- Investing in blank-check companies has made hedge funds big winners in the SPAC boom.
- Some market insiders are wary that SPAC mania may be bad news for mom-and-pop investors.
- Insider spoke with a dozen people to understand what’s driving the SPAC boom and how it’ll end.
- Visit the Business section of Insider for more stories.
Hedge funds have been big winners in the blank-check-company mania that’s gripped markets over the past year — to the point that some industry veterans are wary of what they’re seeing.
A seemingly endless stream of splashy blank-check company launches has spurred constant speculation about which companies they will take public. Many have gotten caught up in the hype.
“The greedy part of me would love” to launch a special-purpose acquisition company, said Adam Cohen, who runs the credit-focused hedge fund Caspian Capital. “The moral and ethical part of me doesn’t want to play into this nonsense. It’s going to end in tears.”
Last week offered up a case study in just how volatile SPAC shares can be when Churchill Capital IV (CCIV), sponsored by ex-Citigroup banker Michael Klein, announced it had struck a deal to buy electric-vehicle maker Lucid Motors.
The SPAC had surged in anticipation of the deal, but then plunged more than 50% once it was actually announced. Reddit chat boards lit up with gripes, serving as a reminder of how retail investors took to WallStreetBets to drive up the price of GameStop shares.
But in the case of CCIV, lots of smart money got in on the game early — and may still chalk things up as a win. The SPAC counted many large hedge funds as owners at the end of last year, including Millennium Management, the massive hedge fund run by Izzy Englander. Citadel and Highbridge Capital Management ranked high, too.
“Someone will spin this as a cabal, based on what we saw in GameStop,” said David Tawil, the president of hedge fund Maglan Capital. “Everyone should be concerned about that.”
A ‘cheap basket of options’
To understand why big money is pouring into SPACs, it’s important to understand the various roles that hedge funds play in the blank-check ecosystem.
SPACs trade like stocks on an exchange, generally going public at $10 a share. Investors who buy SPACs when they go public also get one half or one third of a warrant per share. The unit can be split into its components after some time, giving investors the option to play two hands.
Many sell the stock on the open market or sell it back to the manager when the merger target is announced, recouping their initial investment. They hold onto the warrant as a free call option.
Hedge funds act as pre-IPO investors to anchor a forthcoming share sale, enjoy a favored status with investment banks that give them good allocations of hot SPACs, and buy shares in the secondary market after the shares have gone public.
Many funds quickly flip the shares they get in an IPO, when retail enthusiasm and frothy markets make many SPACs pop on their first day of trading.
University of Florida professor Jay Ritter found that the first-day SPACs in 2021 were jumping an average of 6.5%, nearly six times the typical pop.
Funds juice those returns with money borrowed from investment banks, which see SPACs as a relatively safe bet, said a banker who asked for anonymity to discuss the inner workings of the market. That means they can often put up as little as $1.25 to buy a share at $10, which also comes with a fractional warrant to buy another share.
The trade is effectively “a really cheap basket of options,” said John Culbertson, the president and CIO of Context Capital Partners. “They’ll buy all the SPACs in the world if they can.”
New-money private-equity barons
Some hedge-fund managers, including hedge-fund billionaires Bill Ackman and Paul Singer, are even sponsoring their own SPACs.
In many deals — though Ackman’s is structured differently — sponsors get as much as 20% of the blank-check company for a nominal fee, a provision known as founder’s shares. This gives them a chance to swing for the fences with the type of capital that’s typically reserved for their private-equity neighbors: long-term funds that can’t be redeemed by skittish pension funds every three months.
“The one thing about hedge funds that the hedge-fund guys don’t like is that the capital isn’t permanent,” Maglan’s Tawil said. “A SPAC is essentially, for all intents and purposes, a PE fund. It’s every hedge-fund manager’s dream.”
It can also be a way around the protections that the Securities and Exchange Commission has set up to limit investments in private-equity funds, which are available only to sophisticated investors with a certain level of wealth. That’s making market participants and others worry about the danger that lies in wait for retail investors.
What’s more, private-equity funds — already flush with cash they need to deploy — are going to be forced to compete with SPACs for deals.
“[SPACs are] distorting prices, and it’s competing directly with PE, which has been raising a ton of capital,” Culbertson said.
The snake eating its own tail
In other cases, hedge-fund managers are turning to their brethren to support their deals, either as anchor investors or big buyers in the IPO. Seth Klarman, the billionaire CEO of Baupost Group, is a big backer of Ackman’s SPAC.
But while big investors are getting in early, they’re not necessarily betting on the long-term success of what SPACs eventually buy. Morgan Creek Capital Management, run by former UNC endowment head Mark Yusko, manages a SPAC arbitrage hedge fund that solely invests in SPACs before their IPOs and sells once a deal is announced.
Meanwhile, the sheer pace of new SPAC launches is mind-boggling. More than 187 SPACs have gone public since the calendar flipped to 2021 — at a rate of nearly three a day, SPAC Research’s database found. One pension fund manager said he has spoken with bankers who say their IPO pipeline is the biggest it’s ever been.
That supply has given bankers great currency to reward their best customers with premarket shares in plum deals, which is widening the divide between the biggest hedge funds — which pay billions in trading commissions to Wall Street every year — and smaller funds that can be left on the outside looking in.
Chris DeMuth, founder of the event-driven hedge fund Rangeley Capital, in Connecticut, said he’s never seen the SPAC market so competitive. He’s adapted by focusing on building strong relationships with SPAC sponsors, who look out for him when it comes to allocating shares.
“There is a lot of competition to get allocations,” DeMuth said. “If you do an enormous amount of trading business with the bank, at this point the allocation is a reward for the relationship.”
Even A-Rod, Paul Ryan, and Shaq have SPACs
Thanks to the unprecedented amount of money that has been pumped into the financial system by central banks, huge chunks of capital are flying around the system faster than ever before. Now, that money is trying to find a home.
“Does it feel frothy? Yes,” said Tiger Williams, the founder of Williams Trading, which was the selling group for Rogers Silicon Valley Acquisition Corp., which is taking battery-maker Enovix public in a $1.1 billion deal.
Williams compared the life cycle of a SPAC to an Ironman Triathlon. The initial fundraising is the first leg, followed by the longer haul of finding the right company at the right price before competitors do.
But the last leg — when a sponsor has to operate the company it bought — is the stage many investors in the current SPAC boom haven’t reached yet. And only then will they know if the investment was actually worth it.
“If you overpay for a company, it’s going to be like the tech bubble,” Williams said. “In almost every expansion, there are ways to lose money. This is no different.”
Other parallels to the tech bubble have begun to emerge.
One example: Celebrity-connected SPACs have become de rigueur. Former Speaker of the House Paul Ryan, basketball great Shaquille O’Neal, and pop star Ciara are among the bold-faced names who have backed SPACs.
Alex Rodriguez is one of the most directly involved celebrities in SPACs. The former New York Yankee is the CEO of $500 million Slam Corp., named in honor of his record for most grand slams by a single player.
Along with hedge-fund founder Himanshu Gulati, Rodriguez is planning to put the money from Slam’s investors toward a company in the sports and entertainment sector — though the SPAC has already made it clear that it is not looking to buy a franchise. (Rodriguez was part of a buying group for the New York Mets before the franchise was sold to billionaire investor Steve Cohen.)
Gulati, who was an investor in the top-performing SPAC last year — the QuantumScape and Kensington Capital tie-up — understands why seeing celebrities flock to these deals can seem like a market top. But he said that Rodriguez has had success in private investments like personal-care company Hims & Hers Health and electric-aircraft startup Archer.
“I didn’t partner with Alex just because he’s a celebrity,” Gulati said.
Still, Rodriguez’s fame as a baseball player has been a plus. The SPAC was oversubscribed, and they have already seen a lot of deal flow, Gulati said.
“His social media, his reach, that’s an asset for investors,” he said. “We think our target company will increase on day one because of that.”
Gulati said he and Rodriguez plan on investing alongside the SPAC in the deal and joining the board of the newly public company.
“If we were just in it for the sponsor economics, we wouldn’t be planning to put so much capital into this,” he said.
The aftershocks of the SPAC boom
The SPAC revolution has warped every aspect of the capital markets, industry observers said. Struggling companies and unprofitable startups have another avenue for capital, vulture investors face additional competition, retail investors believe each SPAC is going to the moon, and the private markets stay awash in capital.
George Schultze runs Schultze Asset Management, a $200 million hedge fund that goes after distressed opportunities. He launched a SPAC at the end of 2018 and took Clever Leaves, a cannabis company, public in December in a $205 million deal.
He viewed the SPAC as an extension of the investment strategy he was already running.
“There’s a lot of overlap,” he said. “There are a lot of companies we look at day to day that could use a SPAC solution.”
Cohen, of Caspian Capital, said his firm was evaluating at least a dozen different names in the distressed space that have been taken public by SPACs over the past half year, allowing these companies to refinance their debt thanks to the equity infusion.
“We’re extremely mystified, slash angry, slash jealous of it,” he said.
The private markets have boosted the fortunes of some of the best-performing hedge funds of the past couple of years, especially big equity players like D1 Capital and Coatue Management. The biggest startups are taking longer to go public, while the scramble to get into the funding rounds of the hottest startups has pushed valuations higher and higher.
A ticking clock adds to the pressure. Most SPACs need to find a target to take public two years after going public or liquidate.
Adam Stone, the chief investment officer for healthcare and biotech specialist Perceptive Advisors, said valuations in those sectors have mostly stayed in a respectable range. Still, he said he’d rather liquidate a SPAC than “massively overpay” for a company.
“This is a reputational issue for me,” he said. Perceptive manages a hedge fund, several credit and venture offerings — and now four SPACs. For Stone’s firm, a single SPAC deal “is not worth ruining our reputation for.”
But Stone sees how sponsors who only do SPACs can get involved in lower-quality deals amid the intense competition, since just getting a deal done “is a good financial outcome for them,” he said.
The incentive structure for SPAC sponsors touches every investor, Culbertson of Context Capital Partners said.
“Managers that aren’t involved in the SPAC market are frustrated. There’s a lot of ‘can’t beat ’em, join ’em’ happening out there because of it,” he said.
Diamond hands holding the bag
If there’s a correction, the massive hedge funds and celebrity sponsors won’t be the ones hurt the most.
For investors who pumped money in before a SPAC’s IPO, their risk is minimal. Sponsors will collect a big fee on any acquisition they make, even if it’s a bad one.
But those who buy into the SPAC once it is public — and before it has taken another company public — are risking their money on the ability of Ackman, Singer, A-Rod, and more to not only pick the right company but run it well.
Yusko of Morgan Creek also runs a SPAC-focused exchange-traded fund that invests a third of its assets into SPACs without a target. He bets on sponsors he believes in — such as Churchill Capital’s Klein and Social Capital founder Chamath Palihapitiya — and puts the rest of the assets into companies that were taken public via a SPAC, such as DraftKings and Magnolia Oil & Gas.
Yusko said that if there’s a crash, “people who chase red-hot SPAC IPOs and pay more than $10 a share” will be the ones left holding the bag.
Statistics bear out this fear. Greenwich-based investment bank Renaissance Capital found that of the 93 SPACs that took a company public between the start of 2015 and summer of 2020, only 29 had positive returns.
Even SPACs that take more traditional companies public have struggled: The biggest SPAC deal yet, the $16 billion United Whole Mortgage-Gore Holdings tie-up, has lost more than 30% of its value since it began trading on Jan. 22.
Yusko said that in some cases, the premiums being ascribed to SPAC sponsors are warranted — but he doesn’t think it’s “a huge percentage” of sponsors.
And if the bets some SPACs are making seem bubble-like, that’s the price of trying to predict the future, he said. For example, companies that are focused on space travel or electric vehicles are going to be tough to value because there are no true comparisons.
Still, SPAC proponents believe that the structure, while not the perfect cure for democratizing finance, is fairer for small investors than the traditional IPO allocation structure.
“For transparency and opportunity, I think it’s better than trying to determine who gets shares” in a traditional IPO, Williams said.
And as long as both large and small investors are excited about the structure — and the incentives remain for the biggest money managers — few expect the SPAC train to slow down.
“I think there’ll be thousands of SPACs,” Williams said.
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