AND MAX HILL
Estimated reading time: 6 minutes
The article in brief:
- Stock performance post-de-SPAC has been poor; de-SPAC stocks in the last two years generally lose half their value following a merger.
- The SEC has increased scrutiny in the space, resulting in longer periods for a SPAC to complete its merger process and more extended lockup periods for founder shares and founder warrants, creating greater risks for sponsors and early investors.
- Valuations of restricted securities need to incorporate the new expectations in the SPAC market.
The party is over in the SPAC market.
Long gone are the 2021 days when SPACs could promise a faster option for companies to go public. The lights are on now, and it’s not a pretty sight for SPAC market participants. Extended wait times on SEC filings and de-SPAC companies significantly underperforming projections are leading to materially lower stock prices following merger close and are contributing to the impending liquidation wave as fewer private companies seek to go public via SPAC.
In 2021, SPACs promised a quicker avenue for private companies to IPO. Still, as the sky-high projections have proved unachievable (wildly so, more often than not), scrutiny from the SEC has increased meaningfully. As a result, the SEC has taken longer in its review periods than in past years, leading to longer lockup periods for founders and jeopardizing the financial support from financial investors, especially PIPE investors whose commitments usually have specific expirations.
As shown in the table, SPACs have been taking longer to complete deals since 2021. As of June 30, 2022, approximately 600 SPACs are still searching for potential deals in a slow IPO market compared to 2021. According to SPACInsider, only 70 SPACs had an IPO in the first half of 2022 compared to 613 in 2021 and 248 in 2020. As the SEC is slower to review filings, it is more likely that pre-existing PIPE commitments supporting the mergers will expire, increasing the risk that announced deals would not be completed without the committed financing. The DWAC/TMTG merger is the latest example of a lengthy approval period.
The delays have expanded after merger completion, as well. The time frame for the SEC to declare S-1/F-1 filings effective has more than doubled from less than 25 days on average for mergers completed in 2021 to 60 days on average for mergers completed in 2022, with longer tails becoming more frequent. While not a worry for public shareholders, this has a negative impact on investors in founder shares and especially founder warrants, as the delay in effective declaration prevents founder warrants from being traded, increasing the risk that early-stage investors will not be able to liquidate in the period following the merger, typically the most favorable period in de-SPACs’ stock performance.
Ultimately, relative to historical norms, the time frame from IPO to effective declaration has been extended by more than 2.5 months (~80 days). As we review investments made in founder securities (warrants/sponsor units/founder shares, etc.), it is essential to assess time horizon metrics as longer approval periods increase the time an investor can expect to be able to liquidate their position, leading to an increase liquidity discounts and increasing overall risk.
SPACs have a certain one-and-a-half to two-year timeframe in which they are to complete a merger or acquisition or they are forced to liquidate. Considering SPACs with an IPO in 2020 and 2021 and the dearth of companies seeking to go public, we estimate that 109 SPACs are at risk of being liquidated by the end of 2022, with an additional 279 in Q1 of 2023. Though these search periods can be extended by vote, extensions usually only occur when a merger has already been initiated. If SPACs do not complete a merger in the allotted time frame, the public warrant values will go to $0, and founder shares will expire worthless.
In discussions with market participants over the past two years, the prevailing sentiment was that a SPAC was almost guaranteed to find an acquisition target. Given the recent icy market, however, this sentiment has shifted. Increasingly, we are seeing sponsors endeavor to generate value in alternative ways, saving face with their early-stage investors. Still, some have closed up shop entirely – Bill Ackman closed his $4.0B SPAC, PSTH being the highest profile example in recent months. We’ve rolled this shift in sentiment into our valuation models, which has largely reduced the expected values for investors in founder shares and founder warrants.
While the process of merging has become more precarious, the SPACs that do close deals or “de-SPAC” have materially underperformed expectations and projections as a merged company, with de-SPAC stock performance suffering as a consequence.
Most SPACs are trading materially lower from all-time highs, and the majority are trading at or near their de-SPAC prices. For instance, some of the most watched and top moving de-SPACs, including DraftKings (DKNG), Virgin Galactic Holdings (SPCE), and Nikola Corporation (NKLA), after reaching astronomical highs of more the 5.0x their de-SPAC prices, are now trading at or below their de-SPAC prices, materially lower from all-time highs (ATH).
- DraftKing’s all-time high stock price of $71.72 in March ’21 has fallen ~84% to $11.67 per share as of June 2022, as the company continues to post operating expenses well above revenues, resulting in materially lower EBITDA of -$1.562bn.
- Virgin Galactic’s ATH of $59.41 per share has plummeted to $6.02 as the company expected FYE ’21 revenues of $210mm and EBITDA of $12mm, whereas their actual FYE ’21 results showed a much different story of $3mm in revenue and -$310mm in EBITDA.
- Similarly, Nikola’s ATH stock price of $79.73 has decreased 91% amidst fraud accusations, as well as material misses in performance expectations.
- Nikola projected an FYE ’21 EBITDA of -$211mm, but ended up over 3x lower at -$685mm.
These few examples underscore the norm of post-merger performance for SPAC targets. As represented in our second table “De-SPAC Returns Over Time,” only a small percentage of de-SPAC companies have had a positive return since their merger.
Within the first two weeks, the average de-SPAC that closed in 2022 is trading ~30% lower, and after six months, the average de-SPAC is 62% lower vs. 9% lower and 42% lower in 2021, respectively. On average, mergers completed in 2021 and 2022 have lost 67% and 59% of their value relative to their de-SPAC prices (typically $10). While negative in its own right, this poor performance results in longer lockup periods for the founder shares, increasing risk and liquidity discounts, as these shares are typically subject to a one-year lockup unless the stock trades above $12 for 20 out of 30 consecutive days, resulting in an earlier lockup release.
The SPAC market is not what it used to be, and the assurances of a big payday are not holding up. Founders, co-investors, and sponsors may find themselves in a riskier position than they expected when launching their SPACs, and valuations of these illiquid positions should reflect this.
While the lower appetites amongst target companies to go public via SPAC have increased the risk of even realizing a return on founder-type investments, the additional expected time to complete a deal due to heightened SEC scrutiny, missed performance targets, and poor de-SPAC price performance implies a materially lower return on initial founder investments than a year or two ago for those SPACs that can make a deal happen. These changes and trends represent significant valuation challenges for early-stage investors as they navigate through the SPAC party’s aftermath.