As Deal Optimism Dies, SPACs May Have Surprising Future As Fixed Income Investments

From 2019 into 2021 certain SPACs were among the hottest investments, looking to bring appealing, elusive growth companies to market and rewarding their sponsors handsomely in the process. However, unfortunately for many SPACs, performance for investors after finding a deal was poor.

Now in 2022, as growth investments are out of favor in a bear market. Social Capital, which were an early champion of the SPAC trend expecting them to replace the IPO have announced plans to “wind down” two SPACs. Of course, it’s worth noting that IPO activity has fallen dramatically in 2022 as well.

However, despite the broad pessimism, SPACs may now provide a return to investors. Just not the one sponsors were expecting. SPACs may arguably stack-up relatively well as a short-duration fixed income assets.

Appealing Short-Term Yields

Juliam Klymochko, Portfolio Manager of the Accelerate Arbitrage Fund, which owns over 200 SPACs, explains how this works. Today “98% of SPACs are trading below cash in trust” he says. This means an investor can essentially hold $10 of value for $9.84, on Klymochko’s current calculations for the average SPAC.

Then regardless of whether a SPAC liquidates or votes on a deal or votes to extend, you should have an option to redeem and receive the value held in trust. Of course, a 1.6% discount may not seem too enticing, especially if a SPAC has many months until a redemption opportunity.

However, the recent moves in interest rates create the potential opportunity. Rates on Treasury Bills, where most SPACs invest their cash, have risen substantially, currently paying around 4% for a 1-year Treasury Bill.

This means that the SPAC’s value may grow beyond the initial $10 value as they look for deals and receive interest while they wait. You may receive a discount today on an investment yielding around 4%. Of course, there’s more complexity here than with other fixed income investments, and your view on the path for inflation matters too, but SPACs may be becoming an unexpected fixed income-like investment.

So SPACs may have the potential to earn more than Treasury bills, a fixed income world where even an extra 1% of return can really matter. Furthermore, there’s still the chance that some of these SPAC find an appealing deal for investors amid the bear market valuations of 2022. However, in 2022 performance from SPAC deals has generally been poor and many investors are choosing to redeem rather than embrace deals, which have often performed poorly.

Buyback Tax Presents Risk

One recent unexpected risk for SPACs is the recent buyback tax, which as part of the Inflation Reduction Act, charges company’s 1% of the value of any buybacks starting January 2023. This law wasn’t necessarily intended to tax SPACs when they return cash, but some may have to pay it given current interpretations of the legislation. If so, the question is whether investors or sponsors bear the cost.

The buyback tax could dent returns for those looking at SPACs as a fixed income type investment. Here Klymochko recognizes the uncertainty. He sees some sponsors getting ahead of this issue in their extension documentation, and Cayman-domiciled SPACs are not expected to be liable for the tax. Still, Delaware-domiciled SPACs may be.

However, earlier SPACs with more loosely worded protections for investors in their S-1 filings, may be able to use cash that would otherwise go to investors to pay any buyback tax. When you’re looking at potential yields on cash, these details will matter.

Warrants

Then, as much more speculative investments, SPAC warrants could look interesting too. These typically give the option to purchase shares at a fixed price after a deal occurs, capturing a lot of potential upside if things go really well.

Of course, things haven’t been going really well and 2022 has been a nightmare for SPAC warrants, now off 83% YTD. However, the average SPAC is trading as if there’s an 80% chance a SPAC won’t find a deal on Klymochko’s current assessment. That’s low compared to history, and so unless we do see a massive wave of redemptions, which is possible, there may be some value in SPAC warrants.

The End of a Boom

So the SPAC boom of past years is clearly over. However, SPACs may have an interesting setup as fixed income-like investments for those willing to dive into the details. There’s even an argument to made that certain SPAC warrants may be conservatively priced, based on history, for the more adventurous investor. However, the warrants can still drop to zero when no deal is found.

However, this shows that we are in a bear market. SPACs showed some tremendous growth equity returns for the certain deals just a few years ago, even if temporarily. Now SPACs might be better treated as a fixed income option by investors in the current environment. Times have changed.