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What is a Spac and how do you invest in one

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Conservative Party Treasury Sir Mick Davis today became the latest tycoon to “do a Spac” and raise hundreds of millions of dollars from new investors.

He’s the latest of many, from Shaquille O’Neal to Sir Richard Branson. But what are Spacs and why are they so popular?

Spac is short for Special Purpose Acquisition Company. As the name suggests, it’s a company set up for the one special purpose of buying, or investing in, another business.

Generally, a bunch of people with a big reputation in their industry will hire a broker to pitch investors the idea of raising a tonne of money through a stock market share listing.

The “sell” to potential investors is that the funds will be used to buy assets that will appreciate in value, leading to outsized share price gains.

Institutional investors – pension funds, life insurance funds and hedge funds – tend to get in there first, putting money into the new listing.

Then, when it floats, retail investors dive in and the share price rockets. The Spac then either merges with a private company or begins hunting for acquisitions.

Hang on. So the Spac immediately buys a private company – isn’t that just like the target company doing an IPO by another name?

Good spot. In many cases, that’s exactly what it is – a backdoor route for the target company onto the stock market.

Why not just float like other companies do?

The main reason is paperwork and compliance. To do an IPO, companies have to create a welter of financial information for the potential investors to work out if they want to invest or not. If they float via a Spac, there’s hardly any of that.

Isn’t it super risky for Spac investors?

It is certainly structurally riskier than backing a stock market company with a years-long balance sheet and profit and loss account. The Spac DNA is drawn from the “blank cheque companies” of the 1980s which were very similar and became a byword for defrauding shareholders.

However, safeguards have been put in these days, so they’re not quite as dangerous. Arguably.

Should I invest, and how do I choose?

Spacs are not, as they say, for widows and orphans.

If you’re a retail investor, you’ll have to wait until after the Spac has IPOd before getting in, by which time you might find the price has already jumped.

But if you must have a go, make sure you’ve done your homework on the management team and the sector they’re pursuing.

Sir Mick Davis, for example, made money for a lot of people through his Xstrata mining vehicle. But you’ll want to weigh up what he’s done since selling it to Glencore in 2013. Answer: not much.

However, he’s still got expertise in the mining industry, and is pinpointing “green minerals” used in electric vehicle batteries, windfarms and the like as his targets.

That’s probably an astute market for a strong management team to be targeting.

Many Spacs are for tech investments. Make sure you understand the markets they’re playing in clearly before making your pick.

You should be able to do it through your normal broker or investment platform. Not all list them, but most do. You may have to fill out a “W8” form first. That’s nothing to do with the posh Kensington postcode, but is for foreign nationals buying US stocks. Most Spacs are on Wall Street.

Why are they all in America and not London?

The London investment community is wary of them due to the risks you identified earlier.

Until now the UK has left Spacs to Wall Street and elsewhere.

But that’s probably going to change as the government and the City banks have seen how much money is going into them, and how many UK companies are heading to New York to do Spacs rather than London IPOs.

More galling, post Brexit, is that Amsterdam has been living high on the hog with Spac launches, leaving London looking old fashioned.

Cazoo, the British online car dealer is currently tossing up between a London float and a New York Spac, and the betting is on the Big Apple.

Stories like that make a patriotic government nervous, and Downing Street is likely to support new rules allowing London Spacs. The Hill Report into making the London Stock Exchange more tech-friendly, said we should have them, and Chancellor Rishi Sunak lauded that document in the Budget this month. Full proposals have to be drafted yet, but Spacs will come.

Will they be successful here?

That’s the trillion dollar question. According Spac Track (yes, that is a Thing) Spacs have raised $80 billion so far in 2021 – that’s only $2 billion shy of the whole of 2020. Most of that is in hot-stuff sectors like tech ($64 billion in total so far), financial tech ($15 billion) or sustainability ($6.7 billion).

They’re hot sectors, sure, but they’re often risky and speculative, with low cashflows and losses. Spray and pray jobs, where you hope for every 10 misses, your financial AK-47 will hit one Amazon in waiting.

One reason for their success is clearly because super low interest rates mean institutional investors are prepared to take bigger risks than usual to get a return.

For many, the markets world right now looks frothy and overvalued – a bit like in the late 1990s before the tech bubble burst.

No surprise, then, that greybeards recall the flurry of stock market quoted cash shells back then that raised millions of pounds and saw their valuations rocket even before they’d done anything with the money. Spacs don’t feel much different.

The Knutsford Four were a gang of retail gurus led by supermarket maestro Archie Norman who launched a cash shell to buy up unloved retailers. Its value surged from £5 million to £75 million in a few weeks without them doing a thing. The tech bubble burst before they got a chance to.

In the US, if a Spac doesn’t do a deal in two years, it has to repay the money to investors. Spacs may be a bubble that doesn’t even last that long.

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