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Opinion SPACs are a booming business model, but it’s time to let the cat out of the bag

A Nikola Two truck in 2020. (Nikola Motor/via AFP/Getty Images)

In medieval England, cunning merchants would sell closed sacks containing live animals, assuring customers that the squirming critter was a valuable piglet. By the time credulous buyers got home and discovered a cat instead, unscrupulous vendors would be long gone, having gotten away with selling “a pig in a poke” — “poke” being an archaic synonym for “bag.”

No one could get away with such a thing today, could they? While not precisely analogous to that old English scam, Special Purpose Acquisition Companies (SPACs), do base their business model on the undeniable fact that some investors will take a shot at a big payoff, even if it’s a shot in the dark.

Rapidly superseding “traditional” initial public offerings as the funding mechanism for would-be electric vehicle makers and other “unicorn” start-ups, SPACs work like this. First, a group of sponsors pools their money in a shell company. Next, they sell shares in that company through an IPO, promising investors to use the proceeds to buy another company, usually within the next two years.

People who purchase a SPAC’s stock can’t know much about the potential merger partner except that it will be a start-up with a hot idea — and, sometimes, too little time, or demonstrated business viability, to go through even the limited vetting an IPO of its own would have entailed.

So far in 2021, 160 SPACs have raised $48.3 billion. That’s half of 2020’s record annual total of $82.5 billion — which was four times the 2019 total, according to a CNN report.

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Obviously, attracting investors depends on inspiring their trust. Sponsors of brand-new SPACs, however, lack even the minimal track record of those that sprang up and executed mergers in the past two years. So, they burnish their credentials by recruiting famous formers from politics and major-league sports.

Former House speaker and 2012 Republican vice-presidential nominee Paul D. Ryan is associated with a SPAC, as are ex-Yankee slugger Alex Rodriguez and NBA hall of famer Shaquille O’Neal.

Social justice activist and former NFL star Colin Kaepernick is also involved with a SPAC, which has pledged to “invest in and grow a business in a way that delivers a significant impact financially, culturally and socially.” The Kaepernick SPAC seeks to raise $287.5 million, a typical sum for one of these entities.

For SPAC sponsors in general, though, the main point is to do well, with or without doing good; their incentives are to raise money, find a merger partner and cash out — fast.

So far, sponsors’ upside has far outweighed the downside. Typically, they get 20 percent of the SPAC’s equity in return for an investment equal to 3 or 4 percent of the SPAC’s IPO proceeds. Assuming the SPAC eventually completes a merger, and the post-merger share value exceeds their up-front costs, sponsors almost literally can’t lose.

The average net return for SPAC sponsors between Jan. 1, 2019, and Jan. 22, 2021, was an eye-popping 648 percent, according to a study by Michael Cembalest of JP Morgan Asset Management.

A special category of investors in SPACs, known, arcanely, as “SPAC Arbs,” enjoys options to exit the deal either at a profit or without losing money up until the day before the SPAC merges. Their returns have averaged 40 percent.

The people who do least well, it turns out, have been those who bought shares in a SPAC and held on to them for more than 180 days after it merged with a start-up, according to the JP Morgan Asset Management study.

To be sure, many — probably most — of those who end up faring poorly will be relatively well-off people. Any redistribution of wealth will take place within the upper echelons, not from the bottom to the top.

The societal downside of SPACs is mainly wasting capital on sketchy companies such as Nikola, a would-be electric truck maker whose market capitalization soared past Ford Motor Co.’s after it merged with a SPAC in June 2020, then crashed amid a scandal.

Such distortions also damage capitalism’s perceived legitimacy. And they are bound to happen when the Federal Reserve feeds financial markets on cheap money, though the central bank obviously believes, perhaps correctly, that speculative bubbles are an acceptable price to pay for the recession-fighting benefits.

If you think SPACs are becoming a way to make the rich richer through connections and financial manipulation rather than, say, productive activity, no less a market maven than Jim Cramer of CNBC agrees with you.

“These newer SPACs increasingly feel like an inside joke for the super-rich and a way for celebrities to monetize their reputations,” Cramer said recently.

The marketplace ruse of medieval England also gave us the expression “to let the cat out of the bag,” in honor of those times that suspicious buyers discovered the trick. Cramer’s comment suggests that we have already reached the cat-release phase of the SPAC boom.

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