SPACs – hot stocks or empty promises? 3 things you must know

Special-purpose acquisition companies (SPACs) are all the rage right now in the US in 2020 and 2021 before losing steam in recent months. You might even have invested in some of them without knowing that it was a SPAC, and that’s not good.

(this article was published on 16 Oct 2020 and has been updated on 15 Mar 2022)

Give me 3 minutes and I hope to level up your understanding about SPACs by the end of this article.

What are SPACs?

Special-purpose acquisition companies (SPACs) are essentially blank cheque companies formed to acquire companies and take them public.

SPACs gain popularity as they provided advantages for companies which are planning to go public. The key benefits include:

• Lower listing expenses
• Faster listing time
• Access to the SPAC sponsor’s experienced management teams

For investors, SPAC gives them access to high-growth companies that haven’t gone public yet.

How do SPACs work?

Let’s say I harbour the ambition to acquire a fintech company because I believe it has a great future and disruption is unfolding soon. But I will need $500m and I don’t have enough money to pull it off. Borrowing is not possible since the fintech company isn’t making any profits and doesn’t have much assets to collaterize.

Given that I have an audience through Dr Wealth, I think I can raise money to fund this acquisition via an Initial Public Offering (IPO). Instead of listing Dr Wealth, I launch a new company called Dr Wealth Acquisition Holdings (DWAH), which would be used primarily for the acquisition.

In the IPO prospectus, I wouldn’t want to disclose the acquisition target so as not to attract competition. Investors will have to trust that I have the business acumen, a good plan and excellent execution to make money for them. All they need to do is to write the cheque and fund this new company.

Once DWAH is listed, I will have a deadline to complete the acquisition or the company will have to delist, liquidate and return the money back to shareholders. I will also be incentivised to complete the deal because I will receive a 20% stake in this company, even if I did not put up an equivalent amount of capital. It would be the payment for my work done.

The above is a simplified description of a SPAC. Sometimes it is called a blank cheque company because investors are just putting in money without knowing what acquisitions would be made. Why would they do it? Because they often trust the names of the individuals who run these SPACs.

A typical process for a SPAC starts with the formation and IPO. After listing, these SPAC would look for appropriate targets to acquire. If a suitable one is identified, a shareholder meeting will be held to approve of it. Once the shareholders come to an agreement, the SPAC will merge with the target firm, resulting in the de-SPAC phase where the SPAC will cease operations. In this phase, the shareholders would now own the target company’s shares.

While there is no way of knowing how long it will take the SPAC to merge, there is a timeframe within which the de-SPAC must occur, and this varies with exchanges.

Singapore has listed 3 SPACs as of March 2022, you can learn more about SPACs in Singapore in our article about the 1st 2 SGX SPAC listings.

Next, I’ll talk about 3 things you must know before you put your hard earned money into SPACs:

#1 Prominent individuals have made use of their status to launch SPACs

Bill Ackman, the outspoken shareholder activist and fund manager of Pershing Square, has launched the largest SPAC – Pershing Square Tontine Holdings. It raised $4 billion. If you have Netflix, watch Betting To Zero.

They seemed to be proud of being a blank cheque company by putting the label on their homepage in big fonts:

They have not identified any targets but here are the broad areas they are looking at:

PSTH has not yet selected any specific business combination target. PSTH intends to pursue merger opportunities with private, large capitalization, high-quality, growth companies… PSTH will seek targets in four principal market segments: high-quality IPO candidates, mature unicorns, private equity portfolio companies, and family-owned companies.

Sir Richard Branson, the flamboyant founder of the Virgin Group of companies, is launching VG Acquisition Corp to raise $480m.

Here’s what was stated in the prospectus,

We are focused on effecting a business combination with a target that operates in one of the Virgin Group’s core sectors: travel & leisure, financial services, health & wellness, technology & internet-enabled, music & entertainment, media & mobile and renewable energy/resource efficiency. We will primarily search for consumer-facing businesses. We are not, however, required to complete our initial business combination with a business in one of these sectors and, as a result, may pursue a business combination outside of these categories if we find an alternative opportunity that we believe will result in an attractive return to investors.

Er… It is really as “blank cheque” as it can go.

Chamath Palihapitiya, ex-Facebook executive and prominent venture capitalist with Social Capital, has been filing SPACs under Social Capital Hedosophia. His first was launched in 2017. The second and third were launched in 2020. Now, he’s going for his fourth SPAC.

#2 SPACs have raised over 100B in 2021!

SPACs saw a huge jump in the amount of money raised in 2017 and it has crossed the $100b mark in 2021. This is only made possible because of the insatiable demand from investors.

• 2014: $1.8b (12 SPACs)
• 2015: $3.9b (20 SPACs) +116%
• 2016: $3.5b (13 SPACs) -10%
• 2017: $10.1b (34 SPACs) +189%
• 2018: $10.7b (46 SPACs) +6%
• 2019: $13.6b (59 SPACs) +27%
• 2020: $83b (248 SPACs) +510%
• 2021: $145b (613 SPACs) +75%

Why would tech companies want to go for SPAC instead of IPO or direct listing? (Direct listing or DPO was also gaining popularity as another avenue of going public. I explained DPO here.)

Many tech companies have matured a lot over the last decade and are big enough to go public (especially the unicorns which are private companies worth more than US$1b). But going via the traditional IPO route is a tedious and expensive process. SPACs are already listed with ready funds and the target company just need to negotiate with one party instead of numerous investors during an IPO roadshow. In other words, SPACs offers a cheaper and faster way of listing.

#3 High profile acquisitions by SPACs

The highest profile SPAC would be Nikola, the electric truck maker which was accused of fraud by Hindenburg. Nikola went public in Jun 2020 after a reverse merger with VectoIQ, a SPAC.

It was a popular stock among Robinhood traders and given that Tesla is a hot stock, Nikola rubbed off some of the fame and interest. By the way, Nikola Tesla is a real person – he is the guy who invented the AC power transmission that we power our homes today. This was a more superior way than Thomas Edison’s DC transmission.

The second high profile SPAC acquisition was DraftKings. It is not a tech company but a sports betting business. Diamond Eagle Acquisition was the SPAC that merged with DraftKings in April 2020. Even retired basketball star, Michael Jordan, joined in the party as an investor and board advisor to DraftKings.

The third high profile SPAC acquisition was Social Capital Hedosophia II’s acquisition of Opendoor, a tech company looking to disrupt the way people buy and sell their real estate.

Locally, Grab’s SPAC listing in Apr 2021 tookover the headlines as it was the biggest SPAC merger of its time. Unfortunately, Grab hasn’t done as well in 2022.

#5 There’s even a SPAC ETF

The SPAC bubble is getting bigger while you are figuring out what it is.

A SPAC ETF is now available!

Defiance NextGen Derived SPAC ETF (SPAK) started trading on 1 Oct 2020. It has 373 holdings and here are the top 10:

• Lucid Group
• Pershing Square Tontine Holdings
• Grab Holdings
• MP Materials Corp
• Draftkings
• Sofi Tech
• Digital World Acquisition Corp
• Vertiv
• Blue Owl Capital
• KKR Acquisition

The fund size is has grown from $2.5m to $19.4m in just two years.

Would you invest in any SPAC?

It seems like SPACs are riding on the tech wave and the bull market to raise as much money as possible. I find it uncomfortable to invest in something without knowing what I am getting. Writing blank cheques isn’t my thing.

Some of these acquisitions can be speculative and eventually turn sour. More SPACs would also mean that there will be competition to acquire companies and this could lead to sky-high valuations for the target companies. Even if these are good businesses, paying high prices may not yield a good return at the end of the day.