SPACs: A Primer
"Those blank-check companies!" Of course u've heard of 'em! Maybe even traded a few! But for most of us that's where our knowledge ends. This🧵dives into:
How do SPACs work?
When/why to invest in a SPAC?
Risks in the "investor journey"?
Why 2020's explosion?
👇
"Those blank-check companies!" Of course u've heard of 'em! Maybe even traded a few! But for most of us that's where our knowledge ends. This🧵dives into:
How do SPACs work?
When/why to invest in a SPAC?
Risks in the "investor journey"?
Why 2020's explosion?
👇
1/ History: when & why were SPACs invented?
In 1993, Stratton Oakmont was shilling all these pump-n-dump "blind pools" across the Street.
D. Nussbaum of GKN was fed up. He set out to structure a new blank-check company w/ more investor protection like putting IPO cash in escrow.
In 1993, Stratton Oakmont was shilling all these pump-n-dump "blind pools" across the Street.
D. Nussbaum of GKN was fed up. He set out to structure a new blank-check company w/ more investor protection like putting IPO cash in escrow.
The SPAC was born.
It became the 90s' backdoor for helping small co.'s (esp. in energy) go public. But when Dot-Com hit, SPACs tanked vis-a-vis booming tech IPO frenzy.
Then in 2003, the mid-market turned back to SPACs for exposure to experienced fund managers & higher yields.
It became the 90s' backdoor for helping small co.'s (esp. in energy) go public. But when Dot-Com hit, SPACs tanked vis-a-vis booming tech IPO frenzy.
Then in 2003, the mid-market turned back to SPACs for exposure to experienced fund managers & higher yields.
In 2015, SPACs began to offer IPO investors 100% money-back guarantees, with interest -- like giving buyers a risk-free free call option on rising equity prices! That plus money-printer Fed & PE funds' notoriously overflowing dry powder, it was just a matter of time... til 2020.
2/ SPAC structure & lifecycle: How does it work?
All SPACs go thru 3 phases
(a) formation/IPO
(b) target search
(c) "de-SPAC"/merger
(a) Formation (8+ wks)
A new shell co is incorporated. The "sponsor" (PE fund usually) issues SPAC units: takes 20%, leaves 80% for later public.
All SPACs go thru 3 phases
(a) formation/IPO
(b) target search
(c) "de-SPAC"/merger
(a) Formation (8+ wks)
A new shell co is incorporated. The "sponsor" (PE fund usually) issues SPAC units: takes 20%, leaves 80% for later public.
The sponsor submits an S-1, waits for approval, parties on IPO day, then begins searching for a target. During the search, IPO proceeds are held in a trust account that earns interest, and the SPAC is subject to normal SEC reporting reqs even though it's got no real operations.
(b) Target Search (19 mos)
SPAC formation agreements usually cap how long a sponsor has to find its target (typically 18-24m). After identifying any potentials, the sponsor negotiates merger terms & passes on final decision to shareholder vote. If "no," sponsor keeps looking.
SPAC formation agreements usually cap how long a sponsor has to find its target (typically 18-24m). After identifying any potentials, the sponsor negotiates merger terms & passes on final decision to shareholder vote. If "no," sponsor keeps looking.
If max search time comes due & still no merger, the SPAC dissolves & shareholders get their $ back.
If shareholders approve a target, the "de-SPAC"/merger process begins. SPACs sometimes need extra $$ for this. The can raise via:
- PIPE
- more stock issuance
- preferreds
- debt
If shareholders approve a target, the "de-SPAC"/merger process begins. SPACs sometimes need extra $$ for this. The can raise via:
- PIPE
- more stock issuance
- preferreds
- debt
(c) De-SPAC (<5mos)
To kick off the merger, the SPAC files an 8-K & 14A (proxy) or S4. At this point, public shareholders can redeem their common shares prior to the close of a merger if they do not want to be invested in the target/s.
End Result: target/s now publicly listed.
To kick off the merger, the SPAC files an 8-K & 14A (proxy) or S4. At this point, public shareholders can redeem their common shares prior to the close of a merger if they do not want to be invested in the target/s.
End Result: target/s now publicly listed.
3/ What does the investor journey look like?
Retail investors have 2 chances to get in.
1. @ IPO: new securities called "units" go for $10; 1 unit contains both common stock & OTM warrants that convert on merger
2. Post-IPO: shares often trade @ discount to cash redemption value
Retail investors have 2 chances to get in.
1. @ IPO: new securities called "units" go for $10; 1 unit contains both common stock & OTM warrants that convert on merger
2. Post-IPO: shares often trade @ discount to cash redemption value
Can u describe this "unit" in more depth?
A typical unit is made up of 1 common share and 1/2 or 1/3 warrant to purchase 1 full share at a strike price of $11.50. Only the units will trade at IPO, but the components typically separate for individual trading 52d after the IPO.
A typical unit is made up of 1 common share and 1/2 or 1/3 warrant to purchase 1 full share at a strike price of $11.50. Only the units will trade at IPO, but the components typically separate for individual trading 52d after the IPO.
4/ Why might u buy into SPACs?
a) In a post-brrr US, ex-Treasury investors might look to SPACs as higher-yielding alts to zero-coupon bonds. Why? SPACs' trust accounts contain at least $10 per public share but shares often trade @ discount to redemption value. Same risk profile.
a) In a post-brrr US, ex-Treasury investors might look to SPACs as higher-yielding alts to zero-coupon bonds. Why? SPACs' trust accounts contain at least $10 per public share but shares often trade @ discount to redemption value. Same risk profile.
b) Options traders may find juicy arb trading SPAC warrants. Almost all SPAC warrants carry 5Y terms & expire worthless if no merger occurs, i.e. a binary option on long-dated uncertainty. Institutions shy away from such speculation, which leads to low float & big price swings.
5/ Is it risk-free if it's money-back guaranteed? What's the downside?
a) One big downside is the conflict of interest btw sponsor & shareholders:
At formation, sponsors get founder stake for a nominal contribution & usually buy warrants at deep discount to reach 20% ownership
a) One big downside is the conflict of interest btw sponsor & shareholders:
At formation, sponsors get founder stake for a nominal contribution & usually buy warrants at deep discount to reach 20% ownership
Since the founder shares & warrants expire worthless if the SPAC doesn't de-SPAC, sponsors are heavily incentivized to complete mergers lest they lose their initial investment.
Uh-oh, what if the sponsors get desperate over time & choose some shitty target company?
Uh-oh, what if the sponsors get desperate over time & choose some shitty target company?
Fortunately, retail investors can usually redeem their shares for cash if the deal sounds shitty. BUT, sometimes there are exclusion clauses in the formation docs! Read the fine print!
b) 2nd downside: Let's dig deeper into those "founder shares" (aka "promotes").
b) 2nd downside: Let's dig deeper into those "founder shares" (aka "promotes").
At 20%, the promote "fee" is much higher than average IPO fees a company pays its investment bankers (6-7%). Awesome for the sponsor! Extremely dilutive to the SPAC's retail investors.
e.g. Say target ABC negotiates to receive $100M during the merger in exchange for X shares.
e.g. Say target ABC negotiates to receive $100M during the merger in exchange for X shares.
If there was no promote, the SPAC's public shareholders (retail investors) would get all X shares of ABC.
Add in the promote fee, however, and shareholders are diluted to receiving only 80% of X (since the typical fee sponsor take-rate is 20%). 🤨🤨
Add in the promote fee, however, and shareholders are diluted to receiving only 80% of X (since the typical fee sponsor take-rate is 20%). 🤨🤨
6/ Why did SPACs explode in 2020?
Open any sell-side report and you'll find a buncha "fundamental macro drivers." Frankly most are secondary and missing the big hammer. The only ones that matter:
1) valuation greed
2) too much dry powder/cash to deploy
3) vogue signaling
Open any sell-side report and you'll find a buncha "fundamental macro drivers." Frankly most are secondary and missing the big hammer. The only ones that matter:
1) valuation greed
2) too much dry powder/cash to deploy
3) vogue signaling
7/ Returns Statistics So Far
How well are the hottest SPACs doing since last year's craze? How badly are the shittiest SPACs shitting the bed? Here's a table of the top 20 and bottom 20 SPACs by ARR (annual rate of return).
How well are the hottest SPACs doing since last year's craze? How badly are the shittiest SPACs shitting the bed? Here's a table of the top 20 and bottom 20 SPACs by ARR (annual rate of return).
8/ How's the future lookin' for SPACs?
TLDR: not great.
May '21 data showed the Defiance Next Gen SPAC ETF fell >30% since Feb. Meme SPACs like $QS & $SPCE also down >50%.
Why'd the bubble pop?
1. egregious sponsor fees (20%)
2. not actually easier/faster than direct listing
TLDR: not great.
May '21 data showed the Defiance Next Gen SPAC ETF fell >30% since Feb. Meme SPACs like $QS & $SPCE also down >50%.
Why'd the bubble pop?
1. egregious sponsor fees (20%)
2. not actually easier/faster than direct listing
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