One of the biggest stories in the financial world for the last 18-24 months has been the astonishing surge in SPAC-related activity. Some readers will recall that in the midst of the SPAC ballyhoo, three academics had sounded a serious note of caution. In their conspicuous November 2020 paper, “A Sober Look at SPACs” (here), Stanford Law Professor Michael Klausner, NYU Law Professor Michael Ohlrogge, and Stanford Research Associate Emily Ruan warned, among other things, that SPAC shares were highly diluted, that their post-SPAC-merger performance was poor, and that sponsors’ returns were extraordinarily high.

Critics at the time suggested that the academics’ research was out of date, and that later SPACs addressed the concerns the authors noted in their  data set from an earlier time period. In response to the criticisms, the authors have now updated their earlier paper and published their research results in a January 24, 2022 post on the Harvard Law School Forum on Corporate Governance entitled “A Second Look at SPACs: Is This Time Different?” (here). As detailed below, the authors conclude, based on their review of more recent SPAC transactions, that, contrary to the assertion of SPAC defenders, “this time is not different,” and that “SPACs remain highly diluted, and their returns remain poor.”

And in a separate paper that provides additional interesting reading about de-SPAC transactions, on January 24, 2022, the Freshfields law firm published a statistical analysis of 2021 de-SPACs entitled “2021 De-SPAC Debrief” (here), which, as also discussed below, provides an abundance of additional  information.

The Updated “Sober Look” Research

In their original “Sober Look” research published in late 2020, the academic authors anakyzed a data sample consisting of SPAC-related transactions taking place during the period January 2019 through June 2020. In their updated paper, which can be found here (refer in particular to the paper’s “postscript” beginning on page 78), the authors note that among the criticisms their original research and analysis received was the comment that “your study is out of date – this time is different.” The implication from this criticism was that SPAC deals that took place after the period reflected in their original data sample were higher quality and addressed many of the shortcomings the authors had noted in their original study.

(With a keen sense of irony, the authors note in a footnote one specific statement critical of their research which had cited Nikola Motors as an example of the later, less problematic transaction – of course, Nikola’s founder Trevor Milton is now under indictment and the company itself has paid a $125 million SEC fine, so perhaps Nikola was not the best example for the critic to have chosen.)

In their newly updated research, the authors have compared the SPAC transactions from their 2019-20 Merger Cohort (that is, their original data sample) with SPACs that have merged since June 2020. The authors conclude that there are in fact measurable differences between their original study group and the later transactions, largely as a result of a SPAC bubble that emerged in the period immediately after their study period, as discussed below. However, the authors also concluded that in addition to the changes in the subsequent period, “much has remained the same,” and that some of  the positive bubble-related changes have “reversed themselves” and it remains to be seen whether the remaining differences will continue.

But in any event, “the logical connection between SPACs’ structural flaws and their poor post-merger performance suggests that, on average, SPACs will continue to be a bad investment for nonredeeming shareholders.” The authors also suggests that “so far, this expectation has been borne out.”

The authors begin the updated analysis of their SPAC deals in the period following their original study sample by stating the fundamental principle that all else equal pre-merger SPAC shares typically trade at roughly $10 per share because they can be redeemed at $10 per share when the merger is announced. However, during what the authors call the “bubble period” from the third quarter 2020 through the first quarter of 2021, SPAC shares began to surge above the $10 level. The reaction during the bubble period of SPAC share prices to merger announcements was “even more dramatic” as during the period Q4 2020 through Q1 2021 “the mean and median share prices the day after the announcement were $15.77 and $14.76, respectively.” Shareholders, the authors note, “were either highly optimistic that post-merger SPACs, for the first time ever, would be a good investment,” or the “believe the next guy would believe the hype even more than they did.”

However, by 2Q 2021, the mean pre-merger share price was back to approximately $10 per share, and many of the Q4 2020 and 1Q 2021 deals that “appeared to be such good deals for investors had now soured” as of December 2021; the mean and median prices for those SPACs had fallen to $9.01 and $7.09, respectively. If the investors had redeemed their shares and invested the proceeds in a market index, they would have roughly $12.25 in value.

In their comparison of transactions in the subsequent period to the deals in their earlier study period, the authors noted that certain things had not changed in the later period – the “structural elements” of SPACs that are “the source of their dilution and incentive misalignment” remain unchanged. But there were certain changes the authors did note, relating to “lower redemptions, fewer warrants, larger PIPEs and reportedly higher quality sponsors,” as well as an additional structural element, the introduction of “sponsor earnout.” The authors evaluated each of these noted differences to assess whether these differences are likely to improve returns to shareholders and to last now that the bubble has deflated. In summary, the authors concluded, “SPACs on average continue to be a losing proposition for the nonredeeming shareholders.”

The authors begin their consideration of the changed SPAC conditions that were in effect after their study period by looking at the lower redemptions in the subsequent period; redemptions were indeed lower during the bubble Q4 2020 and Q1 2021, dropping to mean and median redemptions 22% and 0% of shares, respectively (compared to 58% abd73% during the authors’ prior sample period). However, the lower redemptions were a reflection of the higher pre-merger share prices during the bubble; with the higher share prices, a shareholder could exit only through a sale rather than a redemption. Moreover, the lower redemptions stopped after the deflation of the SPAC bubble; between July 1, 2021 and December 1, 2021, the mean and median SPAC redemptions were 55% and 66% respectively. The lower redemptions during the bubble were “a temporary aberration.”

Similarly, during the bubble, SPACs were able to reduce the number of warrants issued per share. During the authors’ study period, the mean number of warrants was 0.5 per unit, compared to 0.33 during the bubble; with shares (and therefore warrants) worth more during the bubble, investors were willing to accept fewer warrants. However, as the bubble deflated the number of warrants increased. During the period from July to November 2021, the number of warrants was back up to 0.5 warrants per unit. The authors note that “the SPAC IPO market thus remains dependent on free warrants in exchange for setting SPACS up as public companies.”

During the bubble, the frequency and size of PIPE transactions increased. In the authors’ study period, the average PIPE was 30% of the money a SPAC raised through its IPO. In the bubble period Q4 2020 to Q1 2021, the average PIPE had grown to 85% of the SPAC value. This, the authors note, is an important difference; as long as the PIPE investors pay a per share price greater than the SPAC’s net cash per share, the PIPE would increase the net cash per share at the time of the merger and could lead to higher returns for SPAC shareholders. However, “unless a PIPE is extraordinarily large, a SPAC will deliver substantially less than $10 per share in net cash” at the time of the merger. Moreover, after the bubble the “PIPE market has considerably cooled,” and it remains to be seen whether the supply of PIPE funds will persist.

As a result of the reduced redemptions, fewer warrants, and larger PIPEs during the bubble period, the estimated net cash per share at the time of the merger during that period was  $6.60 (compared to only $4.10 during the authors’ study period). But in the period following the bubble, the net cash available per share at the time of the merger declined to $6.40 during for mergers during the period September to November 2021, and to $5.40 for mergers announced in the period September to November 2021. While net cash per share increased for SPAC mergers taking place after the authors’ original study period, the net cash per share was “still substantially less than the $10 per share that shareholders forego in choosing not to redeem their shares.”

One criticism of the authors’ initial study is that SPAC in the later period had higher quality sponsors as compared to earlier SPACs. The authors had noted in their initial study that they had segmented SPACs with sponsors affiliated with funds that have more than $1 billion under management and individuals that had been top executives of Fortune 500 companies (as possible markets of “higher quality” sponsors). The authors found in their initial study that SPAC sponsors with these characteristics “experienced lower redemptions, attracted larger PIPES and had higher post-merger returns far higher than other SPACs.” However, the authors also noted that “our findings on returns to SPACs with high-quality sponsors… do not suggest that those SPACs are good investments –only that they are better than investments in SPACs with non-high-quality sponsors.” On a market-adjusted basis, “even high-quality sponsors performed poorly on average.”

The authors also looked a new SPAC structure that involve “sponsor earnouts,” by which a portion of the sponsor’s shares are subject to a requirement that the post-merger company hits a specified threshold within a specified amount of time. However, the authors found that because of the post-merger share price volatility and the length of the earnout period “an earnout does little to reduce the value of the sponsor’s ex ante interest in the merger or to deter the sponsor from proposing a merger that is a losing deal for SPAC shareholders.”

Perhaps most importantly, the authors looked a post-merger market adjusted returns during the period after the authors’ initial study period, looking at returns as of December 15, 2021, relative to the $10 redemption price (rather than relative to the trading prices on the days the merger closed). The authors found that “the returns on mergers that occurred during the bubble are quite poor, as are returns for more recent mergers.” Although, as the authors note, the returns later in the subsequent period following their initial research sample appear to “have gotten less bad” over time, the authors note that their prior research shows that “SPACs’ post-merger returns tend to fall further over two years,” so it remains to be seen wither the apparent improved (“less bad”) returns will persist.

In summary, the authors conclude that “the core problematic features of SPACs remain,” and while there have been “positive developments” that emerged during the SPAC bubble, many of those features have “already reversed themselves.” The authors’ research suggests that SPAC that had larger PIPES and that have high-quality sponsors “will perform somewhat better” than the SPACs in the authors’ initial study”; however, with net cash per share still well below $10 per share, the authors’ analysis suggests that “these will not be good investments on average,” and ‘the returns so far are consistent with that expectation.” In other words, they said, “this time has not been different.”

The Freshfields Memo

The academic authors analysis discussed above refers largely to aggregated research data. Readers interested in more granular detail about the de-SPAC transactions in the merger class of 2021 will want to look at the January 24, 2022 memo from the Freshfields law firm to which I linked above, and, more particularly, to the more detailed research report (here) summarized in the law firm’s memo.

As summarized in the memo, there were 199 closed de-SPAC merger transactions in 2021, far more than the 64 in 2020. Among other things, the memo reports that merger agreements were signed very quickly after the SPAC IPO, on average about 7.5 months post IPO. Consistent with the academics’ research cited above, most de-SPAC deals (95%) involve a PIPE transaction, with an average PIPE size of $316 million. Also consistent with the academics’ research cited above, the redemption rate was relatively low early in 2021, but by the fourth quarter 2021 had reached over 60% (with some deals over 90 percent).

The full report is very rich in detail, and much of the information is very interesting. For example, among other things the report notes that 34% of the SPACs involved in merger transactions in 2021 were Cayman Island corporations, as opposed to only 12% in 2020. In the vast majority of cases (163 out of 199 closed mergers) the post-merger company was a Delaware corporation. Only a relatively small percentage (15%) of SPAC merger transactions involve a fairness opinion. The full report also contains a great deal of other information, for example with respect to post merger escrows and earnouts. In short, for anyone involved with SPAC-related transactions, the report is worth reading at length and in full.