How SPACs Reward Everyone Except Retail Investors
One thing our regular readers know by now is that we always say what we think, and we never apologize for it. Sometimes that might mean we’re wrong, and we’re fine with that. We’ll admit we’ve lost money on some investments or called something totally wrong or said disparaging things about zee Germans. In doing so, we’ve always been transparent about how we arrive at our conclusions. Being genuine with people goes a long way towards distinguishing yourself from all the talking heads out there that don’t have your best interests in mind.
Oftentimes, we’re warning our audience about things like OTC stocks or ICOs, much to the chagrin of those who profit from these borderline scams. (Anyone remember that time we got into it with rapper The Game and famed model Ms. Jessica VerSteeg over their cannabis ICO?) Today, we want to shine the light on investment vehicles that we don’t believe are doing retail investors (your average Joe investor with a 401K and a brokerage account) any favors – SPACs.
What Is a Special Purpose Acquisition Company?
The basic use case for a special purpose acquisition company (SPAC) – also called a blank check company – is as follows:
- A group of institutional investors all throw in millions of dollars into a pool which is then divided up among everyone in the form of shares.
- The pool of cash is then placed in a shell corporation that’s managed by the people running the SPAC.
- The shell corporation then files for an initial public offering – the SPAC IPO. Here’s a look at how many filed last week alone:
- If the IPO goes through, the SPAC is merely worth the cash it holds minus any costs and fees incurred.
- The SPAC then has a certain amount of time to go out and find a target business that wants to become publicly traded in exchange for all that cash.
- When a target is found, an announcement is made about a possible target (sometimes before this a rumor gets leaked), and then eventually the transaction gets solidified and the SPAC is renamed (usually given a new ticker as well) to reflect that the deal is done.
In other words, a SPAC allows a privately held company to go public in much the same way a traditional IPO does, just with much less work on the side of the company going public. (A typical SPAC structure usually contains some convoluted terms that include things like stock warrants, but let’s just try to keep this as simple as possible for now.)
When we first started noticing the hype around SPACs in 2017, we published a piece titled “An Intro to Blank Check Companies and SPACs” that incorrectly assumed these vehicles would target multiple startups. As we’ve seen recently with Virgin Galactic, Nikola Motors, and Hyliion, these SPACs single out just one startup to take public.
Plenty of pundits are now talking about how SPACs will replace IPOs because they’re an easier and cheaper way to go public. ICOs were also an easier and cheaper way for companies to raise capital, and they were largely steaming piles of shite. Today, we’re not going to focus on how much investment banks are profiting from SPACs, or how great they are for founders. Instead, we want to talk about SPACs from the perspective of retail investors.
How A Typical SPAC Behaves
The “efficient market hypothesis” assumes that stocks will always reflect all the available information at any given time. If there is a disconnect between valuation and available information, this presents an opportunity for arbitrage. What we’re seeing with SPACs today is an extremely puzzling situation where it appears that share prices are becoming completely disconnected with the underlying valuations. To show you what we mean, we’ll use the example of a fictional SPAC we’ll call SPAC X:
- SPAC X has an initial public offering which allows investors to buy shares of a pool of cash that will be used to buy a company that is unknown. At this point in time, shares should reflect the value of underlying cash, and they usually do. (Typically, this is $10 a share.)
- Some rumor gets spread around that SPAC X is going to buy COMPANY X. As a result of this rumor, SPAC X shares rise +30%.
- SPAX X confirms the purchase of COMPANY X and releases a glossy investor deck (as opposed to an S-1 filing) and their shares rise an additional +40%, even though the deal has not even closed.
- Following a shareholder vote, the deal finally officially closes and shares of SPAC X are now double the price they were initially.
It’s easy to see how speculation is driving the share price increase here. What’s happening is what we described in our article on Hyliion – the Robinhood speculator types are driving shares through the roof based on nothing more than hype.
SPACs – The Opportunity
This raises a very obvious question. Why wouldn’t we just start buying shares in SPACs as soon as they start publicly trading, then sell them as soon as they announce a confirmed target and the deal closes? We’re firmly against speculating in the markets, but we’re genuinely curious as to why this hasn’t started happening. Here’s a look at the returns for four SPACs if you acquired them pre-announcement and sold them today:
Graf Industrial -> Velodyne
- Graf International began trading in 2018 at a price of $10 per share. The confirmed intent to acquire Velodyne was made just yesterday, and shares closed today at $20.72.
- Return: +107%
Social Capital Hedosophia -> Virgin Galactic
- Social Capital Hedosophia began trading in 2017 at $10.00 a share. After announcing their intent to acquire Virgin Galactic, shares soared to $24.60 a share settling at $16.25.
- Return: +62%
Tortoise Acquisition Corp -> Hyliion
- Tortoise Acquisition Corp began trading in Spring of 2019 at $10 per share. They announced the acquisition of Hyliion and shares breached $30 a share. Today, shares trade at $27.07 and the deal hasn’t even closed yet.
- Return: +170%
VectoIQ -> Nikola Motors
- VectoIQ went public in 2018 at $10 a share. After the announcement of a merger with Nikola Motors, the talking heads went wild, calling it “the next Tesla.” Today, shares trade at $57.19.
- Return: +470%
At some point, the Robinhood types will put two and two together and start pumping up the price of SPACs as soon as they go public. Until then, why not buy shares in a few SPACs that seem like they’re out to hunt some big fish and wait for the fireworks to start? Once a merger is confirmed, just reverse dollar cost average your way out the position by selling 25% every week for four weeks. Take those profits and buy yourself some top-shelf drinks at your favorite gentleman’s club because you deserve it.
Speculating on SPACs
Since there were eight SPACs filed just last week alone, which ones would you speculate on? Well, it seems likely that the other two Social Hedosophia Capital vehicles out there might be interesting (these were the same lads that were behind Virgin Galactic), and also the biggest SPAC yet, Pershing Square Tontine Holdings Ltd.
- Social Capital Hedosophia Holdings Corp. II (IPOB) – $11.48
- Social Capital Hedosophia Holdings Corp. III (IPOC) – $10.85
- Pershing Square Tontine Holdings (PSTH) – Not trading yet
At some point in time, the above SPACs will find a target company, and the wankers over at Robinhood will catch wind of it driving share prices through the roof. Sell for an easy profit. That’s one possible outcome.
The other outcome is that a suitable acquisition isn’t found in which case cash is then returned to shareholders, probably minus all the legal fees, administrative fees, admin expenses the shell incurred during its lifetime. So, let’s say that they return $9.50 a share. For IPOB and IPOC, you’re down -17% and -12% respectively.
Nanalyze has always discouraged our readers from speculating, and this is no different. To trade SPACs in this manner is purely speculative. You’re not investing in anything. We also need to acknowledge that we’re still in the midst of a global pandemic which hasn’t fully played out, yet tech stocks are up +12% since news of the Woohoo Flu first broke. That doesn’t seem to add up.
The worst thing about SPACs is that they’re not working out very well for investors who genuinely want to invest in the companies on offer. That’s because newbie investors seem to think that SPACs are some sort of new alternative asset class that you use to shortcut the hard work it takes to get rich.
SPACs – The Threat
For retail investors (emphasis on the word investors), this whole SPAC thing sucks. If people start buying SPACs before an acquisition is announced, they’re purely speculating and buying shares from someone else who is selling them for a quick and easy profit. If the SPAC finds a private company you are genuinely interested to invest in, by the time that glossy investor deck gets filed with the SEC, shares will already have been pumped up and may continue to be pumped up. Where it stops, nobody knows.
And don’t even think about playing the short game. The irrationality of weekend-warrior traders is far greater than your margin account limits. If you want to invest in the company for the long term, you’re then stuck trying to dollar-cost-average your way into a position that’s possibly way overvalued. The winner in this game is everyone except the weekend-warrior traders who are responsible for the problem and the genuine retail investors who want to own the stock as a long-term investment. For that reason, we won’t participate in any of these SPACs, and we’ll continue to caution against speculating on them.
Of course, the whole thing is a moot point if there are no compelling value propositions on offer. We’ve covered three of the four SPACs mentioned in this article, and all of them presented far too much risk and uncertainty in their business models. (We may also do a follow-up article on Velodyne because we’re interested to see how their LiDAR business is going.)
Now, think about this. What if His Holiness Mr. Elon Musk decided to take Starlink public using a SPAC (heaven forbid)? That’s a problem, because we would very much like to get a piece of Starlink (provided that we first took a look under the hood), but just imagine how much hype would drive those shares up at the first hint of a Starlink acquisition. Even if you bought into those shares as they surged, you’re still taking a huge risk until the deal is actually closed and the signatures are on the dotted line. By that time, shares will have soared into the stratosphere and you’re suddenly faced with all these emotions that lead to bad decision making. Alas, no matter how compelling the company is that’s being acquired, it seems best to avoid these SPAC vehicles entirely.
We’re also not liking the fact that an S-1 is not being filed for SPACs. It’s a lazy way out. Throw up a glossy deck and you’re done. From our perspective, we love poring through the detailed S-1 filings that accompany an IPO. Every company is required by law to disclose all pertinent information in these filings. There’s always a great section dedicated to risks as well. What we’re seeing now are SPACs that simply throw up some investor deck into an SEC filing which takes the place of the due diligence which the company going public would have performed in the case of an IPO.
At some point, the “red hot SPAC market” is going to have a reckoning. For the institutional investors that put money into these SPACs, everything is working out great. Put cash in, wait a year or two, sell shares at inflated prices to bag holders or amateur momentum traders who try to time the market and lose more often than they win. In the meantime, hedge fund machine learning algorithms are homing in on the SPAC anomaly and reaping the rewards as well. The only losers in this story are retail investors who have to pay an unnecessary premium to own companies they want to invest in.
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