SPACs: Europe plays catch-up over blank-check gamble

Wall Street has invested billions of dollars in blank-check shell companies that are given two years to find startups to buy. Europe wants to get in on the act, just as many of those risky investments have turned sour.

SPACs — shell companies that raise billions of dollars to purchase private firms and take them public — have been described as everything from “revolutionary” to the “most obscene type of investing.”

Known as blank-check funding, some $83.3 billion (€69.98 billion) was raised last year to allow 248 SPACs to list through initial public offerings (IPOs).

SPACs, or special purpose acquisition companies, should perhaps be called blindfold investing because when you plow money in, you don’t know which company you are buying. The SPAC manager typically has two years from launch to find their takeover target and complete the deal.

The investments do, however, allow a faster and lower-cost way for high-growth startups to list on financial markets than traditional IPOs.

“SPACs are a good financing instrument, especially for tech companies,” said Norbert Kuhn, head of corporate finance at German think tank Deutsches Aktieninstitut. “But we don’t deny the inherent risk for investors,” he told DW.

“They [investors] trust in the reputation of the SPAC initiator. They are very experienced and have a list of potential companies they might invest in,” Kuhn added. But the risk rises if, for example, a SPAC manager panics when the deadline approaches and buys a lower quality company.

SPACs first emerged two decades ago but have gained traction over the past two years, especially in the United States where 525 have been listed to date. Five of just eight European SPACs that launched last year also chose to list on US bourses.

SPAC investments lose their shine

Europe is now beginning to take this alternative investment vehicle seriously, thanks to increased investor appetite and regulatory changes. The timing, however, couldn’t be worse as SPAC investing in the US has just hit the skids. An index fund of top SPAC companies is currently trading at 20% off its February peak.

Investors, who initially bought into rumors of deals involving high-quality startups, are now demanding greater scrutiny of those firms’ revenue targets. The use of celebrities to promote some SPACs, including rapper Jay-Z, NBA star Shaquille O’Neal and singer Ciara Wilson, even sparked a warning from the US financial markets regulator. The legendary British investor Jeremy Grantham went further, warning last year that “SPACs should be illegal.”

The concerns have led to questions about why European capital markets are so eager to join the SPAC hype. Even the new head of the European Union’s securities watchdog admitted that Brussels first needs to study the rise of SPACs in the US.

“We need to understand why they are so popular, why do people provide money just on the basis of the sponsors’ names and announcement of a project,” Natasha Cazenave, executive director of the European Securities and Markets Authority (ESMA), told the European Parliament in April.

European startups pursued by US SPACs

Despite fears that the SPAC boom is over, many US blank-check firms are continuing to see their shares soar, including risk analytics firm Open Lending, sports gaming startup Draftkings, and gadget retailer Betterware de Mexico, which have all doubled in value over the past year.

European interest in SPACs has also been heightened by domestic startups becoming prey for US-based blank-check companies. They include Germany’s air taxi manufacturer Lilium and the biotech company Immatics, who have already been merged into SPACs listed on the NASDAQ.

With competition intensifying, 17 European SPACs are being prepared for this year, worth $2.2 billion, according to market data firm Pitchbook.

Amsterdam has, so far, beaten off competition from other European markets to launch the most SPAC IPOs as its regulatory environment is the most similar to the US. Britain, meanwhile, is set to announce reforms that will allow London to be a hub for SPAC listings.

The three SPACs that have listed on the Frankfurt Stock Exchange are based in Luxembourg because of the country’s favorable regulatory regime.

“It is legally more difficult to set up a SPAC in Germany and in some parts of Europe due to the legal structuring question — whether you are building a company or an investment fund — which comes with its own set of regulations,” Credit Suisse’s Joachim von der Goltz, head of ECM Northern Europe told Reuters recently.

European investors too cautious?

Europe still has a mountain to climb to match the US demand for SPAC investments. Despite the desire to have more European tech giants, and ambitious plans for post-pandemic infrastructure spending, — particularly on green investments, Europe still lacks the necessary investment landscape.

“Wall Street has a lot of capital available for SPACS and IPOs and it encourages specialist investment knowledge,” Kuhn told DW, adding that European investors are still too risk-averse.

Deutsches Aktieninstitut is calling for reforms to Germany’s pension system to allow more funds to be invested in capital markets, which it says will boost startups and SPACs/IPOs. Germany runs a pay-as-you-go pension scheme, where current retirees are paid out of the premiums paid by those who are still working.

“We should strengthen the [capital markets] ecosystem, to raise more money, especially through the pension system, to help kick-start IPOs and SPACS,” Kuhn said.

He said German Chancellor Angela Merkel’s center-right Christian Democratic Union (CDU) party, the Greens and the business-friendly FDP have proposed to open up the pension system to capital markets. But no decision is likely until after the federal elections on September 26.