SPAC mania likely unsustainable, DBRS says

In 2021, SPAC deals have accounted for 73% of initial public offering (IPO) value, following a year in which SPACs were responsible for almost half (46%) of IPOs, DBRS said.

The flurry of activity is driven by several factors, the report said, including strong investor demand for returns amid ultra-low interest rates.

There are other elements of these deals that appeal to retail investors in particular, the report noted.

“For retail investors, SPACs offer the prospect of better returns with some downside protection because of the right to redeem their shares if they do not approve of the acquisition target,” it said.

Additionally, these transactions “provide retail investors with the opportunity to participate in the acquisition of private companies, something that has traditionally only been available to hedge fund and private equity fund investors.”

On the supply side, companies are eager to participate in SPAC deals as heightened market volatility has hindered the availability of traditional IPOs. These deals can also be a faster, cheaper way to go public, the report said.

Yet, the current level of activity in SPACs may represent a bubble, DBRS said.

“The increase in SPACs being created and competing over a limited number of acquisition targets is leading to higher valuations for these target companies, which may not be sustainable,” said the agency.

Additionally, there are concerns about the risks to investors in these deals.

Currently, there is a fundamental conflict between SPAC sponsors and investors, given that many deals provide sponsors with strong incentives to simply make acquisitions without necessarily seeking the best deal, the report noted.

“As a SPAC reaches the end of its two-year lifecycle, sponsors may become desperate to close on an acquisition without proper due diligence or negotiating the best deal so that they can avoid returning capital to shareholders,” said DBRS.

So, if the SPAC bubble bursts, future deals may have to incorporate better protections for retail investors that more closely align their interests with the interests of deal sponsors, the ratings agency suggested.

In some cases, SPACs are already taking steps to curb these conflicts with more investor-friendly deal structures.

“Widespread adoption of these protection measures could improve the long-term appeal and viability of SPACs as an investment opportunity,” the report said.

DBRS also suggested that there will still be interest in SPACs once the current frenzy fizzles out because SPACs can provide access to capital in volatile markets for private companies. As well, the vehicles may help meet investor demand for access to environmental, social and governance (ESG) investments by increasing the supply of ESG companies that investors can access.

“The expedited process by which SPACs allow a company to go public could be beneficial for these early-stage companies and would also broaden the pool of ESG-themed investments available to retail investors,” the report said. “Furthermore, given that many companies within these rising [ESG] industries may have yet to earn a profit, a SPAC would allow them to market their future prospects, which is not currently permitted with a traditional IPO.”