A One-of-a-Kind Investment With Huge Upside and Limited Downside
Editor's note: Special purpose acquisition companies ("SPACs") were once considered shady...
But over the past few decades, increased regulations and interest from some of the world's biggest investment banks helped to legitimize the entire SPAC market. It has never been bigger, better, or safer for individual investors than it is right now.
And in today's Masters Series essay, Empire Financial Research editor Enrique Abeyta explains why you owe it to yourself to consider SPAC investments today. As he'll show you, participating in a SPAC offers several benefits for individual investors that a traditional initial public offering ("IPO") doesn't...
A One-of-a-Kind Investment With Huge Upside and Limited Downside
At first, it sounds too strange to be true...
A team of investors form a business – let's call it Really Smart Acquisition Corporation ("RSAC") – designed to raise capital to take a private company public. But RSAC can't tell you what company it wants to take public. It might not even know yet.
RSAC's management goes out and raises a pool of money, telling investors, "We're going to go out and find a great investment idea for this money."
The process of raising money is similar to an ordinary IPO process. The underwriter (a brokerage or bank) raises the funds by selling common stocks (i.e., regular shares of ownership in the company).
But unlike a normal IPO, instead of buying shares in a restaurant chain or e-commerce company, for example, you own a share of RSAC's pool of money.
In the meantime, RSAC will hold the money in an account while management – known as the "sponsor" – goes out and looks for a deal.
The sponsor goes out and looks at hundreds of transactions to try to find the best investment. It will usually specify a particular industry or geographic area for its target business or assets. Sponsors may not be prohibited from investing in any industry or location, but they typically stick to what they know best.
Our hypothetical Really Smart Acquisition Company is what's better known as a special purpose acquisition company ("SPAC"). It's a different way for private companies to go public, and it has exploded in popularity this year. But as I'll explain, certain SPACs make fantastic opportunities for individual investors...
The graphic below shows the various sectors for SPACs over the past few years. As you can see, most of the money raised has been focused on technology, media, and telecom ("TMT"), as well as consumer and general-opportunity SPACs...
Legally, the sponsor can't have a specified target already identified. Otherwise, it has to disclose that information in the registration statement.
Again, these are experienced groups of managers who conduct a massive amount of research and due diligence to identify and decide on an investment opportunity.
While they're looking for a deal, the company makes regular periodic filings with the U.S. Securities and Exchange Commission ("SEC") – just like any other publicly listed company.
Once the sponsors identify a company or asset to invest in, they formalize the legal documents around a potential acquisition and then announce the deal. The sponsors typically have a couple of years to identify an investment, though they often find one much sooner than that.
(If they don't find one in that time frame, they go through a process to return the money to investors. In this case, you usually get most of your money back – typically 90% to 95% of your original investment. The portion you don't get back is due to expenses the company incurs through the years to operate, conduct financial filings, etc. This happens rarely – only two out of 28 SPACs have liquidated so far in 2020.)
Once management finds its target, the owners of the common shares can vote on whether to participate in the deal. If you vote "yes," you'll own shares in the new company once the transaction is completed. (The ensuing process of transforming into an operating company is called a "de-SPAC transaction" and typically takes three to five months.)
If you vote "no," you'll get your original $10-per-unit investment back... even if every other owner votes "yes."
This is what makes SPACs a uniquely fantastic deal for investors: If you own shares of the SPAC, you basically get a free look at the investment... and if you don't like it, you get your money back.
Nothing else is like this in any other public market.
SPACs are growing in popularity because they're an attractive alternative to IPOs or direct listings for a number of reasons. That's why over the past several months alone, we've seen well-known private companies going public via SPAC, including space-tourism company Virgin Galactic (SPCE) and online gambling business DraftKings (DKNG).
In fact, since 2012, the SPAC market has grown from 1% of all dollars raised in U.S. IPOs to more than half this year. Over that period, the average SPAC has risen more than seven-fold in size, while the average IPO has shrunk by almost 25%...
Participating in a SPAC comes with several benefits for all of the involved parties – the sponsors, companies, and investors. Let's take a look at each...
Why Sponsors Like SPACs
- They're quicker
Compared with taking an operating company public via an IPO, which involves going through years of financial results, SPACs have none. SPACs are going to buy something, but at the outset they don't own anything. This means the process takes weeks rather than months. (I laughed when I saw tech writer Byrne Hobart recently call them "the Vegas wedding chapel of liquidity events.")
- They're more flexible
While the sponsors will lay out some initial guidelines, they have broad flexibility in the business in which they will ultimately invest. This allows them to be opportunistic and take advantage of changes in the market or the opportunity.
- They're lucrative
The sponsors aren't doing this for free. When a SPAC is formed, the sponsors will purchase "founder shares" for a nominal amount (say, $25,000). These are often registered as "Class B" or "Class F" shares.
Though the situation varies from company to company, the founders typically end up owning 20% of the business. This is called the "promote," and it lines up with the private-equity-fund structure, where they get to keep 20% of any profits they produce.
- They open doors down the road
If sponsors do a good job (and make money for investors), it increases their ability to go out and launch other SPACs in the future. This gives these entrepreneurs an opportunity to create a private-equity-like structure.
Rather than raising one big fund to do a number of deals, though, they raise individual funds (the SPAC) for each deal. This is why sponsors are increasingly launching multiple SPACs... a trend that's likely to continue.
Why Companies Like SPACs
- They're much easier than a traditional IPO
A business combination between a private company and a SPAC is a complicated process that requires extensive due diligence and legal and regulatory requirements. But it's a lot less of a hassle than doing an IPO, which involves a road show, negotiations, and plenty of red tape.
A typical IPO process may stretch out for 12 to 18 months, while a SPAC deal could close in less than six months. This means more time for the company to manage the business and grow value.
- They offer access to more capital
One of the motivations to do a SPAC transaction is for a company to have a publicly traded vehicle. Another equally important benefit is access to more capital. Typically, the majority of the pool of capital that the SPAC raised is then kept at the new operating company to fund future operations and growth.
- They can partner with proven management teams
By selling a company to a SPAC, the entrepreneur can benefit from the sponsor's experience and network. The SPAC sponsor is typically locked up from selling shares for at least a year, and usually remains a significant investor. Just like with venture-capital or private-equity funds, entrepreneurs can benefit from this relationship.
Why You Should Like SPACs
- You get a free look at a potentially great investment
As I mentioned earlier, once a transaction is announced, you can vote to not participate and get your money back. This is a "free option." If the deal looks good, you can participate and make money as the company grows. If you don't like the deal, you simply get your money back.
- You can partner with proven management teams
Venture-capital and private-equity funds are typically closed to retail investors as a result of regulatory constraints. Ownership in a SPAC allows investors to partner with top investment professionals and benefit from their skills. SPAC sponsors also typically have a significant amount of capital invested alongside the investors, so they're even more motivated.
- You're protected
The SPAC is registered with the SEC and subject to extensive regulation. At this point, many well-established provisions exist in the typical SPAC that serve to protect investors' interests. Today, SPACs are well-regulated investment vehicles, just like other publicly traded stocks.
Let's look at how one of the highest-profile SPACs over the past year has performed...
In May 2019, American businessmen Jeff Sagansky and Harry Sloan formed a SPAC called Diamond Eagle Acquisition Corporation. It began trading under the ticker DEAC at $10 per share, as most SPACs do, and drifted sideways for a few months.
In December, Diamond Eagle announced it was taking digital sports-betting company DraftKings public. In late April, DraftKings began trading on the Nasdaq under the ticker DKNG. Investors flooded into the stock and shares sit around $63 today – a 530% return in less than 10 months...
The story was similar with electric-truck maker Hyliion, which announced it was merging with Tortoise Acquisition (SHLL), another SPAC, in June. In September, shareholders voted to approve the deal... And today, SHLL shares trade for about $45 – a 350% gain in just three months.
With some of the world's best investors – like Sloan, billionaire hedge-fund manager Bill Ackman, billionaire entrepreneur Peter Thiel, and venture capitalist billionaire Chamath Palihapitiya – recently launching SPACs, one thing is clear: This is one of the most exciting and potentially most profitable times in history to be an investor.
Regards,
Enrique Abeyta
Editor's note: We hope you've learned a lot about SPACs in this weekend's Masters Series. Now, if you want to take your investing game to the next level, you must join Enrique for the SPAC Investment Summit this Thursday, October 8, at 8 p.m. Eastern time.
During this FREE event, you'll get all the details about a new SPAC deal that could give you a chance to make up to 25 times your money. And remember, you often need as little as $10 to get involved in these types of opportunities. Reserve your spot right here.