of-the-money call options in many cases, are riskier and benefit from volatility, but this large difference in average returns is puzzling.”

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Looking at 114 SPAC IPOs from January 2010 to May 2018, the researchers found investors earned slightly more on average from larger SPACS, which had an annualized return of 10.6 percent, according to the paper.

In previous years, SPAC returns were mostly realized when a merger was announced – but that appears to have changed this year, according to the researchers. In January, 91 SPACs went public with an average first-day return of 6.1 percent, significantly higher than an average 1.6 percent in 2020, they said.

The immediate repricing of SPAC units reduces returns for investors who buy blank-check companies in the market, similar to the traditional IPO market, according to the authors.

“Faced with the strong demand, sponsors have started to react by making deal structures less attractive to SPAC IPO investors and more attractive to merging company shareholders by offering fewer warrants per unit,” the authors said. This way investors experience less dilution when a merger is completed.

But the flood of SPAC IPOs this year and in 2020 may mean too many blank-check companies are chasing deals, leading to high valuations, the authors said — and paying high prices will hurt “deSPAC” period returns.