Special Purpose Acquisition Companies (SPACs), or blank-check companies, aren't a new thing in the U.S. stock market, but what is new is their staggering increase in popularity that has taken over Wall Street in times of easy money. SPAC deals finalized in the 2019-2020 period jumped 400%, according to Dealogic.
However, the SPAC bubble is predicted to burst the same way the reverse merger bubble burst back in 2011, according to a recent article published by Ivana Naumovska, Assistant Professor at INSEAD.
In an article published last month in Harvard Business Review, Naumovska argues that SPACs are just a form of a reverse merger. "In a standard reverse merger, a successful private company merges with a listed empty shell to go public without the paperwork and rigors of a traditional IPO," explains Naumovska. "The shell is usually a remnant of a previously operational public firm formed to combine with a private company."
SPACs are an acquisition process that begins with the raising of acquisition funds by suitors and continues with the search for acquisition targets, without the acquirer having a clear vision of what this acquisition seeks to accomplish and what's the fair price to pay.
This process is in sharp contrast to the conventional acquisition model, where suitors with an already-established business begin with a clear vision of what company they want to acquire and why they want to achieve it. They find the acquisition target company first and then raise funds to pay for it.
In this year's letter to Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial) Stockholders, Warren Buffett (Trades, Portfolio) explained how he's going about acquiring companies:
"Charlie and I will simply deploy your capital into whatever we believe makes the most sense, based on a company's durable competitive strengths, the capabilities, and character of its management, and price... If that strategy requires little or no effort on our part, so much the better."
Simply put, the SPAC acquisition process replicates the model of allocating resources beginning with the supply rather than the demand side of the market. We can predict that most SPACs will ultimately collapse, too, based on this.
Naumovska describes how this will happen by drawing parallels between the reverse merger bubble in the early 2000s and today's SPAC bubble:
"Our study offers an institutionally and sociologically informed explanation of the boom-to-bust dynamics of controversial practices. While finance and economics have suggested that decision makers' cognitive biases drive these bubbles, we add to evidence that such bubbles can relate to institutionally driven dynamics. In effect, we show that the popularity of reverse mergers planted the seeds of its own demise."
In other words, the popularity of SPAC is already planting the seeds of their demise.
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