Wednesday, September 29, 2021

Riding the SPAC rollercoaster: Experts give a birds-eye view

By Lene Powell, J.D.

Experts involved in helping companies go public via SPAC IPOs provided an outlook on the current SPAC landscape at a recent securities law conference. With record highs due to robust valuations and surging investor demand, SPACs have seen a raging hot market. But recently, SPACs have been facing headwinds due to saturation and a variety of SEC regulatory moves that are slowing down the process and causing an uncertain legal environment for SPACs.

The panel, “An Ode to F.O.M.O. (Fear of Missing Out)”, took place September 22, 2021 at Northwestern Pritzker School of Law’s Garrett Institute and Corporate Counsel Virtual Institute. The panel was chaired by Cathy Birkeland, partner at Latham & Watkins, and included Robert Goedert, partner at Kirkland & Ellis; Jonathan Ko, partner at Paul Hastings; Eric Orsic, partner at McDermott Will & Ellis; Roxane Reardon, partner at Simpson, Thacher & Bartlett; and Kristen Rossi, global head of consumer retail investment banking & head of Midwest investment banking, Morgan Stanley.

SPACs at “truly epic highs.” Putting numbers to the current SPAC craze, in the first half of 2021, there were 362 SPAC IPOs, which is “truly an extraordinary number,” said Birkeland. In addition, there were there were 164 de-SPAC business combinations and 425 SPACs seeking a target.

According to Rossi, robust valuation levels have been driving tremendous investor demand, and in turn both SPACs and traditional IPOs have seen tremendous spikes. Equity markets are at historic highs with a “risk on” tone, fueled by economic stimulus. Markets are seeing muted volatility despite macro issues like the Chinese Evergrande debt crisis. Some have likened the Chinese property developer’s credit crunch to the failure of Lehman Brothers, but Rossi sees it as more akin to the collapse of Long Term Capital Management, in terms of the level of shock to the system.

“In the consumer retail industry, in any given year, we might see six or seven U.S. IPOs in that vertical. This year, through the beginning of September, we are already through 26, and we'll probably see 35 to 40, before the year is out,” said Rossi.

From here, Morgan Stanley economists see possible “fire and ice” scenarios, said Rossi. In the “fire” scenario, the Fed starts to tighten policy in the environment of a strong or overheated economy. That leads to higher rates and lower equity valuations, and possibly a market correction of down 10 percent. In contrast, the “ice” scenario envisions slightly weaker consumer sentiment, supply chain stresses, and margin pressure leading to a more disruptive correction, possibly down 20 percent.

Despite the potential for significant correction, the market is still at extraordinary valuation highs, so there could still be meaningful opportunity for continued high levels of transaction activity, said Rossi. But markets may have to again become more accustomed to slightly higher levels of volatility than currently. And volatility is the enemy of the equity markets, observed Rossi.

The unusually high level of deal activity is leading to fatigue, which is having a cooling effect, said Rossi. Morgan Stanley has had to become selective about the deals they bring to market and how to tell those stories so they really resonate.

Another cooling factor is issues with performance out of the gate. Given the challenging environment, a number of companies have stumbled in their first or second quarters following their IPOs. That has caused investors to start to become more skeptical and highly questioning of the stories in which they're investing. From an operational perspective, issuers are asking themselves, are these the quarters that I want to be my first, with all that we are navigating, said Rossi.

Signs of slowdown. Despite the roaring SPAC market, there have been signs that volume is falling off due to several factors.

First, while historically SPACs offer a faster time to market, that is no longer as true, said Orsic. He is seeing a four-to-six month timetable for SPACs, which is “very similar” to the timeline for traditional IPOs.

Ko noted that the Nasdaq rule for SPACs references 36 months as the horizon to complete a business combination. Historically the timeline has been around 18 to 24 months, and it's now circling around 18 months. There have been some deals where it's been 12 months in terms of trying to get to a de-SPAC transaction, with some ability to flex the duration so long as you are willing to contribute additional capital into the trust account, said Ko.

Second, there have increasingly been a lot of first-time issuers that had “no business” launching a SPAC, said Ko. There is a lot of frothiness and retail investing in the market that had not previously been investing in the market, driven in part by headline names like DraftKings, Virgin Galactic, and Luminar. Some of that has flowed out of the market, which has affected the demand for SPACs.

SEC headwinds. Another factor causing a cooldown is that the SEC has raised certain accounting issues that have introduced uncertainty, said Ko. First, SEC staff issued a statement on warrant accounting regarding classifying warrants as liabilities. In addition, staff has been issuing a stock comment regarding the presentation of permanent equity on the balance sheet, which impacts the ability to list on Nasdaq. Ko said that Nasdaq recently held a webinar on this issue to address concerns and prevent a flight of listings to NYSE.

Goedert agreed that the accounting issues have introduced a wrench in the works. He sees this as reflecting that the SEC just does not seem to like SPACs very much. SEC staff do not trust SPACs and approach them with a very skeptical lens. Examiners are also overwhelmed and facing tremendous time pressure to get through filings. There has been a move to slow things down.

Beyond the accounting issues, SEC staff is using very, very strict enforcement of regulations, said Goedert. Previously, registrants could expect waivers on certain topics, but now there seems to be a position where waivers are not granted on anything. Staff is also taking new and novel interpretations of existing regulations, including the warrant accounting issue. Further, staff is increasingly not giving all their comments up front, but lobbing them throughout the comment window, even up to the last moment.

Finally, staff are expecting increased due diligence on the de-SPAC side, in the name of protecting retail investors, said Goedert. That has formed the basis for some enforcement actions. For example, in a recent enforcement case, the SEC took issue that a SPAC had hired only one expert to consult on a particular issue that was pertinent to this business, and said the SPAC should have hired multiple experts, said Goedert.

Takeaway: treat it like a traditional IPO. According to Goedert, the takeaway from all this is that SPAC targets and their management teams really need to be thinking about the de-SPAC process like a traditional IPO, and getting ready for doing the diligence for it that you would if you are going public. That way, said Goedert, when you hit the SEC and the public markets, you are ready for that increased scrutiny that you are going to be facing,