James Gowen, CIO Small Cap Equities

Wall Street is not immune to periodically being subject to whims, fads and ephemeral trends.  A recent trend we’re witnessing is the tremendous activity in special purpose acquisition corporations (SPACs) going public. While SPACs, also known as blank check companies, have been around since the 1980s, they’ve become increasingly popular this year amid high levels of liquidity and a desire for new growth companies.

A SPAC is formed to raise money through an initial public offering (IPO) to buy another company, and while it does not have commercial operations, it does have a limited management team, a board of directors and articles of incorporation, but little else.  Oftentimes, a SPAC has a limited balance sheet and an income statement without revenues, if in fact a quarter has been reported.  A SPAC goes public with a management team and/or corporate sponsor behind it seeking to acquire and merge with an existing operating business, allowing that business to go public without the costs, time, and in some cases, the scrutiny of a traditional IPO. The IPO process is typically lengthy involving numerous discussions between investment bankers and the selling company regarding valuation and offering sizes, meetings with prospective investors, as well as a detailed review by the SEC.  Commonly with IPOs, after a company goes public, the investment banks launch coverage with, more often than not, favorable recommendations.

A SPAC, on the other hand, allows a quicker route to the public markets, offering sponsors and management teams a reduced risk of missing the window of opportunity while the IPO is being filed and executed. IPOs tend to be hindered by unforeseen events and the changing sentiments of the markets. Additionally, IPOs are often subject to valuation changes leading up to the offering and after the initial trading (the IPO “pop” we have all read about).  While this is generally positive for shareholders and the management teams, this pop also indicates additional proceeds that might have allowed greater spending on growth initiatives that were foregone.  When SPACs merge with operating businesses, it allows bankers tighter control of the terms and valuation assumptions around the transaction.

In general, SPACs are not seen negatively, particularly in the public equity markets where we’ve experienced a notable decline in the number of listed companies, allowing fewer opportunities for stock pickers such as ourselves. Heavy SPAC activity (and concurrently a robust IPO and secondary market) does indicate a level of speculation in certain sectors.

SPACs do provide opportunities for many investors.  Our team closely monitors SPACs that have consummated transactions with real businesses that can be analyzed, appraised and valued with management teams that can be interviewed and a board whose governance can be judged.  These are important elements, as we would not consider a SPAC that does not have an underlying business to analyze, value or investigate.  It is important that we follow our research-driven investment approach to uncover these developing growth opportunities when selecting companies for our Small Cap Growth strategy.

The popularity of SPACs doesn’t seem to be decreasing anytime soon.  Both SPACs and IPOs are positively increasing the pool of listed securities, and eventually our opportunity set, and for that, some speculation by others can be a good thing.

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