The “blank check” acquisition funds known as SPAC, or special purpose acquisition corporations, are booming, but concerns about the trend are also rising.
Investors are wondering if space SPAC prices will rebound this year as share prices for Redwire (traded at 55% of its initial price), AST SpaceMobile (55% of its staring price), Astra (around 48% of its initial price), Spire (23% of its starting price), Planet Labs (59% of its starting price) have declined following the price dip at the end of 2021. Even AAA Clyde Space is steadily losing their value despite revenues (41% of its initial price). Meanwhile, Iridium Communications, Lockheed Martin, Boeing, and Northrop Grumman have been winning amidst the frenzy of SPAC.
Why do some companies strive while others fail? Let’s dive deeper into SPAC investments.
SPACs are shell companies in which a single manager pools money from several investors. The purpose of these companies is to utilize all the money in a particular spot sometime in the future. These companies actively seek private organizations in 2 years for the merger process which turns the private firms public. The manager of SPAC companies returns the pooled money if no investment opportunity is found. In other words, shareholders are buying a pig in a poke.
The exact problems with shell companies are:
- Private organizations are merged without a diligent review process and merging requirements are weak;
- Celebrity sponsorship compensation fees dilute the value of investor’s purchase;
- A general imbalance between the quality of target companies, and the incentives of SPAC founders to make deals on unsatisfactory terms for investors;
- SPAC has a history of unsustainable situations and huge losses. Share prices are 10$ at the time of issuance but drop to 6.67$ for each outstanding share when the merger process is finished.
All of these raise the risk of losing money, despite the speed and simplicity of SPAC investments.
The growing trend of these shell companies has led to an increase in litigation cases against them in 2021, which doesn’t exactly inspire a lot of confidence in SPACs.
A total of 22 security class actions were taken against SPAC last year. Out of the 22 filings, 21 contained anti-fraud provisions. A separate study showed that 12% of SPAC companies that became public and completed de-SPAC mergers from 2019 were hit with anti-fraud filings.
The following are the types of risks of litigations against SPACs that should be noted.
Disclosures associated with SPAC IPO or de-SPAC transactions will be at the heart of potential litigations. A conflict of interest will arise when sponsors, executives, and other parties linked to de-SPAC transactions, are incentivized by actual SPAC managers even when it is not what investors wanted.
The SEC published guidelines to deal with these issues, that highlight unsatisfied investors as the main targets that seek to claim their rights. Plaintiffs find these issues attractive as it allows them to circumvent the default business judgment rule.
Pre-merger diligence is also a key aspect related to SPAC. Two such cases, namely the Nikola and Immunovant were involved in mergers that took place before SPAC boomed last year.
Stock prices of Nikola dropped after the SPAC’s alleged failure to engage in proper due diligence on the organization before the merger. The other company Immunovant was accused by a plaintiff to have performed inadequate due diligence prior to the merger.
Forecasts created with a de-SPAC transaction fall under the Private Securities Litigation Reform Acts which is a secure spot for envoys. Transactions related to de-SPAC make for a distinctive chance to establish connections with investors at the retail level regarding the financial forecasts of the quarry company.
It is risky to rely on financial projections in de-Spac transactions, mainly the security of PSLRA is not applicable to misleading forecasts. This discretion in such forecasts makes it difficult to protect it against known misleading information.
In addition to the lawsuits, the two most frequent allegations made against SPACs and De-SPACs on basis of securities class action are:
- Section 14 A of the securities exchange act of 1934 prohibits SPAC teams from forging material misrepresentations and omissions in proxy statements sent to stockholders’ business combinations.
- Rule 10b-5 of the Exchange Act of 1934 related to securities fraud in connection with the completed business combination.
The most notable SPAC cases are PureCycle Technologies, Clover Health, Canoo, XL Fleet, Quantsumscape, and Akazoo S.A.
Some cases could be dismissed in court, but others see huge penalties. Akazoo S.A. paid off security lawsuits from the SEC for $35 million and was delisted from Nasdaq. PureCycle Technologies lost 40% of its stock after being filed by plaintiffs for misinformation. Hindenburg Research, a research firm, alleged the company was misleading investors with wild revenue forecasts.
The SPAC trend is also wide-spread among space companies. Here are some of the startups that went public through the “blank check” acquisition funds and faced some difficulties.
One of the investors in a special acquisition company initiated a legal case against New Providence Acquisition Corp. He intended the measure to stop a merger involving AST SpaceMobile until shareholders get a list of alternatives considered for acquisition. The problem was that shareholders didn’t get sufficient information before they had to vote for or against the de-SPAC transaction. Even before, there’s been an investigation to find out whether AST and some its directors/managers engaged in securities fraud.
The SEC announced its settlement with Momentus on July 13, 2021, regarding its case with Stable Road. The in-space transportation company was alleged by SEC for misleading Stable Road on the state of its technology and security problems regarding Kokorich. Stable Road failed to perform proper due diligence to determine the security issues and endorse the false claims in the merger documents. As a result, the SEC’s settlement includes $80 million penalties on both Momentus and Stable Road among other conditions.
Short-seller Kerrisdale Capital revealed multiple reports on Astra Space on December 29, 2021. The reports revealed there was insufficient demand to support Astra’s forecast on its planned 300 launches. The report added that Astra’s 2021 EBITDA will come under -35% of original SPAC forecasts, and the company was burning cash $50-$60 million per quarter.
On March 21, 2021, Genesis Pak Acquisition Corp (GPAC), announced its plan to merge with Redwire. On December 17, 2021, a plaintiff shareholder filed a lawsuit against Redwire on behalf of investors who purchased Redwire’s stocks before the merger. The filings alleged that Redwire failed to disclose the accounting issues in one of their subunits which lead to financial reporting issues. The complaint alleges Redwire for violating Section 10b and 2a of the Exchange Act and Rule 10b-5 and seeks to recover the damages on behalf of the plaintiffs.
Investing in SPACs is highly risky since investors actually are buying a pig in a poke. SPAC companies might be a profitable option, but what we see now is that there’s enough data to call the SPAC boom a failure.
You need to proceed with caution when investing in SPACs, especially in space SPACs. Analyze the market, listen to experts, and consider the history of markets in order to make the best decisions. Anyway, it’s up to you whether to take a bigger risk and try to get a unicorn, or to prefer well-known IPOs that have proven to be overwhelming but reliable investments.