As has been previously discussed, SPACs are having a helluva year. 2019 has already seen 37 SPACs price their IPOs raising $8.7 billion in gross proceeds, which is a 35% increase over 2018 during the same time period. Plus, we have enjoyed a number of high quality teams and high profile deal announcements, so it’s no surprise that SPACs have attracted a lot of interest from new investors. But is that the only reason SPACs have been so hot? And is this year’s momentum about to turn? Or, more ominously, has it already started to turn…
SPAC investors invest for a number of reasons. Some prefer the warrants, while others view the SPAC vehicle as a free look to invest in a private equity-like transaction. And still others invest for the yield. However, it is these “yield players” that have traditionally formed the largest component of SPAC IPO shareholders and, as a result, are an integral part of the IPO process. To be clear, some investors straddle one or more of these strategies (sometimes depending on which deal they’re looking at), but for the most part, these are the three main focuses of SPAC investing. Nevertheless, it is the yield strategy that we are going to discuss, but first let’s look at what the 2019 SPACs have looked like so far this year.
If you noticed, of the 37 SPACs priced so far this year only three of them have been “over-funded” at 101% in trust ($10.10 per share), which is approximately 8% of the 2019 SPACs. To have 92% of SPACs be 100% in trust is very unusual. If we take a look back at 2016, 2017 and 2018, we see that it was more typical to have approximately one-third of SPACs over fund the trust in a given year. (See below)
% SPAC with Over-Funded Trusts
By over funding, that means that rather than $10.00 per share held in trust at IPO (or 100% of proceeds), SPACs have to top off the trust by putting in a little bit of extra money, via the at-risk capital, to bring the trust value to $10.10 per share, or 101%. Occasionally, you will see SPACs over-fund at even higher amounts, such as 102% or even 103%. However, it’s important to note that any interest earned on the trust account is accumulated on TOP of the starting trust amount. So if SPAC Alpha and SPAC Beta are the same size of $100 million and both earn $0.30 of interest over a 24-month period, they will both have per share redemption prices of $10.30. However, if SPAC Beta is a 101%, or $10.10 in trust at IPO, the redemption price would be $10.40 after 24 months ($10.10 + $0.30 of interest). To summarize, investors can expect an extra 1% of yield for every percent over-funded.
However, over-funding is costly to teams. Obviously. And that extra 1% or 2% that sponsors are contributing to the trust account is ALL at-risk in the event of a liquidation – they can kiss that money goodbye if their SPAC fails. So teams will only ever over-fund the trust if they absolutely have to in order to get the IPO sold.
Nonetheless, the last SPAC to over-fund its trust was Hennessy Capital IV, which IPO’d waaaay back on February 28, 2019, six months ago, at 101% in trust. So why is 2019 so different? Why have all the other SPACs been done at 100%? Part of the reason why is simply SPAC market dynamics – terms tighten and loosen based on supply and demand and 2019 has seen a tremendous amount of demand for the SPAC product. Bankers keep supplying them, but the market has been so hot that teams have been able to command very generous terms as investors keep gobbling them up. However, there is also something else going on….
NEW SPAC INVESTORS
As noted above, 2019 has ALSO seen a tremendous amount of interest from new investors who have never previously looked at SPACs. And many of these new investors are yield players that are looking to invest in the best yielding securities they can find. They’re chasing yield. And you know what happened in 2019? Specifically, in March of 2019? The yield curve inverted. Forgetting for a moment that an inverted yield curve is sometimes a harbinger of a recession, what an inverted yield curve means is that shorter duration T-bills start earning a greater interest rate than longer duration Treasury securities.
As a result, SPACs, whose trusts are invested in short duration government securities, such as 6-month T-bills, were earning a greater interest rate than the 10-year treasury note. Naturally, many of the yield chasers turned to SPACs since they were earning a better yield percentage. Plus, don’t forget that a SPAC unit comes with a warrant and sometimes a right, which adds to the overall return of the SPAC investment. Hence, new SPAC investor interest made it easier to meet the supply of new product. Sure enough, SPACs took off like a rocket around the same time that the yield curve inverted.
6-month T-Bill Rate
10-Year Treasury Note Rate
Now for the second part of this interest rate equation (bear with me…). If we focus on the 6-month T-Bill rate for 2016 (first chart, above), most of that year the rate was sub 0.50%. Correspondingly, we had four SPACs in 2016 that significantly over-funded their trusts: Jensyn (103.5%), KLR Energy (104%), Stellar Acquisition III (102%) and M I Acquisitions (103%). This is because the trust was going to earn such a small amount of interest that in order to make it worth SPAC investors while (and to get that potential redemption figure to a level that justified an investment) teams needed to over-fund. The remainder of the 13 total 2016 SPACs were all Tier-1 teams that could command better terms (Conyers Park, for one). Essentially, the Tier-1 deals were priced with the assumption that they had already brought a winning deal that would trade significantly above any theoretical redemption value. As a result, they did not need to over-fund. (Side note: that didn’t work so well…only one was a winner. See below).
|Silver Run Acquisition Corp||February 23, 2016||500.0||100%||1/3||Centennial Resource Development||CDEV||$4.57|
|Jensyn Acquisition Corp||March 2, 2016||40.4||103.5%||1||Peck Electric Co.||PECK||$4.46|
|KLR Energy Acquisition||March 10, 2016||85.1||104%||1||Rosehill Resources Inc.||ROSE||$2.27|
|CF Corporation||May 19, 2016||690.0||100%||1/2||FGL Holdings||FG||$6.95|
|Landcadia Holdings Inc||May 25, 2016||250.0||100%||1 for 1/2||Waitr||WTRH||$3.76|
|M III Acquisition Corp||July 7, 2016||150.0||100%||1 for 1/2||Infrastructure & Energy Alternatives||IEA||$2.50|
|Conyers Park Acquisition Corp||July 14, 2016||402.5||100%||1/3||Simply Good Foods Company||SMPL||$25.74|
|Stellar Acquisition III Inc||August 18, 2016||70.4||102&||1||Phunware||PHUN||$1.50|
|M I Acquisition Corp||September 13, 2016||54.7||103%||1||Priority Technology Holdings, Inc.||PRTH||$6.14|
|Saban Capital Acquisition Corp||September 15, 2016||250.0||100%||1/2||LIQUIDATED||----||---|
|Avista Healthcare Public Acquisition Corp||October 10, 2016||310.0||100%||1 for 1/2||Organogenesis||ORGO||$4.18|
|GTY Technology Holdings Inc||October 26, 2016||552.0||100%||1/3||Six companies in Gov Tech sector||GTYH||$6.31|
|Hunter Maritime Acquisition Corp||November 18, 2016||151.7||100%||1/2||NCF Wealth Holdings||HUNTF||$2.30|
So why is the 2016 rate important to 2019….
Well, if we drill down and look a little more closely at the current 6-month T-Bill rate (just 2019), we see that starting in June, the rate starts to drop (below).
Furthermore, the Fed cut the Fed Funds rate at the end of July with another expected in September and potentially one or two more before the end of the year. So we’re in a falling interest rate environment. That means trust accounts can expects a much smaller amount of interest earned. If rates fall low enough, we lose the new yield chasers and possibly some of the traditional SPAC investors too. And ultimately what that means is, we could start to see some SPACs need to over-fund trusts again to get investors to participate. To be sure, not all SPACs, but the ones that investors aren’t completely sold on might need an extra sweetener to get them to participate in the IPO.
There is a caveat though….The A++ teams. At the same time SPACs have been getting a lot of new attention from yield players, some SPACs (again, the A++ teams), have also been getting attention from “non-traditional” SPAC investors – fundamental investors, long only. We talked about this in “Peak SPAC”. As long as the A++ teams continue to announce winning transactions, they should be protected from any interest rate movements (sort of, terms will still tighten for even A++ teams). However, you’re really only as good as your last deal, so if we start to see some duds, well….those “long only” guys aren’t going to want to give you another 24-month chance.
Regardless, all signs are pointing to a tightening of terms this Fall. How MUCH they tighten is still up in the air. However, even today we saw Silver Spike needed to go to 18 months and they are arguably the strongest Cannabis SPAC team we’ve seen thus far.
Perhaps July really was “Peak SPAC”…stay tuned.