SPACulating the SPACtacular...
SPACs provide an alternative for going public: you don't really need to be profitable and just need a famous promoter and a narrative that can convince people to believe in your vision...
If you follow any tech or financial markets chatter, you probably will have heard of SPACs by this point – Special Purpose Acquisition Company – de facto a “blank check company” and a new way to acquire businesses and go public instead of the traditional IPO route.
When I thought it was a new emergent bubble back in last summer, I wrote a couple emails explaining what SPACs are. But my email list was still private back then, and the SPACs market also wasn’t as SPACtacular as it is today, so I think it’d be nice to reshare my summer emails in this consolidated post, along with some new statistics and thoughts.
This email will be more of an overview of the properties of SPAC, and in my next email I’ll explain my thoughts on today’s SPAC bubble and dominant narratives in greater detail.
SPACs are “taking over” the traditional IPO market
Some quick facts about the scale and speed of SPAC’s spectacular rise over the last year in global capital markets:
Deutsche Bank shows that SPACs now make up 50% of global IPO volumes (in terms of the amount of money). Charts from Apollo Chief Economist Torsten Slok shows that SPACs also make up 95% of the IPO market in terms of the number of IPOs.
Goldman Sachs notes that 90 SPACs raised $32bn in IPO capital in February, the largest issuance month on record. GS estimates that if current trends persist, 2021 SPAC issuance will surpass the 2020 full-year total before the end of March. This pace is pretty crazy.
Last summer the largest SPAC deal at the time was an $11 billion acquisition and a big deal in the finance industry. This number was soon surpassed by later SPAC deals that grew much bigger. Now the largest SPAC deal is Churchill Capital Corp IV’s intention to purchase a stake in Lucid Motors at a pro forma equity valuation of $24 billion, announced on February 22nd. The average 2021 announced SPAC target has an enterprise value of $2.9 billion compared with an average of $1.7 billion in 2020 and $832 million for the preceding decade.
What are SPACs?
In essence, the punchlines of my previous emails were:
Traditional IPO process is often seen as broken since investment banks charge you heavy fees;
SPACs provide an alternative for going public because you don’t need to announce your IPO plans to the public with as many details – therefore, for companies like WeWork or Airbnb, they can hide their disappointing financial performance from public investors for longer;
SPACs require famous promoters, like Chamath, Bill Ackman, Colin Kaepernick, etc.
Fake it til you make it
Alex Danco’s Substack email back in July titled “SPAC Man Begins” gave a very comprehensive overview about SPACs – Special Purpose Acquisition Company – basically a “blank check company.” To over-simplify – typically if you want to take your company public, you’d have to build a company first, and then after it’s grown to a decent size, you have your IPO on Nasdaq or the New York Stock Exchange (NYSE) or something, and convince the public markets that your company is worth investing in.
The way SPACs work is that you go to those same investors, tell them that you actually have NO company, but you got this thing called SPAC instead, and you tell them to invest all their money to take your SPAC public first. In return, you have a 2-year deadline to find a legit company to merge/acquire so that you can become “a legit public company” that gets traded publicly later… You can see why it’s called a blank-check company – because you kind of get the money (and go public) first before you have an actual company. It’s kind of like a “fake it til you make it” situation.
Have a good (or notorious) personality
There are a few important pieces in this puzzle. One is that you need to have a famous promoter: Chamath’s SPAC has been famous in its acquisition of Virgin Galactic because Chamath “is willing to say crazy things on TV”; Bill Ackman raised a $4-billion SPAC – again, someone with a very distinct reputation – to find a “mature unicorn” lol…
This is important because when you and your SPAC go around raising money, you’re not selling your company (since you don’t have one), you’re selling your own personality.
Last summer it was mostly finance celebrities, but then as the pie got bigger, celebrities outside of finance joined: Colin Kaepernick raised a $287 million “social justice SPAC” – which boasts of a board made up entirely of “Black, Indigenous and people of color.” It apparenetly underwhelmed in debut… Other celebrities going into the SPAC mania include Shaq, Serena Williams, Steph Curry, Alex Rodriguez, and Ciara…
Banks don’t work for you in IPOs, but they do in SPACs?
Everyone’s talking about the rise of “day traders” like Dave Portnoy – how he’s not seriously trading stocks but just saying wild things during his day-trade broadcasting and making money from those publicity stunts. Well, how is this SPAC promoter thing different? Sure, people like Chamath and Ackman are more seasoned investors, but ultimately it’s the personality rather than the substance, right? It’s not about solving the fundamental issues of being public (you’ll still need to file quarterly earnings and be under public scrutiny afterwards); it’s about showing off a fancy process with a famous promoter to bypass the steps of going public (so you’re being taken public by a SPAC, not a bank like Goldman Sachs)…
Alex Danco’s article has a very interesting thesis that captures part of the truths about SPACs: When you IPO, the bank doesn’t work for you – it works for the ecosystem. SPACs may rip you off (much higher fees than IPO), but they really work for you. This is a hot take because it’s essentially saying that the IPO process is broken, guarded by corrupt gatekeepers (the investment banks) who rip you off while they take you public.
SPACs don’t need to make money; they just need someone to believe in them
The power of SPACs is that if you’re WeWork, Airbnb, or any fancy SV tech startup that doesn’t make money, you really don’t have to convince the public markets that you’re valuable anymore; instead, you can just go find some SPAC that believes in you and take you public. Had WeWork or Airbnb done SPACs rather than the traditional IPO process, they’d be under much, much less scrutiny before being public and be in a much more comfortable position.
Many of you might not see the reason why SPACs can be such an attractive alternative to certain unprofitable private companies like WeWork or Airbnb, and it’s because the public markets and the IPO process generally have the tendency to destroy “wild-dream unicorns.” Here’s the detailed logic that I see:
There is an "investment trap” or essentially a significant disconnect between the private (primary) and public (secondary) markets. In private markets, investors like VC or PE funds care a lot about growth. They care about it so much that they’ll make up new metrics to justify your existence.
If you’re an e-commerce platform that doesn’t generate much actual revenue or positive profits, the private investors will measure you by GMV (gross merchandise value), which is how much goods in general are transacting on your platform rather than how much money the vendors are paying you the platform as your actual revenue.
For instance, if Policy Punchline sets up a merchandise store on Amazon and we sold $100 goods today to someone, the $100 will be the GMV, not revenue, for Amazon. Amazon would only generate $5 of revenue from us (assuming a 5% take rate). So, you can be a huge platform like Alibaba and have huge amounts of goods transacting but you might still not make that much actual profit as a platform.
This means, if you’re an e-commerce platform with negative earnings, VC and PE funds will often make up a hypothetical “normalized” earnings number (GMV * take rate), imagining what your value would be as a firm while you’re in fact not profitable at all.
A funny example would be the fraudulent Chinese company Luckin Coffee that was public on Nasdaq and eventually went bust for fraud. They once said they’re profitable “excluding sales & marketing costs” – yeah no sh*t, it’s like saying that I will have saved 100% of my summer salary if I don’t pay any rent or eat food…
My point is, VC and PE funds tend to ignore profitability metrics because they care more about growth – as long as you have the prospect of becoming a “disruptor,” we’ll let you keep burning cash. This is the thesis behind so many startup investments.
The public markets don’t buy all these private market narratives
They don’t because if you’re going public, you should now officially transition from your role as a “disruptor” to the “mature” company. A similar analogy is that Trump or the Tea Party can yell all they want before they get elected, but once you get elected, you’re now expected to push forth realistic policies rather than still claiming you’re “the outsider” – you’re now the swamp lol…
So, if you’re a high-growth startup that doesn’t make money and you still go public, you’ll likely get destroyed because public investors actually care about profitability and dividends. This private-public disconnect is getting increasing attention throughout the global financial markets, and the tanking of Uber, WeWork, or Airbnb’s IPOs are very good examples of how public investors keep those unicorn dreams in check.
This is at least how I have been seeing why IPOs and public markets destroy unicorn startups… But the market dynamics today are arguably very different compared to pre-Covid or even last summer. We now have even more cheap capital flowing around; there’s more volatility and froth; the economic outlook is stronger… So perhaps you can be a non-profitable company and still go public just fine?
Anyways…
Alex Danco, Matt Levine, and I are all missing out a lot of technical details about SPACs here – such as the shares & warrants capital structure that gives investors more flexibility, how the exact negotiation process may go down, the differences between SPACs and traditional spin-offs, etc.
But you can kind of get an idea of how SPACs are this new disrupting trend on Wall Street that everyone’s talking about these days.
Last summer, I felt this new thing was going to evolve into some sort of bubble because of all the market excitement, but it ended up blowing up even more than I expected as some of the charts above showed. This could have some implications for retail investors, tech growth, macroprudential risk management, and all kinds of other areas, which we’ll hopefully explore a bit later.
The saga of SPAC is to be continued…
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