Commentary on Political Economy

Friday 16 April 2021



SPAC Hot Streak Put on Ice by Regulatory Warnings

SEC steps up scrutiny of accounting and growth projections for newly public startups

Investors have recently soured on speculative SPAC stocks such as electric-vehicle startup Lordstown Motors, maker of the electric Endurance pickup. PHOTO: TONY DEJAK/ASSOCIATED PRESS
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Investors are cooling to one of the hottest bets on Wall Street as new regulatory scrutiny of special-purpose acquisition companies cuts the flood of new issues to a trickle while share prices tumble.

SPACs have raised about $100 billion so far this year, more than last year’s record of $83.4 billion, which itself was more than the amount raised in the nearly 30-year history of these blank-check companies.

The market notched another record on Tuesday, when Grab Holdings Inc., the Southeast Asia ride-hailing, food-delivery and digital-wallet group, said it would go public via a SPAC deal at a valuation of nearly $40 billion.

Critical comments from regulators appear to be scaring off some investors and new offerings. Until last month, roughly five new SPACs hit the stock market every business day in 2021. In the past 14 days, 12 new SPACs have started trading, SPAC Research data show.

The slowdown comes as other assets such as stocks and cryptocurrencies are at or near records. SPACs are among the market’s worst performers lately.

SPACs are blank-check firms formed for the purpose of merging with a business and taking it public. They have proliferated as a faster alternative to initial public offerings, giving many risky, young companies an opening to raise large sums of money and sell shares to the public.

Over the past two weeks, the Securities and Exchange Commission, which was largely silent about SPACs through most of last year, questioned the optimistic revenue projections used by startups that are merging with SPACs. An SEC warning that could require SPACs to restate their financial results put the brakes on some new offerings.

“The SEC effectively has now come in and stopped the party,” said Matt Simpson, managing partner at Wealthspring Capital and a SPAC investor.

Another factor is the confirmation Wednesday of Gary Gensler as SEC chairman. He is expected to take a tougher stand on financial regulation than his recent predecessors.

Some people involved in SPACs believe the SEC is trying to cool off the market. “There is a pattern of making public announcements that is seeming to have a chilling effect,” said Douglas Ellenoff, a partner at Ellenoff Grossman & Schole LLP, who has worked on hundreds of blank-check listings.

Regulators have been concerned about the SPAC frenzy leading to deals that ultimately burn investors, according to people familiar with the SEC’s thinking. The concern stems from SPACs’ unusual structure: They need to find a company to buy, usually within two years, or give their cash back to investors. There are about 430 blank-check companies seeking private firms to take public.

While some SPAC deals have soared, overall the sector is struggling. An exchange-traded fund that tracks SPACs is down more than 25% from its peak in February. Speculative stocks such as electric-vehicle startups Fisker Inc. and Canoo Inc. that went public through SPAC mergers have tumbled.

Potential scandals involving other SPAC companies such as electric-vehicle startups Nikola Corp. and Lordstown Motors Corp. have soured investors and worried regulators.

The Blank-Check Boom Poses Pitfalls for Investors
Private companies are flooding to special-purpose acquisition companies, or SPACs, to bypass the traditional IPO process and gain a public listing. WSJ explains why some critics say investing in these so-called blank-check companies isn’t worth the risk. Illustration: Zoë Soriano/WSJ

The SEC blindsided the SPAC market this week with a warning that some companies may have to restate their financial results because of the way they accounted for warrants, which are instruments that give investors a right to buy more shares in the future. The SEC hasn’t raised questions about the accounting treatment before.

Warrants are a key part of how early SPAC investors make money on the deals. While the change doesn’t affect businesses’ operations, it has effectively paused the IPO process for roughly 260 blank-check companies that have filed to go public. The pace of filings for new SPACs is also slowing down.

The problem emerged after Luminar Technologies Inc., LAZR -5.99% which went public through a SPAC merger, asked the SEC whether warrants should be classified as equity or liabilities, according to people familiar with the matter and securities filings. Hundreds of SPACs must now review whether they might need to restate their financials after the SEC released its new position on the accounting rules, lawyers say. Luminar disclosed Wednesday that it reclassified its warrants as liabilities.


What happens next in the SPAC saga? Join the conversation below.

Two midsize accounting firms, WithumSmith+Brown P.C. and Marcum LLP,  accounted for 90% of all SPAC audits from January 2010 to September 2020, according to data from research provider Audit Analytics. The Big Four accounting firms audit nearly every member of the S&P 500, and about 49% of all public companies, according to Audit Analytics.

WithumSmith declined to comment. Marcum Chief Executive Jeffrey Weiner said the SEC’s position runs counter to years of practice and that many in the accounting industry disagreed with that view.

Regulators are questioning the rosy financial outlooks provided by some companies that merge with SPACs. Companies doing traditional IPOs generally don’t make projections about the future, but companies that use SPACs can.

The SEC is concerned some of them might have gone too far. In January, the SEC asked Ouster Inc., which makes sensors for self-driving cars and other machinery, to better explain how it projected to go from just $12.5 million in revenue in 2020 to nearly $1.6 billion by 2025. In December, the regulator asked a plastics recycling firm, Purecycle Technologies Inc., to disclose and explain projections it had vaguely alluded to in a filing. The company revealed that it planned to go from zero revenue this year to $2.3 billion in revenue by 2027.

Some companies, including electric-car-technology startups Canoo and Romeo Power Inc., have slashed their projections or changed strategies since going public via SPACs.

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