Feb 2, 2021, 9:41 AM ETPodcast

The IPO SPAC-Tacle

Global IPO issuance exceeded $300 billion in 2020, with U.S. IPOs alone reaching a record $170 billion.
The U.S. public market saw a 248-company SPAC surge in 2020, compared to near-zero SPAC activity in the 1990s.
2020 U.S. IPOs were dominated by biotech, with 77 companies going public, the highest volume for any year on record.
The number of operating U.S. companies going public in 2020 was 165, contrasting with 248 via SPACs and over 300 in the average 1990s year.
The market reversed a prior trend of companies staying private longer, driven by a shift from venture capital to public market valuations.
In the first three weeks of 2021 alone, approximately 60 U.S. SPACs were brought to market, surpassing previous weekly records.

Goldman Sachs notes the current boom is unique for occurring alongside a pandemic-strained economy, fueled by vaccine optimism, low rates, and fiscal stimulus.
Tech IPO valuations reached a median price-to-sales ratio of 24 in 2020, doubling the 2018-2019 median of 10-11 and far exceeding the ~6 median of the previous two decades.
Jay Ritter attributes higher multiples to a risk-free rate environment where 30-year Treasuries yield approximately -30 basis points, compared to +400 basis points during the 1990s internet bubble.
Investors justify high multiples based on the precedent of companies like Google and Facebook justifying initial high valuations through subsequent outperformance.
Goldman Sachs observes that modern IPO candidates are generally more established and profitable at listing than the less developed businesses prevalent during the 2000 tech bubble.

Potential risks to the continued IPO boom include a faster-than-expected rise in interest rates.
A decline in investor confidence regarding vaccine efficacy or the emergence of new viral strains could disrupt the financing environment.
The inclusion of companies "not ready to be public" could lead to inconsistent returns, potentially slowing investor receptivity to new issues.
Market hypersensitivity means a stock market dive similar to February 2020 would likely cause the IPO market to shut down rapidly.

SPACs create a structural "dilution hole" driven by four factors: sponsor promote (typically 20% of post-IPO equity), warrants, underwriter fees on redeemed equity, and shareholder redemptions.
Median cash available per $10 SPAC share after merger is approximately $6.60, indicating significant equity is issued without corresponding cash backing.
Shareholder redemption rates vary wildly in historical data, ranging from 0% to 98%, creating the largest source of variability in total dilution.
Post-merger performance is closely correlated with the size of the dilution hole, with median post-merger returns often disappointing.
Michael Klausner argues the current SPAC model is unsustainable because it imposes costs (dilution) almost entirely on post-merger shareholders while pre-merger investors capture risk-free returns.

Pre-merger SPAC IPO investors have historically realized average annual returns of 9.3%, functioning similarly to default-free convertible bonds due to escrow accounts and redemption rights.
Post-merger investors face polar opposites in return profiles, with average historical returns being negative due to the structural dilution.
In 2020, the average price of SPAC IPOs jumped 1.6% above $10 at trade, compared to 0.6% in prior periods and over 5% in the first week of January 2021.
Recent SPAC mergers, such as Virgin Galactic and DraftKings, have shown better-than-historical returns, though experts caution past patterns do not guarantee future outcomes.

Goldman Sachs anticipates traditional IPOs will remain the majority, but direct listings and SPACs will represent materially larger percentages of the market over time.
Michael Klausner predicts SPACs in their current form will die out or shrink, suggesting a future where sponsors and PIPE investors are involved in a standard IPO or direct listing rather than a separate blank-check vehicle.
Emerging structures like Pershing Square's model are viewed as improvements due to better incentive alignment and reduced dilution.
The market is experiencing model convergence, with direct listings adding IPO-like liquidity elements and IPOs adopting features to provide faster liquidity.