April 1, 2023 – “It’s probably overpriced,” is a common Wall Street adage when talking about initial public offerings. Historically, participating in IPOs has produced mixed results for investors.
Some of the more cynical market participants regarding IPOs may use the phrase, “idiots purchase only”.
There has been a myriad of high-profile traditional IPOs that have flopped over the past couple of years, so skepticism regarding new issues may be warranted.
As special purpose acquisition companies have gained a following in the market, their prevalence compared to traditional IPOs has surged.
Historically, SPACs had been a modestly used tool to go public and represented only a fraction of new issue activity. In 2016, SPACs accounted for just 10% of IPOs, while traditional offerings were 90%. By 2021, SPACs were more popular than traditional IPOs, accounting for nearly 60% of new issues.
While a traditional IPO probably is overpriced when it is broadly marketed to investors, given that operating companies generally choose to go public when the business is over-earning, the same dynamic does not necessarily translate to SPAC IPOs.
The value, or lack thereof, of a SPAC IPO is laid out from the onset.
There are two key value drivers for investors in a SPAC IPO:
1. Yield – A SPAC provides yield in two ways. First, the income generated by T-bills held in its trust account currently yield around 4.5%. Second, the discount to NAV that IPO investors typically receive adds a return of approximately 1.0% to 3.0%, as represented by an overfunded trust account of $10.10 to $10.30 per share. Currently, adding these two return components equates to a baseline yield of 5.5% to 7.5%.
2. Optionality – Additional value ascribed to SPAC IPO investors includes the upside optionality on a business combination announcement, which can be significant in certain market environments (remember Churchill Capital IV went up >500% on the Lucid Motors deal), and the value provided by SPAC warrants and/or rights offered to blank check IPO investors. These warrants and rights can provide an additional value of $0.05 to $0.25 per unit, equating to an additional 0.5% to 2.5% return before a business combination is announced.
Adding up the T-bill yield (4.5%), the NAV discount return (1.0% to 3.0%), the return from warrants/rights (0.5% to 2.5%), and ignoring the stock upside optionality (which is uncertain but can be substantial), gets us to an upfront expected yield from a SPAC IPO of 6.0% to 10.0%, assuming a 12-month term.
In addition to the attractive yield offered through SPAC IPOs, the limited risk aspect of the investment is compelling.
The built-in redemption option offered to investors in every SPAC, allowing them to exit at the blank check’s NAV prior to closing its business combination, provides downside protection for investors.
The opportunity to earn high-single-digit returns with limited downside risk is attractive. Therefore, it is not surprising that recent SPAC IPOs have performed well.
There have been 10 SPAC IPOs over the past two months, and they are up +2.4% on average from their offering price of $10.00. Contrary to what you may have heard, SPACs are not dead. The blank check market remains alive and kicking.
Given the highly favourable risk-return dynamics, it is no wonder these new issues are in demand from investors and highly competitive to obtain an allocation. The Accelerate Arbitrage Fund (TSX: ARB) participated in the majority of the above SPAC IPOs, allocating nearly 5% of its portfolio to these recent attractively-priced new issues.
While the classic Wall Street adage “it’s probably overpriced” continues to be a useful framework to view the initial public offering of a traditional business with skepticism, when applied to a SPAC IPO, it is best to assume “it’s potentially an opportunity”.
The Accelerate AlphaRank SPAC Monitor details various metrics on the current opportunity set while offering details on every individual SPAC currently outstanding. The Accelerate AlphaRank SPAC Effective Yield tracks the average arbitrage yield offered. The Accelerate AlphaRank SPAC Index tracks the price return of the SPAC universe.
* AlphaRank is exclusively produced by Accelerate Financial Technologies Inc. (“Accelerate”). The Accelerate Arbitrage Fund may hold a number of securities discussed in this research. Visit AccelerateShares.com for more information.