The Rise of SPAC's
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There are a lot of blank-check companies that have been coming out of the woodwork over the past several months. If you are not familiar with blank-check companies, or a SPAC (Special Purpose Acquisition Company), I wouldn’t blame you - this isn’t exactly something they teach you at business school (maybe in your MBA, but not undergrad). SPACs are called blank check companies because they have no holdings and have no operations. They typically go public with the intention of acquiring / merging with another company.
If you look this up on Investopedia or something, you will hear that SPACs allow retail investors to participate in private-equity adjacent transactions, like leveraged buyouts. Which, is fine, I guess, but it can’t really be that simple, can it?
Of course, there are deeper layers to the inner workings of a SPAC. These financings are, inherently, backed by an asset management firm of some sort - someone with deep pockets who can effectively “underwrite” the investment vehicle. Typically, investors in SPACs are afforded redemption rights, so if the company that gets acquired via this investment vehicle is not to their liking, they can ask for their money back. However, many strategies surrounding SPACs are pretty well-baked by the time they come to market, and it’s rare that surprises occur.
SPACs are sometimes viewed as an alternative to IPOs, as they frequently take a company public that was previously private. SPAC transactions are also very beneficial to the firm that set up the SPAC. They get improved economics and can tap into a funding source that is typically not utilized by a lot of buyout shops.
There have been several high-profile SPACs this past year, including DraftKings, Virgin Galactic, and Nikola Corp. In 2020, there has been ~$12 billion raised by SPACs over 38 deals, which is crazy when you compare it to the $13 billion that was raised via SPACs for all of 2019, another big year for the vehicle. To put that in perspective, so far, in 2020, there have been ~45 IPO’s though Q2.
If you follow the public markets, you are probably familiar with a lot of the SPACs I listed above. Virgin Galactic ($SPCE) drew a lot of attention last year for it’s performance in the market and for being one of the few ~space~ companies that retail investors could dabble in. It shot up like a rocket ship, and then came crashing back down to Earth, but has since leveled out.
But prior to SPCE’s rollercoaster ride, it was trading pretty steady - that’s because the SPAC had been launched and was still trolling about, looking for a company to buy. This SPAC was launched by Chamath Palihapitiya in 2017, with $650 million in its coffers. And the Virgin Galactic acquisition makes great use of the SPAC: a company that is heavily reliant upon future earnings and essentially has no comparable companies for the market to judge it by. It would have been very difficult to take it public via IPO (at least, that’s the consensus), but it still needs a lot of capital to hit the right inflection point. The IPO market, even in the best of times, can be shaky for a company like that. And although there is a lot of money in the private markets chasing down deals with big price tags, most of them are either (i) large venture players who want to get in earlier than that, or (ii) buyout shops who don’t tend to take those kinds of industry risks. Plus, space-tech companies require extremely long-term thinking, with Chamath has built his entire career on.
As luck would have it, in the middle of writing this newsletter, I happened to listen to the most recent episode of 20 Minute VC featuring Palihapitiya. Around the 23:30 minute mark, Stebbings asks Chamath about why he uses SPACs and what he thinks makes them so special. I tried to summarize his response as follows:
First of all, there’s not a lot of first principals thinking when it comes to IPO’s / utilizing the public markets effectively.
From the year 2000 to the year 2020, the number of companies that are invest-able in the public markets in the US has shrunk from 8,000 to 4,000. But on the flip side, the number of investors have increased significantly and the amount of capital have increased even more significantly (somewhere between 100x - 1,000x).
Chamath then asserts that the public markets are better for young tech companies because there is an increased appetite for growth.
Interest rates have gone to zero, which means all of those investors who are looking for growth need to eventually turn to technology companies. (Not sure I agree here).
The goal of a SPAC is to do things effectively and efficiently as possible. It’s much more founder friendly and company-employee friendly. IPO’s, Chamath argues, can get very complicated and can cause a lot of value to be lost when being priced - in other words, they leave money on the table (see NCNO for an example of a company that left money on the table). Direct listings, although more price-transparent for companies, can still be very complicated and difficult to pull off. Both of these take 18-ish months to pull off. Chamath recently sat on the board of Slack, who went public via direct listing and apparently took some issue with the process.
Enter the SPAC - it’s a 90-day process, going public via a merger. You are able to spend time with Wall Street. SPAC’s allow for a forecast to be created. They can add any amount of money to the market that they want (must be nice).
SPACs require founders to be relatively financially savvy and understand capital markets. Which sounds more like a downside to me.
Ultimately, this is just a tool, however, and it still requires strong companies.
Now, I certainly don’t agree with everything Chamath brought up in his interview, but he is one of the guys who has been using this tool very effectively in the public markets recently. His thought-process is a view into the world of the folks who are putting SPACs to work to raise equity capital. If you really want to understand why they are in vogue, that’s a great place to start.
An important aspect of this discussion is the idea that it really is an investment manager who is raising capital to hunt for an acquisition. It’s not like these asset managers are not doing this out of the kindness of their hearts - they reap some extra rewards through improved economics (they get more than what they chipped in for). But also, you need really deep pockets for this to work. It’s an easy process compared to an IPO, but, from what I can tell, that doesn’t mean it’s not somewhat difficult to pull off anyway. And just like anything in the capital markets, in order to be really effective at it, you need to have a good Rolodex and know how to find the folks who will back you. That’s not the easiest thing in the world to do.
So, in theory, a private tech startup or large business with unique characteristics could use a SPAC as a workaround for an IPO, that hasn’t been the primary use case thus far. Most startup management teams are more focused on building solid businesses, creating good product, and building a great team and less focused on taking a financial instrument like this to market.
And SPACs don’t always have happy outcomes - if you are looking for an interesting case study, check out Global Blue & Far Point Acquisition. There are tons of reasons why SPACs can break bad and end poorly. And like anything in the capital markets, there can be incentive misalignment that a savvy investor needs to look out for.
So, again, why are SPACs so in vogue? One theory is that the cost of capital is much lower with SPAC’s. IPO’s currently have a reputation for leaving money on the table (check out Bill Gurley’s twitter feed if you don’t believe me). However, I find this somewhat hard to believe that the cost of capital for SPACs is so much better than IPOs. First of all, bankers are still involved in the underwriting of SPACs, so they get some fees that way, and they are also involved in the M&A process when an acquisition target is identified. That’s a decent chunk of change that ibankers can make on these vehicles.
What’s more likely is that SPACs are an easier way to avoid the choppiness of going public via traditional means. And although I don’t think companies are necessarily driving the boat on SPACs being spun up, if you mix a SPACs advantages over a traditional IPO process with investor friendly terms, increased economics for the sponsor, and a simpler process, SPACs start looking pretty interesting.
And I think another wrinkle is that SPACs are ultimately one way for retail investors to be able to bet on an M&A focused asset manager. I think Chamath is a pretty interesting guy and tend to listen to what he says. If I were some big acolyte for Chamath and I wanted to find a way to invest in his investment process, investing in one of his SPACs would be a great way to accomplish that goal. Buying companies and increasing their worth is a lucrative business that is hard to gain access to as a retail investor.
Whatever the reason, there’s no denying that SPACs are something to watch for the time being.
Friday Links
WeWork expects to have positive cash flow in 2021, Financial Times reports
“Everybody thought WeWork was mission impossible,” Claure, who is also a SoftBank executive, was quoted as saying by the FT. “And now, a year from now, you are going to see WeWork to basically be a profitable venture with an incredible diversity of assets.”
The WeWork Saga is an incredible story of hubris, fiduciary oversight issues, investor folly, and, very importantly, financial mismanagement. While WeWork will almost certainly be a complete abject failure for many of it’s later-stage investors, it will be interesting to see if it carriers on some second life, like EOG Resources (Enron’s exploration arm that is still in operations today).
I am dying to dig into this one. This is a preview for my post next week.
Matt is one of the smartest finance guys I have met since I moved to Columbus. I am excited to see what him + team are able to accomplish with Longvue. I think there is serious potential here.