For a short while merging with a special purpose acquisition company (SPAC) was the most popular way of going public on Wall Street, even more than a regular IPO. The tech share bubble that was created made the short cut offered by merging with a SPAC (a company without any business activities that raises money from the public to merge with an existing company) very much in demand at a time when investors were mainly interested in the revenue growth of a company and less in its ability to make a profit.
There were consequently 631 SPAC offerings on Wall Street in 2021, most of them in the first four months of the year. But since then the tech trend has cooled and the markets have fallen sharply and the SPAC phenomenon has been shrinking to the point of becoming a very rare occurrence. Since the start of 2022, there were 74 SPAC offerings by the end of August.
Due to the fall in the markets in the second half of 2021, companies that had merged with SPACs mainly fell further than the market average. The reason for this was that the market was already tiring of the SPAC mechanism, due to disappointments caused by companies that published optimistic forecasts before the merger, but did not meet them afterwards.
A, the founder of a company that recently agreed a SPAC merger saw the trend. "During the process," he says, "we saw what was happening in other companies that merged with SPACs. At first, the rate of redemptions before the completion of the merger (investors who asked to withdraw their money after investing in the SPAC) was 7%, and suddenly we saw that it had reached 50%, and we realized that we might not reach the end of the process. There is no doubt that this creates concerns."
And there were other changes A recalls, "When we began, SPACs could publish forecast but was no longer possible because the SEC made terms more difficult and the process became more like a regular IPO."
Despite this, A went for it. "Most of the companies in our field were public and we understood that if we wanted to grow, we needed to be like them. Because our revenue was still not very high, if we had gone for a regular IPO, they would have told us to wait until next year."
So we could say that you went for a SPAC merger because you had no choice?
"Not exactly. We would have succeeded in raising money on the private market. We could have also held an IPO on one of the smaller stock markets but we wanted Nasdaq and there we could not have done it now without doing it via a SPAC."
Crazy valuations of billions of dollars
A double-digit number of Israeli tech companies merged with SPACs in 2021, most of them in deals that reflected crazy valuations of billions of dollars, including ironSource, Taboola and Hippo.
Despite the sharp declines suffered by investors in the shares of these companies, which lost more (and sometimes much more) than half of their value, there are still Israeli companies that have announced a SPAC merger, even as the trend has faded. These include fintech company Pagaya (whose stock has become a sensation in recent weeks), travel-tech company Holisto, satellite technology company SatixFy, hospitality network Selina and autotech company Newsight.
It is true that this is a trickle compared with last year, and still, it is possible that eulogies about the SPAC are premature. Adi Mimran, one of the owners and managing partner of Fundem Capital, which advises SPACs, feels that after the great decline there is a revival, and according to him, he receives calls - both from companies seeking SPACs through which they can list on Wall Street and from SPACs looking to merge companies into them, while there is still time. "Companies that last year told us no, today are calling." "Today there are quite a few SPACs that are looking for activities to merge with," agrees Eli Daniel, Deputy Director Disclosure and Reporting System in the Corporate Department of the Israel Securities Authority (according to the data of the website that coordinates SPAC activities in the US, there are about 600 companies). "How many of them will succeed? It's hard to know, but the phenomenon exists, and will continue to exist. It's a matter of ups and downs."
Barclays Israel CEO Ilan Paz says, "The SPAC market will not disappear but it will become more modest. In 2020-2021, the number of SPACS was ten times the average, and it is clear that it had reached illogical proportions."
The Tel Aviv Stock Exchange was spared the declines of the kind experienced by most of the SPAC mergers overseas, and only one SPAC company found its way to the market (probably due to the length of time that the Israel Securities Authority worked on defining strict criteria that would allow such issuances).
So how does the process work? The SPAC companies (blank check companies) raise money on the stock market without having any activity, while committing to merge with a "real" company within two years (otherwise they will be required to return the money they raised). Behind the companies are entrepreneurs, "sponsors", who in fact seek the investors' trust (and their money) based on their past experience, and the reputation they have gained.
Until the sought after merger is found, the SPAC itself is traded, but the money is kept in trust, and the investors reserve the right to receive it back if for some reason they decide to abandon the SPAC before the merger.
After the company that will merge with the SPAC is found, negotiations are held over the valuation, and usually a private investment public equity (PIPE) investment is closed as part of the completion of the merger, and then the merged company begins to trade on the stock exchange.
In this way, quite a few "dream companies" listed on Nasdaq, but later experienced an angry backlash on the market, when the hype soon wore off and they experienced a dramatic drop. For example, the market cap of Talkspace, a company that provides online mental therapy and was founded by Oren and Ronnie Frank, was cut by 85%, while that of the insurtech company Hippo was cut by 90%, and these are just a few examples.
"Aiming for real companies not dreams"
So why are there still companies that despite everything choose the SPAC merger path? This is a process that is usually faster than an IPO, and instead of a road show, which includes dozens of meetings and presentations, everything is done before one set of investors, the SPAC entrepreneurs. Also, since the value was determined at the beginning, and based on forecasts only, at least in the past, it might have been higher than the valuation a company would have received in a regular IPO.
"If you take away all the noise," says the owner of a SPAC, "It's an instrument that's like an IPO, only it's supposed to give a company that wants to issue certainty or speed. The market is weak today, and companies are afraid to reveal all their cards, and in the end the IPO won't happen. In a merger with a SPAC, you don't have all this."
Aren't you afraid that you'll find yourself in trouble because of the bad name associated with SPAC mergers?
"No, because we are targeting real companies, not dream companies. There are many companies that cannot hold an IPO, so they are coming to us now. Six months ago the market was dead, and now we have a lot of inquiries."
"What separates failure from success is people"
Sometimes the reason for choosing a SPAC is simply more prosaic: early acquaintance with the entrepreneurs. This is also what led to G's decision to merge with a SPAC about a year ago: "I am very happy with our partners. In the end, all that separates successful companies from failed companies is people."
He adds, "The significant thing is whether the company deserves to go public. If you went public without deserving it, the market will punish you. There were SPACs that received crazy valuations, much too high for their revenue."
"The negative sentiment towards SPACs," says Mimran, "is a specific event within a general event." He points out that there have been sharp declines in many Israeli tech stocks who came to the market through a regular IPO, such as Fiverr and Outbrain.
But it has to be said: some companies went through a SPAC merger because it was their only way to list on the stock market. They couldn't get in through the front door, and the SPAC let them in the back door. The SPACs that are currently looking for companies to merge with see this. "So many 'trash' companies are coming to us," says a source in the market.
Paz said, "For some of the companies that merged with a SPAC, this was the only way not only to enter the stock market, but to raise money in general. This is how an irrational explosion actually took place. In the end, it is a merger between companies. The SPACs did not behave like companies that buy other companies."
In what way?
"In terms of due diligence, there was a kind of bubble here. You need the buyer and the seller to agree, and here the seller (the company that wants to go public) wanted a high price, and the buyer (the SPAC) didn't care. The result is valuations that are too high."
Where will all this lead?
"I predict that in the spring of 2023, the SPACS will find themselves in a huge battle," says Shahar Cohen, founder of Lucid Capital investment fund. "Lots of sponsors will be in trouble. After the absurd valuations and crazy multiples, they will be forced to return money to investors and absorb losses."
Did the SPACs "steal" good companies from you?
"On the one hand, the SPACs competed for deals, but on the other hand, they allowed venture capital funds to show phenomenal returns on paper, so the reality is more complex."
And there is another matter. The SEC's activity to make the regulation for SPAC offerings more difficult. "The SEC was troubled that some of the merging companies provided groundless forecasts, and based on that they were creating hype," says Daniel. "After an initial memo on the subject was published, the market was pressured and a natural filter was created for SPAC offerings. Later on, the official rules will be published, and with them will come certainty."
"I assume we will see a slowdown in SPAC offerings, at least until there is regulation that will allow companies to choose this path as a legitimate alternative, and not as a way to bypass the existing hurdles," says an industry source. "Until there is no certainty, we will continue to see contraction. The most difficult thing for bodies in the public sphere is uncertainty."
Published by Globes, Israel business news - en.globes.co.il - on September 7, 2022.
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