Shares of special-purpose acquisition companies and firms they have taken public are tumbling, punishing individual investors who piled into the once-hot sector.
The Defiance Next Gen Spac Derived Exchange-Traded Fund, which tracks companies that have gone public through Spacs along with Spacs that have yet to do any deals, has fallen about 30% in the past three months and recently hit a six-month low. Popular firms tied to the sector such as electric-car-battery company QuantumScape and space-tourism firm Virgin Galactic Holdings are down 50% or more during that span. Spacs listing splashy firms such as electric-car startup Lucid Motors and personal finance company Social Finance are also taking a beating.
The reversal highlights the risks that come with popular speculative trades. It is occurring as investors retreat from technology stocks amid fears that rising inflation will force the Federal Reserve to end its easy-money policies more quickly than anticipated. Those concerns make wagers on rapidly growing companies less appealing. Those related to Spacs have been among the worst hit by the selloff and have been battered by signals that regulators are increasing scrutiny of so-called blank-check companies.
The swift change in momentum for what was one of the winter’s hottest investments shows how quickly volatile assets from startups to cryptocurrencies can inflict pain on traders. Early this year, nearly all Spacs were rising, even when there was little fundamental reason behind the gains.
Former athletes and celebrities from Alex Rodriguez to the singer Ciara are involved with Spacs, which made stars out of prolific dealmakers such as venture capitalist Chamath Palihapitiya. Now, nearly all companies tied to the space are in a uniform free fall, engulfing names backed by even the most popular SPAC creators.
“It’s nothing short of a slaughter,” said Garrick Tong, a 42-year-old physician in Southern California who has more than half of his six-figure portfolio tied to Spacs. Its value has fallen about 30% from a February peak. Some of his biggest holdings include blank-check companies that are taking Lucid, SoFi and Rocket Lab USA public.
Spacs are shell companies that list on an exchange with the sole purpose of acquiring a private firm to take it public. The private company, often a startup, then gets the SPAC’s place in the stock market. Many individuals view SPACs as a way to get in early with exciting companies of the future—and companies that go public through a SPAC are allowed to make rosy projections that aren’t allowed in a traditional initial public offering. Blank-check firms have raised a record $103bn this year, according to data provider SPAC Research.
Tong trades shares of Spacs as well as more complex investments including options and warrants, both of which give traders the right to buy or sell the underlying shares at specific prices in the future. When warrants are exercised, the underlying shares underpinning the warrants are issued by the company. With options, they typically come from another investor.
Several Spac-related companies were among the most heavily traded stocks on brokerages such as Robinhood Markets. earlier this year. The outsize trading activity coincided with gains in shares of videogame company GameStop and other popular stocks but has now turned into a rout for some investors who didn’t sell.
The losses lend credence to the idea that Spac mergers enrich insiders through unique incentives while often sticking individual investors with losses if shares struggle, sceptics say. Spac creators are typically protected by the right to buy a large chunk of shares at a steep discount, while savvy professional investors often quickly sell their SPAC shares before deals are completed to minimise losses.
Still, even Spac insiders have seen their massive paper profits slashed in recent weeks. The selloff could also complicate valuations for SPAC mergers that have been announced but not yet completed.
One reason for the volatility is that many investors such as Tong have used options and warrants to amplify their Spac wagers. Both options and warrants are much more volatile than underlying shares, and frenzied trading in them can exacerbate stock moves in either direction. Heavy options activity in Spacs such as Churchill Capital Corp. IV, the blank-check firm taking Lucid public, helped fuel the sector’s rise but is now likely contributing to its retreat, analysts say.
The declines in shares tied to Spacs since mid-February coincide with outflows from ETFs tied to the space and a drop in stock-market and options trading activity by individual investors in March and April after such activity boomed to start the year, according to data compiled by JPMorgan Chase.
Some investors seem to have moved on from stocks related to the Spac sector to cryptocurrencies, analysts say, while others such as Jeremy Chavis are simply favouring different stocks. The 31-year-old project engineer for a construction company has a roughly $100,000 investment portfolio and has liquidated nearly all of his positions tied to SPACs and companies they take public.
He had as much as about $12,000 tied to the space in recent months. With the rally reversing, the San Luis Obispo, Calif., resident is instead favouring beaten-down value stocks, penny stocks and companies tied to the energy sector that he thinks can log fast gains.
“The party really is over” for Spacs, he said.
Chavis is also an active cryptocurrency trader, identifying with the millions of younger traders who have been at home during the Covid-19 pandemic and increasing their investing activity in search of quick fortunes.
While the depressed prices are opening opportunities for bargain-seeking investors, some analysts expect the turbulence to continue until sentiment shifts again. For now, conditions seem ripe for the fallout from the speculative excitement to continue, investors said.
“There’s absolutely a herd mentality,” said Mark Yusko, chief executive of hedge fund Morgan Creek Capital Management, which helps manage the Morgan Creek-Exos Spac Originated ETF. It is down roughly 30% in the past three months. “You have the recipe for these parabolic moves both on the upside and the downside,” he said.
—Gunjan Banerji contributed to this article.
Write to Amrith Ramkumar at [email protected]