Motley Fool analysts Dylan Lewis and Bill Mann look back on the great SPAC boom, when more than $240 billion flowed into blank-check companies between 2020 and 2021, and discuss:

  • The incentives that both created the boom and bust.

  • Rare SPACs that may have a bright future.

  • A potential arbitrage opportunity for investors watching SPACs.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on May 21, 2022.

Bill Mann: [music] That is so important. There are currently more than 600 SPACs that are looking for companies to buy. If you think about that, do you think right now there are 8,000 publicly traded companies in the United States? So, not an apples-to-oranges comparison. Do you think that there are 600 companies that are ready to go public right now?

Chris Hill: I'm Chris Hill, and that was Motley Fool senior analyst Bill Mann. You remember the great SPAC boom of 2020 and 2021, right? Dylan Lewis and Bill Mann are taking a second look at what happened when more than $240 billion flowed into blank-check companies over a two-year period. So far, most of them haven't really done so well. Out of nearly 200 companies that used a SPAC to go public last year, just 11 percent trade above their offering price. Some of the most talked-about companies, including Nikola and Virgin Galactic [Holdings], are down about 90 percent from their all-time highs.

The guys break down the incentives that created the boom, the rare SPACs that are showing some promise, and one arbitrage opportunity investors might want to know about. [music]

Dylan Lewis: We're checking in on SPACs and trying to pull lessons from the past two years. Bill Mann, thanks for joining me to walk through it all.

Bill Mann: How are you?

Dylan Lewis: I'm doing all right. Perhaps not as good as the recent SPAC classes are doing. You've been investing a long time, Bill. You've seen the market through cycles, through crashes, through fads. If you could capture the roller coaster of SPACs over the past couple of years, how would you do it in a sentence or two?

Bill Mann: Really, how I would do it is to say this: There ain't no such thing as a free lunch. SPACs became spectacularly popular in 2020 and 2021. In 2020, there were $83 billion worth of deals that were launched through new SPACs; in 2021, that number was $161 billion. You have to ask yourself why a formerly somewhat disreputable way of going public became so hot. It's very rare, Dylan, that things like this happen in such volume if it is beneficial to the buyers of these instruments. Now, we've always described SPACs as being little more than a bank account plus a promise. What we found in 2022 is that that was exactly the case.

Dylan Lewis: So I could ask you to explain us back, but I think it would be more fun to roll some tape from our interview vault; we want to make sure we lay that context for our listeners. Back in 2020, you spoke with Chamath Palihapitiya, the CEO of Social Capital, and the SPAC king. Here was his quick pitch on SPACs.

Chamath Palihapitiya: A SPAC is a special-purpose acquisition company. What is it? It's basically a group of people. The leader of that group of people is called the sponsor -- in my case, it's myself -- and I have a handful of partners that I consistently work with in these things. We file an S-1 [Ed. note: Securities and Exchange Commission form for initial registration] and go through a traditional IPO [initial public offering] process, except that what we are describing in the S-1 is essentially a company that has one asset, just money. It doesn't make a product, it doesn't sell anything. And then the purpose of that vehicle is in the business of finding another company to acquire. Whereas Google's [now Alphabet's] S-1 would've described a search engine in the business of acquiring users and providing them relevant information, et cetera, ours is a shell company, a balance sheet of cash, which we then use to go and find the business that we think is really compelling and interesting.

We can describe that interest on many dimensions. It could be geographical, it could be about a specific vertical, and then we go and we buy that company. When we do that, it's effectively a merger. So for the company that we acquire, they go public by being acquired by us. What it does is that it allows them to actually write an S-4 document [Ed. note: Securities and Exchange Commission form for mergers and acquisitions] together, and by writing an S-4 versus an S-1, we are covered under a different body of securities law that's enforced by the SEC [Securities and Exchange Commission]. And the major difference there, for the purposes of the viewers and the listeners, is essentially that it allows you to talk about the future.

The reason why I think that single thing is such an important feature for SPACs, and why SPACs are a really important part of building a modern portfolio, is that in a world of zero rates, I would put out there that everything is about the future, and that you need to be really understanding the potential of a company's performance in 2023, '25, '27, '29, and 2030 even. Those future cash flows, especially for technology companies, are very poorly described by looking at the past, so 2016-2019 don't really mean much for 2025's earnings. That's not true for other businesses, but it is very true for tech businesses. So the S-4 process allows Vivek and Andrew [and] myself the ability to really understand the business, underwrite the future for many years out, and then have a conversation with people who may potentially be interested in buying it about describing that future performance, and then give folks a chance to buy.

Dylan Lewis: Bill, as you mentioned, SPACs absolutely surged in an incredible way. It almost defies hyperbole, the activity that we saw. Chamath was a big part of the reason why. He famously wanted to bring companies public from ticker[s] IPOA to IPOZ, and was behind the debuts of Opendoor, Virgin Galactic, Clover Health [Investments], and SoFi [Technologies]. How would you characterize on your end the appeal of SPACs, and what were your impressions as we saw this activity blossoming?

Bill Mann: Internally, I'd released a document in late 2020, basically saying that SPACs were -- there was really no functional difference between coming public through a SPAC and a traditional IPO, that what we were just talking about was simply a new wrapper for the same purpose. Also, at the end of the day, we cautioned people -- like it's really whenever you see something where something becomes as popular as this in any form of finance, you need to be careful. Because SPACs, ultimately, they were a promise that was somewhat unfulfillable. Because as Chamath Palihapitiya said, one of the things that you get to do if you go public merging with a SPAC is you get to use an S-4 form instead of an S-1.

Now that sounds like government Ds, but S-1 forms have a form to them that's really important for investors, and it is this: You can't be too promotional about what your company is. It is a lot of what is, whereas the Form 4, the S-4 is: What do we think this company will be? There are reasons why you would really appreciate a Form 4 in the hands of someone who is not promising the moon and the stars. Because obviously, whenever a company goes public, you're not buying it based on what it is, you're buying it based on whatever you think it will be. Maybe you could go farther, to say that's true with any investments. So a Form S-4 seems like a really good idea.

But Dylan, what you had instead was five different electric vehicle companies coming public through SPACs filing S-4s and saying that they would, within five years, have $10 billion or more in revenues. That was their projections. That has only happened once ever with any company, and that company was Google. What ended up happening with S-4s -- and Chamath was right, to a degree -- but the lack of oversight, and the lack of experience that investors had with SPACs, to me, was a real signpost that there were going to be some abuses coming down the pike.

Dylan Lewis: Bill, do you think to some extent that's emblematic of how much we were in a growth-on mindset over the last three to five years?

Bill Mann: SPACs are generally priced at exactly $10 per share when they [are] launched. And so when you had a SPAC before it met a dance partner trading above $10 a share, you were literally saying, hey, that's a bank account there, and I would like to buy those dollars in that bank account at two to three times the price that I am willing to pay, so I'm willing to pay you $2.50 for each dollar in that bank account. And to me, it just ultimately became a question of...does that actually make sense? And in the main, the answer was no.

Dylan Lewis: Yeah, I can see, though, why seeing these valuations in the private markets, because of how active we've seen the private market over the last decade, you would look at that and say: I have seen these businesses swell to valuations in the tens of billions of dollars. This vehicle is letting me hopefully get in on businesses that I otherwise wouldn't necessarily be able to, and be alongside some pretty well-heeled investors.

Bill Mann: It's not the dumbest theory in the world. If you're talking about a pre-merger SPAC, you are in fact talking about getting in on something before it becomes public. But Dylan, the challenge became this: The reason why SPACs became popular from the other side of the ledger is that so many insiders watch their companies come public through a traditional IPO, and they would leave lots of money on the table in the form of the IPO "pop." So you've got a company that comes public at $20 a share, and it immediately, once it hits the open market, moves up to $50 a share. That means that's $30 per share that has been offered of money that is going to someone other than the company itself, or the selling insiders. And that's in fact a problem, and it's part of the gamesmanship, if you will, of the IPO process. But that does not mean that a SPAC is necessarily a better way for the outsider to move to the inside, because at the same time, the reason that SPACs were coming along and became popular was that the insiders were trying to prevent the outsiders from ending up with all the money from the event of going public.

Dylan Lewis: I'm sure a lot of those outsiders, and we're generally talking here about the retail investors that wind up buying these shares, are not particularly thrilled with the way that this class has performed. They are in a lot of ways the "growthiest" of growth stocks, and we know that that category has been absolutely punished recently. When you look at the growth of this space over the last couple of years, who were the winners?

Bill Mann: The insiders who actually took companies public were the winners because they were able to, in some cases...there were some really abusive cases where you would see the promoters bringing, let's just name a number which sounds both low and high at the same time, $50,000 to the table, and because of the incentive structure that was placed on the SPACs, they would end up with millions of dollars of shares of a company once the SPAC merged in with a company. It happened over and over and over again. At that point when you start with $50,000 and you end up with millions of dollars worth of shares, do you care that the stock drops that much? Like you don't, you have absolutely positively won -- so the insiders won in a great deal of the situations.

There have been some companies [that] have done OK post-SPAC. It's not a segment of the market. I don't even think of it. You used the term "asset class" earlier and I would disagree that it's actually an asset class, it's just a strategy. It's a strategy that tended to let you up off the mat in this description. It tended to attract growth companies that wanted to go public. But SPACs themselves, you could end up putting anything into that vehicle and it would've been OK.

Dylan Lewis: I'll use "bucket" next time. How about that? [laughs]

Bill Mann: Thank you. I don't ask for much here, Dylan. [laughs] I want our nomenclature to be proper. No, it's a reasonable way to describe it. I just don't happen to think that... SPACs, you could probably call an asset class before they find a merger partner, because they are, as I described earlier, just bank accounts looking for a home.

Dylan Lewis: Actually, those high-level numbers we hit before were referring to those SPACs overall, not necessarily those who have found dancing partners. I want to talk about the other side of this. We were talking through the performance of companies that came public this way, and it's been fairly disappointing. Some of that is market conditions, and some of that's just the reality of how forward-looking a lot of those companies were. There's another piece to this, though, where there were SPACs that were created that have not yet found their dancing partner, and that means that there's cash that's available in the market here. Bill, what do you make of that?

Bill Mann: That is so important. There are currently 600 SPACs -- more than 600 SPACs -- that are looking for companies to buy. If you think about that, do you think right now there are 8,000 publicly traded companies in the United States? So, not an apples to oranges comparison. Do you think that there are 600 companies that are ready to go public right now? The answer is, yeah, you're shaking your head, which is great radio. [laughs]

Dylan Lewis: I know, I didn't want to cut you off there [laughs], but just think about the sheer percentages of that, 600 over 8000.

Bill Mann: Exactly, 15% of the publicly traded market is currently in the form of SPACs that have not found a merger partner. Now the reason why that's important is that SPACs generally are given a two-year period in which to find a merger partner. Or one of two things have to happen: Either the members of the SPAC, the owners of the SPAC, have to vote to extend that period of time, or they've got to give the capital back. When they give the capital back, they give it back at $10 per share. So there's some interesting opportunities out there right now in arbitrage where there are SPACs that are coming close to the end of their period that are trading below $10 a share. Again, the efficient market theorist in me says, well, that shouldn't make sense. But there's always the risk that their period of time will be extended to find a merger partner.

Dylan Lewis: We've been in a space recently where growth stocks in the public trade markets have been absolutely walloped. We don't have as much insight into the valuations of private companies. They're not something that gets updated by the minute or by the day. But there's a part of me that thinks we've seen growth stocks get hit hard. We know that there are some high-growth private companies out there that are probably going to have their valuations reflect what's going on in the public markets at some point. There's some cash here on the sidelines with the SPACs. Does that create an interesting acquisition opportunity? Do you think there's going to be a little bit of a bump in activity because of these compressed valuations?

Bill Mann: That's definitely possible and you were exactly right. I very artfully dodged the question when you were talking about the private market valuations perhaps being at least an explanatory reason why SPACs became so popular. We're now seeing companies that are having down rounds that are still private. I think that you're probably going to be seeing companies that have been valued on a private-market basis, and let's be frank about this: Private market valuation is, in some ways...they're made-up numbers. That's essentially like you being in 11th-grade calculus class and the teacher saying, "Dylan, how do you think you did?" And you're like...

Dylan Lewis: I think I got an A, Bill.

Bill Mann: I think I got an A. I think my company is worth $50 billion, even though it doesn't make a penny. Some of that is they're creating their own momentum around these private valuations. But with these venture capitalists, they do want an exit event, and there are, as you mentioned, ready buyers in the form of SPAC companies that are looking for merger partners. So I think maybe you might actually see some more activity. It's not going to be on the same frothy level as when Nikola came public through a SPAC in the middle of 2020, and it was as if the stock price had been shot out of a gun. I mean, it just rocketed higher, even though they had barely any revenues at that point.

Dylan Lewis: I do wonder what the quality of businesses would look like that would come public that way, because one of the concerns that I had in looking at SPACs in general over the last couple of years was: These are not going through our traditional IPO pipelines. What does that say about the businesses that will be coming public? I think we've seen a range of answers on that over the last couple of years?

Bill Mann: Yeah. There are two answers there. One is again, when we talked about the S-4, let's call it the SEC Form Arbitrage, just to be really fancy about it -- the companies that were able to come out and promise the moon and they didn't have anything. There are really two ways that you can think about going public through a SPAC versus going public through an IPO.

There were companies that didn't want to go public through a traditional IPO with, as you described, that period of time in which the investment bankers come in and actually do analysis to put a valuation on the company. There are other ones that probably couldn't go through a traditional IPO, where the easiest route to the market was going to be, find a single credible SPAC and merge in with it and next thing you know, you're publicly traded.

I think ultimately because of the volume of SPACs that were launched in 2020 and 2021 -- as I mentioned earlier, there's still 600 that are out there that have not consummated merger partners -- that there was a lot more of the latter, of the types that just use this as an opportunity to go public without having to go through that scrutiny, than there were high-quality companies that went this route because they thought they would end up with more of the money in the coffers of the company than through a traditional IPO.

Dylan Lewis: In researching the show, I thought it was interesting: We tend to look at SPACs and say this was a two-ish year phenomenon that just happened. If you zoom out a little bit, we saw growing SPAC activity in the mid-2000s. It was basically ended by the great financial crisis. I'm not saying in any way that SPACs are a leading indicator of downturns or recession, or anything like that. But I do think that there's something interesting there about the activity, and the deals you are more likely to see at various points in the market cycle.

Bill Mann: You said it earlier and I love that point. Now the number of SPACs that happened in 2007 was a tiny fraction of what happened in 2020 and 2021, but you're exactly right. When 2008 hit, that activity dried up entirely -- just poof, went away. I think that I wouldn't describe SPAC activity as a leading indicator, but I would pay more attention in the future about what types of companies are coming public this way. Because if they are getting credibility by virtue of going public through a SPAC, it really may be a sign, as you said, that we are in a growth-on and a risk-off environment. And investors are just simply not considering the downside of certain vehicles, as much they should. Because I think that it is absolutely the case that when companies go public through a SPAC, your No. 1 question ought to be: Why?

Dylan Lewis: We've talked about the incentives. I think that's a great lesson there on the why, and what is the reason that this company is coming public this way. Are there any other lessons you see with this, Bill?

Bill Mann: I think ultimately, whenever you see so much activity in any segment of the market happening all at once, you immediately need to grab your wallet. There was a sense to me, in 2020, that the SPAC rise was coming alongside with investors giving way too much credibility to companies that did not yet deserve it. Whenever you see that much activity in a segment of the market that prior to that had not seen that much interest, you really have to be a little bit cautious that maybe the ultimate goal is to separate you from your money, not giving you an opportunity to invest in this new new thing.

Dylan Lewis: So that we're not ending on a total downer, I do want to see if there's some shining light here [laughs], Bill, for us. At core, the idea of SPACs is that we're looking for futuristic businesses that, especially in Chamath's case, are exploring where the world is going, exploring solutions for where the world's heading and some of the major problems facing it.

That's something that we as Foolish investors can very easily get behind. We're looking for those five-, 10-year roadmaps for companies. This is a space that has been hit hard. But are there businesses that came public by way of SPAC that you still think people should be paying attention to, and shouldn't be writing off just because the category's had a hard time?

Bill Mann: Certainly. I would say that maybe at the top of the list is actually Lucid [Group], which is an electric-vehicle company. They've just come out with their first ultraluxury cars, and that SPAC has actually done quite well. QuantumScape is another one; it's a battery company with electric-vehicle potential. Utz [Brands]...you know Utz, let's go from -- [laughs]

Dylan Lewis: The consumer package.

Bill Mann: The consumer package company, yes, the best potato chips on earth -- that was a SPAC, that came public through a SPAC. There are plenty that are out there, and yes, because I don't want us to be super dour at this point.

I do think that it really is important to mention, again, that SPACs are just a method to go public, and it's not so much that they are illegal, immoral, or fattening, or bad [for] your health. It's just simply when so many happened at once, and there was so much interest at the same time, it almost could not have ended any other way than the way it ended, with a bunch of SPACs finding marginal companies, and other SPACs not finding companies to merge with at all. [music]

Chris Hill: As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill; thanks for listening. We'll see you tomorrow.