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The SPAC Illusion

Buy high, sell low. It’s exactly the opposite of what investors should do, but human nature, time and time again, compels them to do it. The latest example of this tendency can be seen in the performance of “special purpose acquisition vehicles”, also known as SPACs. These investment vehicles have been branded as a new, creative way for Silicon Valley startups to be listed on public stock exchanges while avoiding some of the usual regulatory hurdles.

But they aren’t new.

In the 1980’s, the predecessors to SPACs were known as “blind pools” and associated with penny stock fraud. Today, they remain speculative, early stage investments. What was Wall Street’s solution? Slap a new name on them and promise investors the chance to get rich quick through unrealistically optimistic financial projections. Their high management fees also made them great business for Wall Street banks and insiders.

The allure of getting rich proved enticing to retail investors. SPACs raised more than $80 billion in 2020. And their recent performance has shown they may have been too good to be true. Half of the companies that completed SPAC deals in the last two years have seen their shares drop by 40% or more. Many of the most popular names have seen declines of 60% or more. Investors who chased the promise of high returns are now getting burned.

It’s a familiar story in the markets:

  • Wall Street and insiders promise unrealistically high returns
  •  Investors get excited and pile in
  • Strong investor demand pushes the valuation for the speculative investment upward
  • This initial price movement upward gives investors the illusion that they will indeed “get rich quick”
  • Insiders make a lot of money from fees earned on all of the money raised
  • Reality sets in that the initial projections were unrealistic (sometimes it’s years before this occurs)
  • Price begins to drop in response to this new reality
  • Price drop makes investors fearful and they begin to head for the exits in droves
  • Mass exodus puts even more downward pressure on the price as there are more sellers than buyers
  • Insiders keep their wonderful fees, investors are left holding the bag

Whenever this cycle plays out, it’s great business for Wall Street but terrible for investors. Buyer beware.

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