Why some SPAC investors may get burned

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Churchill Capital Corp IV (CCIV)
Churchill Capital Corp IV (CCIV-UN)

The Special Purpose Acquisition Company (SPAC)juggernaut storms into 2021 raising more than $45 billion with no sign of slowing down.

"The front end of these SPACs is exploding. January, February will be the biggest months ever for those front end SPACs," JMP Securities CEO Mark Lehmann told Yahoo Finance Live. "I just caution the overall public, this GameStop fever, unfortunately will probably bleed a little into the SPACS."

Lehmann said investors can find great opportunities in SPACs, as these blank check companies raise capital to acquire private companies. But "like any other investment, you got to do your homework, you got to make sure you invest in good businesses, and you got to invest in good managements," he said.

With SPACs, that may be easier said than done. A recent note from Jared Woodard, investment & ETF strategist at Bank of America Securities, warns investor "desperation for returns" is helping drive SPACs to new highs.

"In 2020, SPACs raised $106 billion in funds, five times the prior peak ($19 billion in 2007) and more than the total from the past 10 years. Recent market volatility was no deterrent: the number of SPAC offerings in January alone exceeded the last six years combined, with 2021 on pace to set a new record," Woodard wrote.

Bank of America data indicates Individual investors represent 40% of all trading in SPACs, compared to only about 20% of the activity in S&P 500 and Russell 2000 stocks.

But, Woodard points out, "Unfortunately, post-acquisition SPAC returns have trailed far behind both traditional IPOs and the broader market. Since early 2019, the 30 largest SPACs have lagged the 30 largest traditional IPOs by 69 ppt"

Betting big on SPACs

The Churchill Capital Corp IV (CCIV) SPAC jumped 30% on news that it is about to close a deal to acquire luxury electric vehicle maker Lucid Motors Inc. The deal would value Lucid at $12 billion. Yahoo Finance reached out to Churchill Capital and is awaiting comment.

Yahoo Finance Editor-in-Chief Andy Serwer recently explored the SPAC frenzy and cited Stanford Law Professor Michael Klausner's study “A Sober Look at SPACs,” which found, "SPAC investors that hold shares at the time of a SPAC’s merger see post-merger share prices drop on average by a third or more."

Bank of America's Woodard points out, "By design, early investors have no idea what the ultimate acquisition target will be; they have the option to redeem SPAC shares for a return of principal prior to completion of an acquisition, but still bear credit risk and the opportunity cost during the pre-acquisition period."

And after a SPAC acquires a company, Woodard warns "lenient rules" can impose heavy costs on individual investors. "One study found that the hidden fees and costs are so large that for every $10 raised in a SPAC IPO, less than $7 in cash remains by the time the average SPAC acquires a target. Sponsors are also allowed to negotiate side deals with large or influential investors privately, offering more favorable terms without disclosing them to the rest of the investor base."

However, Lehmann said investors can "make a lot of money because [SPACs are] not a one trick pony." He points out there are "wonderful companies that are raising capital to find great private companies."

Woodard advises "the desperation of investors to chase blank check companies may serve as a contrarian indicator" because after prior peaks in SPAC issuance, 2007 and 2011, the S&P 500 fell 58% and 22%."

Adam Shapiro is co-anchor of Yahoo Finance Live 3pm to 5pm. Follow him on TwitterSteemit @yahoofinancelive

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