SPACs Are Down 55% Already – And Terry Smith Says It’s Going To Get Worse

There’s nothing very new about the basic idea of a Special Acquisition Vehicle (SPAC) it’s really just the creation of a clean shell company. A shell is something quoted but that’s all there is, the shell. So, a private company can then reverse into the shell and gain a listing without having to pay the expenses of an IPO – that can be 7% of the money raised.

The old and classic shells were companies that had done something but that business died or failed. So, there’s the quote, someone else uses it. A SPAC is the idea of setting up an entirely new quote, fresh and clean, which can then be used. As a basic idea, it’s fine.

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As ever, the problem was/is competition. With hundreds of SPACs set up all looking for a deal then the deals being done weren’t all that great value for shareholders. If there are many potential buyers – the SPACs – and only the same number of viable businesses worth buying then price is going to move against the buyer. That’s just simple common sense, not even economics.

This is what does seem to have happened. The De-SPAC index is down some 55% from its high back in June 2021. Competition for deals meant SPAC deals took place at high prices and then the market reverted to more reasonable valuations over time.

But there’s more to it than just this, as Terry Smith of Fundsmith points out. The macroeconomic environment is changing. Interest rates are going up, inflation is looking a lot less transient than many were thinking – or insisting – it would be. Both mean that revenue tomorrow is worth less than revenue today.

The effect of this is that capital investment now for returns at some point in the medium or distant future is worth less. Technically, the discount rate we should be using to net present value those future profits rises.

The effect of this is that speculative attempts to swallow capital now in order to be cash generative in some few years are less valuable than they were. Businesses which throw off cash right now – mature ones that is – are more valuable relative to start-ups that is.

And what were most of those SPACs? They were companies swallowing capital in order to try and build something for the future. That was one of the attractions of the SPAC format, it was a cheaper way of raising capital. If you just want a quotation, a listing – say to allow early investors to exit – then a SPAC isn’t in fact more attractive than a limited (say, a small float) IPO or even an introduction.

The net effect of this is that as interest rates rise, whether alongside or because of inflation, the standard SPAC deal will become less attractive in relation to a mature and cash generative business.

Now, whether interest rates really are going to rise as much as the market currently thinks is another matter. But the indication is that this year isn’t going to be much better for SPACs than the performance since June of last year.

It’s also true that investing comes and goes in fashions. As with women’s hemlines and that sort of fashion. No self-respecting woman wants to be seen in last year’s and in investing it’s often worse. Investing in last year’s fashion has, historically, been an excellent way to lose money this year. Sadly, that’s not a definitive rule as it doesn’t always work but it’s not strongly supportive of SPAC share prices all the same.