This is an audio transcript of the Behind the Money podcast episode: How Spacs went splat

Jess Smith
When Ortenca Aliaj was named the FT’s mergers and acquisitions correspondent, it was July 2020 so still the beginning of the pandemic. Financial markets were panicked, and it was a really tough time to be covering M&A deals.

Ortenca Aliaj
There were basically no deals, and the entire M&A market had shut down and I was like, great, I’m gonna lose my job (laughs). And then Spacs magically appeared. And first of all, there was one and two and then, eight Spac listings a day.

Jess Smith
So Spac stands for Special Purpose Acquisition Company. The name doesn’t give much of a clue as to what it does, but it’s basically a financial investment vehicle that has no operations. It’s like a shell company.

Ortenca Aliaj
So a special purpose acquisition company known as a Spac will list on the stock exchange and raise money from investors. It is literally just a blank-cheque company that will have traditionally two years to hunt for a private company that it will then merge with, thereby taking that company public as well. So it used to be known as a backdoor listing because you weren’t going through the traditional initial public offering process.

Jess Smith
So the pandemic arrives and these once obtuse kind of shell companies just take off in popularity like instantly.

Ortenca Aliaj
It’s like a, it’s like a sort of a wildfire. Everyone and their mother is launching a Spac.

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Jess Smith
Today we’re gonna tell you about the rapid rise of Spacs, why the pandemic fuelled their popularity and why this investment boom wouldn’t last. I’m Jess Smith, in for Michela Tindera. From The Financial Times, this is Behind the Money.

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Hey, Ortenca. Welcome to the show.

Ortenca Aliaj
Hi. Thank you for having me.

Jess Smith
So why did Spacs take off during the pandemic?

Ortenca Aliaj
There was, the main reason that people give is because of the retail investor boom. So we had the, we had people who were at home who weren’t spending their money on the traditional things you spend money on — going to restaurants, going to the cinema, seeing your friends — and they were locked at home, not doing anything. So a lot of them just downloaded Robinhood, the trading app, and started trading these things. And the companies that the Spacs were targeting initially were extremely attractive companies for your layman investor.

Jess Smith
What kind of companies are we talking about?

Ortenca Aliaj
Some of the companies that were going public through Spacs were kind of mind blowing. You had a vertical farm. You had these sort of businesses that you were just like, how is this going to make enough money? A lot of them didn’t have a product, let alone revenue. But what they did have was these cool, glossy presentations that you could access once a Spac had announced a merger with the company. And in those, during the start of the sort of Spac boom, you could say, pretty much anything you wanted in these in these presentations, right? There were companies, some flying taxi companies who were promising to make 10bn in the next five or six years in revenue. And so you could make these, like, lofty, rosy projections that investors will look at and be like, wow, I don’t wanna miss out on this concept that sounds great. And if I’m buying in at $10 and this goes to the moon, to use an expression commonly used by retail traders, I’m making a ton of money. So that was the attitude that drove the market. But there was also a lot of institutional investors who are investing in these things. It wasn’t just your retail investors. There were smart, those smart money, as it’s called, that was giving money to these vehicles at the very initial stages.

Jess Smith
Do you have any favourite Spacs in terms of what the name of the Spac, what it reported to, what it planned to go out and acquire, or the people involved? There were all kinds of celebrities getting involved in Spacs as well.

Ortenca Aliaj
Yeah, there were. I have a soft spot for Nikola, which is an electric truck company that, you know, said it was gonna revolutionise the market. It was gonna compete with Tesla. And this was the point at which I realised that Spacs were going to be a massive deal. But it went public with this company that had raised money. So Spacs will raise money at $10 per share and it had merged. It was called VectoIQ. And all of a sudden you see these shares shoot up to the point where the company had 28bn in market value. So it’s actually worth more than your traditional carmaker who is making cars. And to be clear, Nikola was not making any cars. Nikola barely had a prototype. It just had this grand promise. But I saw this share price go up and up and up, and I was like, what is happening? This company hasn’t got anything to sell yet. Like, why are we seeing why are we seeing it shoot up to 28bn?

Jess Smith
So in this case, so Nikola was the company, not the Spac, right?

Ortenca Aliaj
Nikola was a company.

Jess Smith
So does the company find the Spac if it wants to go public in a, in an easier way? Or does a Spac find the company, or do they find each other?

Ortenca Aliaj
Yeah, look, this is a bit of a grey area. So when you list a Spac, you’re not really supposed to have a company in mind. That’s actually prohibited. You’re supposed to list your Spac, and then you’re supposed to say, OK, I have the money from investors. Now I’m going on the hunt for a company. Whether that always happens is a question we’re still wrangling with. But the Spac will talk to its underwriters, who initially were very big banks like Goldman Sachs, like JPMorgan, Stanley. It will talk to its advisers and they’ll ask them, hey, do you know of any companies we could merge with? And they sort of go on the hunt. They present 40 or 50. They narrow it down. They signed letters of intention. So it’s a process that should take a lot of time, but at the peak of Spac boom, it was taking like two months to strike a deal, which doesn’t look good because you’re asking yourself, are you doing the due diligence? Are you sure this company is ready to go public?

Jess Smith
We’re using words like shell companies and companies that produce nothing, suddenly shooting up to $28bn market valuation. This is seems really risky or is it, is it shady or how do you describe the kind of product this is in terms on a risk scale?

Ortenca Aliaj
I mean, in and of itself, a shell company, they have a bad reputation. It’s not necessarily a bad thing. I think in this context, what happens, especially when retail investors getting pulled in, is that you get people who aren’t your average bank analysts. They don’t, they don’t know how to look at these companies and be like the fundamentals actually don’t match the price at which I’m paying. And so all of those people, I mean, Nikola shares are now trading at 4.85, and at a peak, I believe, it was as high as about $80. So all of those investors who bought on the way up and didn’t sell have lost a ton of money. That’s where it becomes a problem. And that’s hence why regulators had to get involved because you’re not, you’re selling a dream really. A lot of these companies are just selling a dream. And whether they can execute it or not is another question. But in the initial phase, you’re pitching people in something that even you don’t know whether it’s going to be successful, let alone anyone else.

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Jess Smith
So how big did the Spac phenomenon get? We’re talking just a couple years of the pandemic. How fast did it go up? What, what . . . How many Spacs came on to the market? And is there a collective number for how much value they represented collectively?

Ortenca Aliaj
It was ginormous. So 2020 was like the prelude. And then 2021 was like, wow, Spacs have exploded. They were like 20 listings a day. There were deals left, right and centre. There was a point at which Spac deals were contributing to 20 per cent of US mergers acquisitions totals, which is insane and unheard of. So the market really took off in 2021. And at some point, and this was around March and April, I think the Securities Exchange Commission, which is the regulator for Spacs, the financial regulator, took note and said this isn’t good. Retail investors are sort of getting fleeced here, and we need to take action. But on the whole, just to give you an idea of how many Spacs raised money, there are still, despite all those deals that I’m talking about, I think there are still like 680 Spacs waiting to find a target.

Jess Smith
Wow. So was that when the SEC, when regulators took notice and seemed ready to take action, was that the beginning of the end?

Ortenca Aliaj
It was. There was a notice in December of 2020, and they issued this statement saying, hey, if you see a Spac endorsed by a celebrity, don’t just invest in that Spac or in that company because it’s endorsed by a celebrity because you had people like Alexander Rodriguez, famous baseball player; J. Lo launching Spacs; and I think Serena Williams backed one. Everyone was clamouring to get into this market, and investors were, again, at home just looking at this happening and being like, hey, if A-Rod and J. Lo run this company, probably a good company, and they were putting money into it.

Jess Smith
Maybe they had the same investment adviser.

Ortenca Aliaj
(Laughter) He’s probably fired now.

Jess Smith
So, but was it really the regulator’s action that started to when you heard the hissing sound coming out? Or was it ultimately also the economic environment, the sort of the growing prospect of interest rates going up?

Ortenca Aliaj
Well, look, it was a bit of both. So if you look at March 2021, there’s this SEC document issued or SEC guidance, which is about this very niche aspect of a Spac called a warrant. And they had come out and said, actually, in your filings you’ve been mischaracterising what warrants are. So we need all the Spacs to go back and refile this. And that really slowed down issuance. People were looking at the Spacs they already had. They didn’t want to launch new products. So that kind of slowed it down and then it really picked up. Then the SEC was issuing guidance saying, hey, why are you doing rosy projections? Why can you give projections when you’re taking a company public and there is no accountability for the projections that you’re giving? But when a company goes public in a traditional way through an IPO and they give projections, which a lot of companies don’t for this very reason, but if they do, they are held liable for the statements that they make. And the SEC couldn’t quite reconcile the two. It was asking all these Spacs and Spac sponsors and all the banks and advisers who work on these deals. If the end result is that you’re taking the company public, then you should be, you should be subject to the same scrutiny that a traditional IPO gets. And the Spacs and their advisers are turning around saying, hey, no, this is a merger, this is not an IPO. So there was this like back and forth. And again, this obviously slowed down because then all these Spacs that could give all these rosy projections to draw in investors thought, wait, are we at some point going to be held accountable for the things we’re saying? Is this going to become an issue for us? So in 2021, the stock market was hot. The S&P 500 was up. It was not, there was an issue in the, in the financial environment. The issue was with regulators. They were really trying to clamp down on these things despite saying they weren’t, but they were really trying to slow the market down, and they succeeded.

Jess Smith
So March and April then were the peak, March and April of 2021.

Ortenca Aliaj
I’d say the first quarter of 2021 was the peak.

Jess Smith
OK. And then what happened after that?

Ortenca Aliaj
Things started to slow down and all of these Spacs that had found target companies started to not do so well. A lot of them were missing the numbers that they had projected they would make. Others were seeing their share prices tank. A part of it was that bitcoin was again of a sort of flavour and came back into fashion. So a lot of these retail investors, investors who want these shiny things were like, uhh, we’re done with Spacs. We’re gonna move to crypto, which also hasn’t worked out well. But there was this sort of kind of confluence of factors that made Spacs undesirable. And I remember running data on this, and I could see honestly on an almost week by week basis that more and more Spacs were falling below the $10 price. And the $10 price is crucial because when an investor buys into a Spac, the price is, historically, almost always $10. So if you merge with a company and that company starts to fall below $10, what the market is saying is you’ve done a bad deal, and this company wasn’t worth the valuation that you gave it. And I just started to see all these companies decline in share price and fall below $10. And so at one point it was like 65 per cent of the companies that had gone public through a Spac since January 2020 were trading below $10.

Jess Smith
So where are we now? How would you describe where we are now with in the Spac market? How what portion is it now compared to when it was at its peak?

Ortenca Aliaj
Well, now it’s back when things have really taken a turn in the market. So by my last calculation, I think about 90 per cent of Spac deals are trading below $10, which is an astonishing number. And that’s just because investors have completely or almost completely abandoned the market. They’re not really interested in Spacs any more. You have very few listings, certainly very few, even less deals, to be honest. And so there’s a sort of quiet periods where everyone has realised that 2021 was a period of excess in more ways than one, not just in the Spac market. It was certainly a time of excess within that particular industry. And they’ve also, they’re also coming to terms with other things. There’s, you know, there’s rising inflation. There’s a war in Ukraine. Interest rates are going up. So Spacs are not as attractive to people as they were a year ago. And that’s unlikely, in my opinion, to change anytime soon. There’s a proposal at the SEC right now to hold banks liable for the statements made by companies going public through Spacs. So before this was in the case, like I said earlier, in a traditional IPO process, you can do that but not in a Spac process. And the SEC has said, no, that doesn’t make any sense. We should reconcile the two. So a lot of the banks have said ahh, we’re not gonna work with Spacs any more. It was fun while it lasted. We made a hundreds of billions of dollars, and now we’re gonna, you know, take off it out of the market, and we’re just gonna, we’re gonna let leave Spacs to their own devices.

Jess Smith
So when the Spac boom kind of went bust, who were the losers?

Ortenca Aliaj
It’s difficult to say because any investor who participated in Spacs in the early stages and then stayed in the, in the or I guess you’re rolling over your investment into the new company and then saw the shares decline, you’ve lost money, right? Probably a lot of your average retail investors have lost out, but so have institutional investors who are providing financing for these deals. They were traditionally also buying in at $10. Some of them did get special deals. But generally, you were seeing them buying at $10 so they’d have lost money. But again, these are sort of large investors who it’s a drop in the ocean for, it’s not gonna cause them any massive losses.

Jess Smith
So who’s the biggest winner from this Spac boom?

Ortenca Aliaj
So there’s two winners. You have the Spac sponsor. When you, say if you’re a Spac sponsor and you decide to launch a blank-cheque company, you get a 20 per cent of the shell company, not of the target company, but of the shell company, for a nominal sum, which is usually $25,000. And when you merge your Spac with the company and that company then goes public, you end up making a ton of money. Whether that business performs well or not, it’s kind of irrelevant. You still make millions and millions of dollars. So you can see why sponsors were so eager to constantly, there were people that launched six or seven Spacs because as a sponsor, unless you have to liquidate your vehicle, there was really no way for you to lose. And the second cohort to make money were the bankers and the advisers who were charging pretty hefty sums to advise these companies to set up financing. And they had no, no skin in the game in terms of whether the end company was going to be successful or not.

Jess Smith
So I guess for these two groups, you could say for them, it was it was great while it lasted.

Ortenca Aliaj
It was great while it lasted. Yeah, that’s a very good way to put it.

Jess Smith
So Ortenca, what do you think? Do you think the Spac story is over or do you think Spac listings are just gonna become a lot smaller and fewer in number?

Ortenca Aliaj
I think they will go back to where they were before the big boom. I don’t think they’re going to disappear entirely, but, look, if you’re, maybe I’m wrong. I can’t think of any company that generates revenue, that’s a big company, that’s got a famous name that would say, I’m gonna go public with a Spac rather than an IPO. I just don’t see why you would do it. I think a Spac, unfortunately, is always going to be an avenue for companies that need cash, and companies that need cash tend to be high-growth companies. So I don’t see how they’re going to be more legitimised, especially with the reputation that they’ve built over the past sort of 18 months.

Jess Smith
Ortenca, thank you so much.

Ortenca Aliaj
Thank you.

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Jess Smith
Today’s Behind the Money was hosted by me, Jess Smith. Stephanie Horton is our contributing producer. Topher Forhecz is our executive produce. Sound design and mixing by Sam Giovinco. And special thanks to Arash Massoudi. Cheryl Brumley is the global head of audio. Thanks for listening. We’ll see you next week.

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