Companies going public with the help of special purpose acquisition companies -- SPAC IPOs -- was perhaps the hottest investing trend in 2020. But last week The Wall Street Journal opinion pages fired a broadside at the trend toward IPO-ing via SPAC .
Denouncing the phenomenon as a "fad on Wall Street," Stanford Law School professor Michael Klausner and management consultant Emily Ruan teamed up to explain how a company that sponsors a SPAC IPO gets "a nice return on its investment ... essentially for free." Individual investors who buy into a SPAC, on the other hand, lose an average of 12% of their investment within six months of the IPO.
That may be true. But even so, I have to say that despite all of the risks inherent in investing in SPAC IPOs, I also see a bright silver lining around the phenomenon: Thanks to SPAC IPOs, the stock market is getting bigger and more diverse, and giving investors many more companies to choose from.
Image source: Getty Images.
The incredible shrinking stock market
The number of companies listed on U.S. stock exchanges hit its high of 8,090 in 1996, just ahead of the dot-com boom. (You might expect a "boom" to add companies to the market -- and it did -- but not as fast as mergers and acquisitions took them off the table.) Regardless, by the time the Internet Bubble was ready to pop in 1999, there were still 7,229 stocks available for investors to choose from.
When the Bubble popped, however, the number of publicly traded companies declined and kept on falling all through the 2008 Financial Crisis -- and then fell more afterward. Eventually, things bottomed out in 2012, with only 4,102 listed companies left on the market or barely half what there were at the peak.
Cutting investors' choices in half was one downside of the declining number of stocks. Additionally, because many smaller companies were gobbled up by larger companies along the way, investors lost the chance to invest in many faster-growing small caps, as small companies got replaced with large caps. In 2018, Bloomberg hypothesized that the U.S. stock market might be suffering from "an unhealthy degree of industry concentration."
Enter the SPAC
Conditions improved from 2013 to 2018 as new companies resumed listing in greater numbers. Even so, this five-year time span saw fewer than 300 companies added to the market. It took 2020 -- and the arrival of the SPAC craze -- to really shake up the market.
In addition to "ordinary" IPOs, 2020 saw some 219 separate SPACs formed, according to Goldman Sachs, attracting more than $82 billion in new investor dollars. Granted, not all of these SPACs have succeeded in finding private companies to acquire and bring public yet, but at least 71 have. This means investors now have at least six dozen more companies to choose from than they did before the SPAC craze began -- and by the time all of 2020's SPACs do find their targets, we could have closer to 18 dozen new companies to choose from.
What it means to investors
Will all of these companies be winners? I highly doubt it. Most of the SPAC IPOs coming to market lately have been companies devoid of profit -- or even revenue! (See: Nikola (NKLA -2.41%).)
Many will fail, I suspect, and many more will turn out to be vastly overpriced, such that their early investors will lose money. (See Also: Nikola.)
Then again, not all companies that go to market via ordinary IPOs are winners, either. By definition, half the companies on the S&P 500 are "below average" companies, and underperform the index every year. The real point is that there may be some winners among the tidal wave of SPAC IPOs that came to market last year -- companies that individual investors would never have had a chance to invest in had they remained private, but that we can invest in now that the SPACs have brought them public.
My advice: Invest in SPAC IPOs with greater-than-usual levels of caution. Seriously consider not investing in any SPAC IPO until the frenzy surrounding it has subsided and it has acquired its target company, begun trading under that company's name, and published a few quarters of audited financials. Only then can you be truly certain what you are getting when you buy into it -- and whether it is worth owning at all.
That being said, now that the SPACs are here, let the hunt begin!
