What Is A SPAC And Why Have They Become So Popular?
You may have noticed that 2021 is becoming the year of the SPAC. SPAC-Attack as they say! In 2021 alone, SPACs have already raised a mind boggling $38 billion and we’re only in March! This averages out to roughly $296 million for each SPAC offering this year. For context, the amount of money raised through SPACs in January of 2021 surpassed all SPAC money raised in 2019.
What is a SPAC?
SPAC stands for Special Purpose Acquisition Company.
SPACs do not have business operations, nor do they bring in revenue.
SPACs were created solely to merge with a growing company and help them go public.
When a SPAC initially goes public, investors may not know who the SPAC is targeting for merger. SPACs have two years to complete an acquisition or they must return any capital raised back to investors.
As we established, when a SPAC goes public, they do so without a revenue model or business stream in place. They are formed to help raise funds to eventually acquire a new operating company. SPACs are also commonly referred to as blank check companies.
When a SPAC completes a merger, the newly acquired company is then able to become publicly traded without completing the formal Initial Public Offering (IPO) process. Then the newly joined company will update their ticker symbol to represent the joint venture.
Funding a SPAC
SPACs are formed when a sponsor invests capitol, typically20% interest. These are known as founder shares. The remaining 80% of shares are expected to be held by public shareholders. Institutions may also be a funding partner of the SPAC.
What Other Avenues Can A Company Take To Become Publicly Traded?
Traditionally, most companies go public through one of two ways:
Also referred to as a stock market launch. This happens when a private company agrees to go public by selling shares of stock to both institutions and retails investors.
For a company to officially launch an IPO, there are several requirements that must be met by the Securities and Exchange Commission (SEC).
IPOs are the most common way for a private company to raise funds, but it also comes with heavy regulation and increased scrutiny.
IPOs use liaisons or ‘underwriters’ to help facilitate the IPO process. The use of an underwriter can add substantial fees to the company.
Companies may choose to defer an IPO in favor of a direct listing.
- Direct Listing
Companies that go public through a direct listing do not create additional shares; they simply sell all their existing shares.
Direct listings do not require underwriters which make them a less costly avenue to going public.
Benefits of Merging with a SPAC
As we noted, SPACs can help a company become public quicker and with less red tape than a traditional IPO. In fact, since SPACs are formed without a merger in mind, they are typically able to meet minimum regulation requirements and may become public in just 2 to 4 months.
Why would a company merge with a SPAC?
One of the main goals of a SPAC is to raise money. An operating company can then merge with the SPAC and immediately increase their balance sheets.
SPACs require less paperwork.
Reviewing Recent SPAC Mergers
The Harvard Law School Forum on Corporate Governance studied nearly 50 SPACs between January 2019 to June 2020. Highlighted below are some of the key takeaways they found:
The average price of a SPAC share trades for roughly $10 before the merger.
Historically, the share price has dropped nearly33% after acquisition.
Share dilution was listed as a key driver in the post-merger price drop.
SPACs with high profile sponsors and a proven track record tend to generate the highest returns.
On average, three months after a merger, medium returns were -14.5%.
Now that we understand how SPACs work, let’s look at a chart in real-time. The chart below comes from CCIV who recently finalized a huge merger with luxury EV car maker, Lucid Motors.
|Churchill Capital Corp Life Cycle- Pre & Post Acquisition|
This is a really great example of a SPAC’s lifecycle. Low share price with no presumed merger. Shares start riding on the hype of a big acquisition. Merger is completed successfully and the stock skyrockets! Share price immediately tanks as profits are booked. It’ll be interesting to see what CCIV shares trade for when the ticker officially changes to represent Lucid.
Characteristics of Successful SPACs
So how can we tell if a SPAC is worth your hard-earned dollars? As previously noted, the brainchild or sponsor of the SPAC can have a huge influence on the long-term success of the newly merged company. Additionally, many successful SPACs also have the support of large institutional investors. These hedge funds do more than simply generate cash, they also help with the demand of the future merger. Top performing SPACs can turn a great idea into are venue generator.
Top SPAC Sponsors
When investing in a speculative SPAC, it pays to identify sponsors who have a proven track record of not just completing the merger but growing their investment! Below are some of the most prolific SPAC sponsors around today:
Alec Gores – 12 Total SPACs
Notable Mergers: Luminar Technologies (LAZR) Hostess Brands (TWNK)
Michael Klien – 11 Total SPACs
Notable Mergers: Multiplan (MPLN) Lucid Motors
Jon Ledecky (Owner of NY Islanders)- 8 Total SPACs
Notable Mergers: Bark Box
Jeff Sagansky & Harry Sloan – 7 Total SPACs
Notable Mergers: Draft Kings (DKNG) Skillz (SKLZ)
Chamath Palihapitiya – 6 Total SPACs
Notable Mergers: Virgin Galactic (SPCE) Sofi (announced) Open door (OPEN)
You may personally have one or even several of the companies noted above in your own portfolio. Did you know they all went public via SPAC?
Risks of Investing in SPACs
Limited paperwork does not mean there is NO paperwork:
- 1a. Though the requirements are less stringent, a SPAC still needs to file an S-4 to go public. An S-4 will provide more details on any potential deal or merger and any unexpected news can quickly have a negative effect on a stock price.
Deals can fall apart:
- 2a. If you’re investing in a SPAC after they’ve identified their acquisition target, understand the risks of investing when a contractual deal has not been finalized.
What if the acquired company turns out to be a dud?
- 3a. Just because a company has acquired funding and decided to go public, that doesn’t mean there’s a market for their services. More importantly, it does not guarantee potential returns. Plenty of publicly traded companies fail.
How to Invest in SPACs
We preach this all the time at the Swing Trading Club, but it is doubly important when investing in SPACs. Understand who owns the SPAC and understand the company they’re acquiring. Could a merger dramatically change the fundamental business model? These are all key considerations to note before investing in a SPAC.
Pick an industry trend you believe in
We want to invest in growing industries. When you’re investing in SPACs you have the potential to get in on the ground floor. Therefore, it’s imperative you identify a lasting value proposition.
Example: Virgin Galactic(SPCE). This SPAC went public in 2020 and the entire business model is predicated on the idea that commercial space travel will become commonplace. If you’re a believer in this industry trend, you may want to get in early, despite all the volatility.
Determine when you want to buy shares of the underlying stock
As we’ve learned, sometimes a SPACs evaluation can take a nose-dive after the rumored merger becomes official. “Buy the rumor, sell the news”.
Don’t overexpose yourself
Position size is important. This is another key trading principle that is amplified when investing in SPACs. These blank check companies will continue to be extremely volatile. Have a plan, and start with a small position
SPACs or blank check companies are becoming a very popular method for taking a company public. One reason is they allow a company to go public without some of the hassles needed for a formal IPO. The problem with SPACs is you never truly know who they will acquire until the deal is official. Historically, SPACs often lose an investor money. When investing in SPACs, it’s imperative to always:
To do your homework on the SPAC itself
Research the sponsor in place
Investigate the target company the SPAC may acquire
Often, the sponsor of the SPAC will be one of the main drivers to long term success. When investing in a SPAC, look for an established sponsor or at least a forward moving industry trend you truly believe in.