After spending years in the investing wilderness, SPACs suddenly became one of the hottest routes to the public market in 2020. Why have SPACs suddenly become so popular and which ones should investors watch out for?
Investors Love A Fad
2017 was the year of cryptocurrency mania, 2018 saw marijuana stocks skyrocket as Canada completely legalized the substance, while last year saw the so-called ‘meatless revolution’ thanks to Beyond Meat Inc's BYND IPO.
In future years, it’s inevitable that 2020 will be remembered as the year of the coronavirus. However, another massively influential trend has cropped up in the U.S. markets this year that looks set to only increase in velocity in 2021.
What Is A SPAC?
A SPAC — or Special Purpose Acquisition Company — is an entity that has been created with zero commercial operations. Instead, its aim is to raise capital through an IPO that will then be used to acquire an existing private company and take it public. This process of taking private companies public is more commonly known as a reverse-merger and is the reason why SPACs are also often known as “blank-check companies”.
Upon the formation of a SPAC, the founders will usually have one or more acquisition targets in mind. However, during the process of raising capital, these targets will not be disclosed which means that investors in a SPAC do not know what company their money might be going towards acquiring.
The capital raised in a SPAC’s IPO will be secured in a trust account. This money can only be used by management to conduct an acquisition or to give funds back to the investors if the founders liquidate the SPAC. There is usually a defined period (typically two years) for a SPAC to complete an acquisition or else be liquidated. If there is interest earned on the money, this can be used as working capital.
2020 has been the best year for SPACs on record. According to the Wall Street Journal, over $41.2 billion has been raised last year so far by blank check companies — more than triple that of 2019’s total of $13.5 billion (which was itself a record at the time). From January to October, roughly 165 SPACs were listed, nearly double the number of global SPAC IPOs issued in the year previous and five times that of 2015.
So why have SPACs suddenly become so popular?
The Benefits Of SPACs
For private companies, going public through a reverse-merger rather than through the traditional IPO process is becoming an increasingly attractive prospect.
A traditional IPO is a massive undertaking for any company to endure, with roadshows, valuations, and negotiations taking up a lot of time and energy. There have been some high-profile instances of companies almost completely collapsing under the scrutiny they endured in the run-up to their IPO (anyone remember WeWork?), which has made the whole process even more unattractive for those businesses that are ready to list.
There is also a big question over money being left on the table in a traditional IPO. As we saw with both DoorDash Inc DASH and Airbnb Inc ABNB recently, there is a stark difference between the offering price and the price that the stock actually opens at on the exchange. The disparity between these figures represents either cash the company could have raised itself or additional shares it did not need to sell.
The Risks of SPACs
However, there are some legitimate risks exclusive to SPACs that investors should be aware of too.
One of the most common criticisms leveled towards SPACs is that the people bringing these private companies public are not as invested in the long-term success of the company as they might seem. Typically, SPAC founders take a ‘promote’ fee of about 20% of the company as payment for their efforts. Not only does this mean that essentially a fifth of the company is given away almost immediately — which puts a drag on other shareholders — but there is also a risk that the SPAC sponsor has no real incentive to find a quality business and will instead go for an easier, sub-prime option that will net them a big return in the short-term.
There are also claims that the amount of due diligence involved in a merger (or in this case, a reverse-merger) is less than that of an IPO, which would definitely raise some warning flags for some investors.
And as expensive as the traditional IPO process is, a SPAC actually works out much more pricey once you factor in merger fees as well as payments to underwriters and investment banks.
SPACs We’re Looking Out For in 2021
As is often the case, you can’t paint all SPAC investments with the same brush and, while there might be a few questionable options out there, there are also some very exciting opportunities.
In weighing up a potential SPAC investment, here are some of the key things to look out for:
- The Management Team
Having a good management team behind the scenes is always important, but even more so with an investment into a SPAC. As there are no actual business operations to speak of, you are trusting this team to make the best possible acquisition with your money. A SPAC run by a savvy dealmaker with a good track record should be your number one consideration.
- Compensation and Other Incentives
To assuage any concerns that the management team of the SPAC is out to make a quick buck, it is also good to see their interests aligned with shareholders. Look out for sponsors that are willing to invest their own money into the newly-formed companies they are creating, or even ones that are passing up on the typical 20% altogether.
- Acquisition Strategy
All SPACs will include details of the types of companies they wish to target in their IPO prospectus. While they are not always completely beholden to these guidelines, they will give you an indication of the types of companies they’re interested in acquiring.
Taking these three points into consideration, here are three SPACs that we’ll be looking at closely in 2021:
Social Capital Hedosophia
This isn’t one SPAC but three!
Chamath Palihapitiya of Social Capital Hedosophia has already made quite the name for himself in the world of SPACs by bringing Virgin Galactic Holdings Inc SPCE public via his IPOA vehicle, as well as securing deals with Opendoor and Clover Health via his IPOB and IPOC vehicles respectively.
With such a strong record of acquisitions to date, investors will keenly await to see what acquisitions Palihapitiya makes with IPOD, IPOE, and IPOF — all of which are targeting businesses operating in technology industries.
Pershing Square Tontine Holdings PSTH
Love him or hate him, Bill Ackman is one of the most renowned names in the investing game, so he is putting his reputation on the line with a SPAC.
Raising $4 billion for Tontine Holdings means that this is the largest SPAC ever created. Interestingly, Ackman has chosen to eliminate compensation for management entirely and instead has pledged to invest at least $1 billion in the company via his hedge fund once a deal is completed. This means that the management teams’ interests are very aligned with shareholders, which is a very good thing.
It was reported back in September that Ackman had unsuccessfully tried to entice Airbnb (ABNB) to go public via his SPAC. More recently, Ackman said that he was eyeing up employee-owned and family-controlled businesses for a potential merger
VG Acquisition Corp VGAC
Not content with his own Virgin Galactic company going public via Chamtah Palihapitya’s first SPAC, British businessman Richard Branson has recently unveiled his own.
Raising $480 million in its listing on the NYSE, the entity is targeting businesses in the group’s already expansive list of core industries, which include travel and leisure, financial services, health, technology, and mobile. In particular, the SPAC is targeting opportunities created by the COVID-19 crisis, which has created “a rare opportunity to invest in fundamentally strong target businesses at attractive valuations while providing needed financial and operational resources and access to the public markets.”
MyWallSt operates a full disclosure policy. MyWallSt staff currently hold long positions in Airbnb, Beyond Meat, Social Capital Hedosophia Holdings IPOB & IPOC, and Virgin Galactic. Read our full disclosure policy here.
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