Doc's Daily Commentary
Mind Of Mav
SPACs Are The New IPO
Today I’ve got something interesting to share.
First, some context.
It’s no secret that the traditional IPO (initial public offering) is dying. That fact alone was what drove my interest and advocacy for private equity offerings through security tokens, i.e., STOs.
Despite how terrible IPOs are, despite how draconian the process is, and despite how much scrutiny is involved with becoming a public company — we still see companies publicly list on stock exchanges because how the insane amount of capital that comes with it.
This is known as the “IPO Pop”, and it’s quite the event. Whenever we see a traditional IPO, the stock price pops. It gets us tweeting. It gives us FOMO. Most importantly for the bank, it makes their clients (that bought the pre-IPO stock) richer.
Banks intentionally design this to happen. I imagine they celebrate the massive wealth arbitrage with bottles of champagne while never asking if they actually did anything to deserve the millions that were showered upon them.
This is why the IPO is dying.
This arbitrage by the banks is very much daylight robbery of the very companies that go public. It is legalized theft.
Everyone needs to realize this unneeded wealth transfer comes straight out of the pockets of employees, founders, & investors. The IPO “pop” you hear is money going out of your pocket and into the hands of the bank’s best brokerage clients.
But we put up with it because it’s the only way for companies to seek public investment.
. . . or is it?
Let me introduce you to the SPAC.
Don’t get caught up by the weird-sounding acronym.
Instead, when you hear or read SPAC, train your brain to translate it as “IPO 2.0” and you’ll have an easier time.
To expand the context for SPACs so we better understand what “IPO 2.0” really means, let’s look back at the last 40 or so years of financial markets. We can make a broad generalization to say that each decade has been characterized by a financial innovation, which then serves to define milestones in economic history.
Going back to the eighties, we saw the introduction of the high-yield bond. It powered the high-flying career of junk-bond king Michael Milken, and helped bring leveraged buyouts to the forefront.
Then, in the great bull market of the nineties, conditions highlighted the exponential growth of the mutual fund, which captivated retail investors and cemented star managers such as Peter Lynch and Michael Price into investment lore.
In the 2000’s, certain complex credit products such as credit default swaps and collateralized debt obligations were borne of a credit binge, of which legendary hedge fund manager John Paulson utilized to make billions of dollars betting against the housing market, setting the stage for the “greatest trade ever.” These CDS instruments also defined the decade by serving as one of the primary causes of the 2008 credit crisis and crash.
Following the tumultuous end of the decade, and fresh off a recession, a more pedestrian financial instrument best represented the years following 2010: the exchange traded fund (ETF). Low-cost and easy to use, ETFs helped bring index investing to the masses, popularized by firms such as Vanguard and iShares.
But, as this decade kicked off, we’ve clearly seen some chaos that will likely still be playing out by 2030. Just as it’s too early to tell what economic conditions will look like between now and then, it’s also too early to tell what financial instrument best defines this new decade.
However, the SPAC has made a strong case to be the defining financial instrument of the decade.
Already, we see that SPAC IPOs are beginning to rival traditional ones:
It comes down to the experience and incentives.
All three stakeholders of a SPAC IPO (companies, lead investors, banks) can have equal or better experiences with a SPAC than a traditional IPO.
Now, before going on, I should mention that SPACs are not a new concept.
In fact, they’re three decades old at this point. In the 1980s they were used in thousands of penny stock fraud schemes. The government clamped down hard with legislation: the Penny Stock Reform Act of 1990 and SEC rule 419. In the early 1990s, there were fewer than fifteen blank check offerings.
In 1992, a new form of blank check company was developed. The aim was to have enough investor protections to be approved by the Securities and Exchange Commission (SEC). This new entity was the SPAC.
While they had a brief surge in popularity before the 2008 crash, they largely fell out of favor in the years that followed. The simplest reason why is that bull markets disincentivize change: if what’s working (IPOs) is making tons of money, why would you change that? But, as the longest bull market ever came to a close (or at least isn’t the same certain bet that it once was), the stakeholders sought alternatives to the bloated IPO.
Here’s what’s interesting about SPACs: All major stakeholders benefit from a SPAC.
Importantly, instead of banks being the main beneficiary (as is the case with an IPO), in a SPAC IPO the company going public is the main beneficiary. Novel concept, right?
Compared to a traditional IPO, SPACs provide companies:
– Security during volatile times (like today)
– Clear pricing
– Straightforward IPO process
So, again, why we’re seeing a surge of SPAC IPOs is due to the pandemic and the subsequent wave of uncertainty that got the market spooked!
SPACs provide a more secure, alternative route of going public. The Wall Street Journal explains why, with an added commentary from Nikola:
Getting an IPO done began to look uncertain as markets tumbled, recalled Nikola Chief Financial Officer Kim Brady. With a typical IPO, a company learns how much capital it is raising only after several months of wrangling with underwriters and investors. It can also fall through at the last minute, especially if markets slide. A SPAC deal [M&A] can take a similar time to complete, but the negotiations are simpler—involving the company and the SPAC—and the terms are determined earlier in the process.
Nikola unveiled its tie-up with VectoIQ in March and completed the deal last month. Its valuation has since soared to $19.5 billion.
“We chose the SPAC route because there was simply too much uncertainty in the market with the coronavirus,” Mr. Brady said in an interview. “If we had pursued the IPO path, we would not be a public company at this point.”
I can’t stress this enough: The pricing process of traditional IPOs infuriates companies. Not only do they leave money on the table (the IPO pop), the whole process is a pain. As Nikola’s CFO noted above, SPACs provide companies more control and clarity on the price. Compounding that, IPOs are being underpriced by 80% on average this year. The SPAC now offers a lower cost of capital.
SPAC IPOs are much simpler, quicker, and less stressful than traditional IPOs — and cheaper, too!
It’s a no-brainer.
To further illustrate that, let’s compare the process of an IPO vs. a SPAC IPO:
In a traditional IPO, a business undergoes a lot of scrutiny. The business has to file an S-1 that requires a host of detailed information: planned use of money, business model, how they are pricing their shares, etc.
With SPACs, it’s straightforward. The SPAC goes public with the ‘pool of money’ part only. This makes SPAC IPO nowhere near as scrutinized. How do you scrutinize cash?
Once the M&A is done, a less painful SEC disclosure is required.
Now, if you’ve gotten this far, I bet there’s a lingering question you’re mulling over: SPACs sound great for the company going public, but how are they different for investors? The catch has to be that investors get the short end of the stick, right?
Would you believe that SPACs are a better arrangement for retail investors, too? I’d go so far as to call them investor friendly! Here’s why.
Major investors (called sponsors) are incentivized to start SPACs. Namely, until the target company is M&A’d, sponsors can park their money in high upside, low downside ways.
There are two benefits for SPAC sponsors by going public. First, they get tons of leverage. Typically a SPAC sponsor funds 2% of the vehicle, and public investors fund 98%. This helps the sponsor buy bigger companies.
Second, in exchange for running the SPAC, sponsors get 20% of the SPAC for almost free!
There’s minimal downside for sponsors. The money sits in a bank account while they search for a target. If they don’t find one, or the deal doesn’t go through, investors get their money back (minus bank fees).
In a world of excess capital, what’s not to love?
So, we’ll continue covering SPACs tomorrow, especially regarding how you can get involved, but the thing to know is that SPACs are back in a big way this year.
The current generation of SPACs includes better-quality companies, better management teams associated with them, and also better sponsorship—which all creates a virtuous cycle and attracts a different kind of investor in your SPACs.
What’s most interesting is that SPACs are still relatively unknown despite their recent involvement (and subsequent explosive growth) with the high-profile hyperbolic charts of Nikola Motors (NKLA), Draft Kings (DKNG), and Virgin Galactic (SPCE).
Furthermore, SPACs remind me somewhat of 2017 crypto in that there’s lots of speculation and capital flowing around. It’s also possible to see 1000%+ gains with SPACs, so the profit motive is akin to crypto’s ICO year as well.
See you tomorrow.
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