2020 Is The Year Of The SPAC, But Goldman Sachs Says 2021 Could Be Even Bigger

This year has been the year of the special purpose acquisition company (SPAC), but next year could be even bigger, according to Goldman Sachs. The firm reports that 206 SPACs raised a record $70 billion in proceeds from initial public offerings so far this year. 

That's an increase of fivefold from last year as a record number of SPACs announced or closed deals this year. This year's increase is remarkable in that it's on top of last year's 44% increase in SPAC activity, which was a record high at that time. 

Why SPACs Are Taking Off

SPAC IPOs accounted for more than half of the record $124 billion in U.S. IPO capital raised so far this year across 356 transactions. Announcements about SPAC acquisitions and deal closures also reached record highs this year. According to Goldman Sachs, 82 SPACs representing $28 billion in IPO capital announced M&A targets this year. Another 36 closed de-SPAC acquisitions, totaling $51 billion in enterprise value. 

SPACs are blank check companies that are created for the purpose of acquiring or merging with another company. A SPAC must make an acquisition within two years, or the capital it raised must be returned to investors. 

With most SPACs, the sponsor raises the initial capital by issuing units that consist of one share and one-half or one-third of a warrant. Shares are usually priced at $10, while warrants are usually struck 15% out of the money or $11.50 with a five-year term and a forced exercise at $18. 

Change From Value To Growth

It's no secret that value stocks have been underperforming in recent years, while growth stocks have been moving up, up, and away. Thus, it makes sense that this trend would extend to the SPAC niche. Goldman Sachs attributes the massive increase in SPAC activity to a sponsor shift in focus from value to growth. 

Analysts led by David Kostin said 68% of SPAC mergers this year were in tech, consumer discretionary or healthcare, mostly biopharma. Only 24% of SPAC mergers were in industrials, financials and energy. Kostin and team said investors are "firmly in a growth mindset," and SPAC sponsors that have focused on growth industries have been able to successfully raise capital. More than half of this year's SPAC IPOs are looking for mergers in tech, consumer discretionary or healthcare. 

Investor Appetite For SPACs Also On The Rise  

Increased retail trading activity has also boosted interest in early-stage SPAC targets, according to the Goldman team. SPACs offer an alternative way for companies to go public, including those that are in the early stages or that lack many comparables that are common to public companies, like green tech, sports betting, or cannabis. 

Kostin and team said the lockdowns associated with the COVID-19 pandemic have triggered an increase in retail trading and demand for extremely volatile shares in firms with "perceived hyper-growth prospects." They also point to anecdotal evidence of heavy retail trading that coincided with the SPAC listings of electric vehicle and sports betting firms, specifically, Fisker Inc FSR and DraftKings Inc DKNG. 

Low Opportunity Cost For Investors

The Goldman team also explained that SPACs have low opportunity cost for investors when policy rates are close to zero. Cash is yielding almost nothing, and due to the Federal Reserve's average inflation targeting plan, it is unlikely to hike interest rates within the next three years. 

SPAC investors receive a de minimus yield while they wait for the sponsor to choose a possible target. Then they have a put option to redeem their shares if they don't like that potential acquisition target. Kostin and team believe SPACs can act as a substitute for cash when interest rates are extremely low. Further, they said the focus on growth industries also makes SPACs long-duration assets that benefit from long-running low interest rates. 

The Goldman team expects SPAC activity to remain high into next year, noting that new SPAC issuance has accelerated significantly in the second half of the year. In fact, more than half of the capital raised so far this year has been raised since Labor Day. Kostin and team estimate that $61 billion in equity IPO proceeds raised by 205 SPACs is looking for acquisition targets.