SPACs have been the darling of the stock market in past years, only to fall out of favor for much of 2021. The reason for the recent lack of enthusiasm for SPACs is clear, post-merger many SPACs have bombed compared to the broader market. New research show that one reason for this is wildly optimistic revenue forecasts. While SPACs can perform poorly for investors, many of the worst performers offer aggressive revenue forecasts that they fail to deliver on.
SPACs have an apparent benefit over IPOs, in that SPAC management can make “forward looking statements” thanks to the 1995 Private Securities Litigation Reform Act. About 8 out 10 SPACs chose to do this. They often provide rosy presentations to investors. These projections appear to move the market.
The higher the revenue CAGR forecasted the more the stock tends to rise around the investor presentation. In fact, a high revenue CAGR in the company presentation can push a SPAC up about 10% on average in the few days around the time of its investor presentation. However, long-term these projections are generally too optimistic and the stocks tend to ultimately face the music and decline.
Extensive research has been conducted on SPACs previously. Most tends to be critical of the vehicles whether for high implicit fees or weak investor returns in aggregate. However, detailed analysis of SPAC revenue forecasts is novel. This is what researchers from Berkeley and the University of Buffalo have investigated in their new paper ‘Should SPAC Forecasts Be Sacked?’. They find a link between more aggressive revenue growth forecasts and SPAC performance post-merger.
What Is An Aggressive Revenue Forecast?
This begs the question, what should base rates be for a revenue forecast? The study found the median SPAC analyzed had a revenue CAGR of 28%. That is high. For comparison, Michael Mauboussin has analyzed the revenue growth that a broad cross-section of firms actually deliver over the 1950-2015 period (here’s a link to the PDF of that research). The median rate of revenue growth was about 5%, not 28%. Of course, one might expect SPAC targets to grow faster than average. Indeed, perhaps that’s why they are sought out and brought to market.
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Still, based on Mauboussin’s data 1 in 8 firms could sustain revenue growth of over 25% for 3 years. Yet just 1 in 40 could manage it for 10 years. So it’s not impossible for SPACs to deliver on lofty projections, but expecting around half of them to do so is perhaps wishful thinking if base rates are any guide.
Then, sadly, the outcome of this for investors is not good. We know that historically SPACs can typically underperform the market if you hold them for a few years post-merger based on historic data. However, those SPACs with the most aggressive revenue forecasts can perform worst for investors.
SPACs promising the highest growth can lag the market’s return by a remarkable over 70% in their first year post-merger. SPACs in the quartile with lower revenue forecasts lag the market by just over 10% on average. That’s still not great, but it’s a lot better than the aggressive forecasting SPACs.
So SPACs as an asset class have delivered poor long-term performance, but if you own a SPAC projecting very aggressive revenue growth of 28% or more, then maybe it’s really time to worry.