Doc's Daily Commentary
Mind Of Mav
It was the fall of 2017.
Everyone in the startup scene was talking about one thing: Cryptomania.
Blockchain was viewed as a game-changing technology. Its merits allowed Cryptocurrency companies to offer new, verified ways to exchange money. People were rushing to fund the future! In the minds of many, even better, this time, us common folks could invest too! Watch out Venture Capitalists…
Crypto companies held initial coin offerings, the cryptocurrency industry’s equivalent to an Initial Public Offering (IPO). These companies raised millions upon millions of dollars through ICOs, outpacing even traditional IPOs at the time.
Demand was overflowing. The champagne was popping. The excitement was electric! What was not to love?
Sadly, as it turned out, a lot.
What was obvious, even in the midst of the buddle, was that the growth was 95% due to speculation. Most buyers bought with the intention to make a quick buck and cared little about the tech or the impact or the long-term viability.
If you’re reading this, you’re probably aware of all these things, so why do I deign to bring them up again?
It’s because the stock market is on fire right now with all the speculative energy we saw in 2017.
More specifically, I think that energy is about to flow into emerging opprotunity we discussed yesterday, the SPAC.
In order words, 2020 may just well repeat 2017 and be defined by a new kind of hype-driven investment vehicle, akin to “Cryptomania 2.0” :
Indeed, much of the discussion on SPAC message boards I’ve seen are about arbitrage. Gains. 1000%+ growth.
For example, right now there is wild speculation (likely unfounded) that Chamath Palihapitiya, who I’ve labeled the “Elon Musk of the SPAC space” due to his eccentric tech evangelist personality that moves markets through hype over substance, could be looking to use his SPAC to reverse merge Coinbase and take them public.
Chamath has two SPACs on the market. In April he announced the formation of IPOB and IPOC. Both are looking to M&A a tech business. IPOB is focused on businesses within the US, while IPOC is focused globally. Another speculated candidate company for the IPOB M&A is AirBNB. Today he’s appearing on CNBC and could very well be close to making an agreement announcement public.
Let’s stop here for a moment.
Think about and consider what I’ve just told you.
Are you starting to see the picture?
Here’s what I see: There is a non-zero percent possibility that you could be an investor in Airbnb or Coinbase, companies that have been valued in the past at $31 Billion and $8 Billion, respectively, before they are officially traded on the public market.
If you bought into stock of IPOB and they later announced their definitive merger agreement with either of these companies, you’d certainly be looking at a massive return on your investment in a short amount of time.
That’s the exciting part about SPACs like IPOB and IPOC: they are currently searching for a target company that will maximize their profitability when taking that company public.
Just look at the return on investment for VTIQU, the SPAC that took Nikola Motors public — $11 in March has grown to $50 today.
Sure, there’s a lot of hype in that equation, but I’m certain that other SPACs are looking to do the same with similar companies.
As an affirmation of that, electric car maker Fisker announced they will go public with a SPAC just last week.
See what I mean?
While the announcement is still fresh and in the short term the price action mostly neutral, it could very well see some activity as more details about Fisker’s future plans come out — especially if they pose a credible competition Tesla or Nikola.
There are other massive SPACs still on the hunt for their ideal company.
Bill Ackman, the controversial hedge fund manager, recently announced the biggest SPAC ever. His firm, Pershing Square Management plans to publicly list a $4 billion SPAC. Before this, the largest SPAC raised $1.1 billion.
Are you starting to see what I’m calling SPACs cryptomania 2.0? Lots of money, lots of potential upside, lots of speculation.
As a technology investor, you should get familiar with SPACs. Why?
There’s a couple of simple reasons:
One, SPACs allow long term investment in tech companies that are able to go public earlier
Two, SPACs allow access to higher risk, higher reward opportunities than what’s out there today
Ironically, replace “SPACs” in that with “ICOs” or “STOs” and you have the same basic equation we’ve been seeking: faster public investment vehicles for a more speculative market era.
After all, these characteristics are similar to the ones pitched during Cryptomania. While I believe SPACs can be a force for good, I have to wonder: what stops SPACmania from happening?
Well, for one, we have to acknowledge that the stock market is completely detached from economic reality right now. The Fed’s actions to flood the market with cheap capital has had its intended effect of detaching it from fundamentals — the hype is the only true driver of movement right now.
That said, that is exogenous to whether SPACs are truly back. In reality, my working theory is that it’s up to the market to decide if SPACmania will happen or not. There are safeguards in place (e.g. SEC Rule 419, Penny Stock Reform Act, Form Super 8-K,) but none I know that will single-handedly stop a ShitSPAC Waterfall (Cryptomania caused Shitcoins, so SPACmania might cause ShitSPACs).
So, to summate the greatest opportunity but the greatest risk of SPACs: SPACs have tons of quick upside potential, but they are a much riskier proposition than a typical stock.
According to SPAC Research, 73% of SPACs have lost value after they announced their M&A.
Yet some, like DraftKings, Nikola, and Virgin Galactic, are up multiples post-announcement.
In this regard, SPACs are pretty similar to ICOs: The average SPAC and ICO will probably not have explosive growth, but you’re doing it wrong if you place all your eggs in one risky basket.
In 2017, had you bought into every ICO equally, which of course means you’d have bought tons of losers, your overall return would still be nearly 2000% because the winners were so disproportionately large.
I expect the same to be the case with SPACs — in fact, it will likely be better because you won’t run the risk of wading through a scam minefield as you did with ICOs. Everything about SPACs is SEC-regulated, so at the very worst you don’t see a return on your investment.
Let’s get pedantic and run through a full breakdown of the SPAC pros and cons so you know the full risks and opportunities:
What are the advantages of investing in SPACs?
High upside potential with limited downside risk. SPAC investors can reap significant upside depending on the target company and know the downside risk is capped near or slightly under the SPAC’s IPO price. In Nikola’s example, VectoIQ Acquisition Corp (VTIQ) traded at or around $10 per share before ramping up significantly after it announced that it was going to take Nikola (NKLA) public. Weeks after NKLA went public, its shares traded near $80 per share, 8-fold higher than what VTIQ’s units were worth at IPO. If VTIQ was not able to find a target company, then shareholders would be paid back near $10 per share, capping the downside risk.
Exercising warrants can add significant upside. If a SPAC goes particularly well, exercising warrants can bring significant upside to the run-up seen with the common stock. For example, NKLA traded near $80 per share. Exercising whole warrants would provide you additional common stock at a price of $11.50 per share. In this case, selling the shares after exercising the warrants would have generated nearly 600% returns.
What are the risks of investing in SPACs?
Unable to Find Target Company. Most SPAC units trade at a premium once the SPAC IPO’s. Investors may pay $11, $12 or more per unit. If the SPAC is unable to find a target and decides to liquidate the trust, then unit holders will be paid at the SPAC’s IPO price, which is likely ~$10 per share, so investors may take a 10%+ loss is they paid a premium for the units.
Opportunity Cost. Because SPACs have ~2 years to find a company, there is associated opportunity cost to holding SPAC units. During the search, the SPAC’s unit price will, generally, not change much from around $10 per unit. The investor’s capital could have been used better elsewhere, generating greater returns. However, some SPACs identify a target company within months of their IPO, so this risk does not necessarily exist with all SPACs.
Too Many SPACs, Not Enough Target Companies. Not all SPAC acquisitions are successful. If there are too many SPACs seeking to take private companies public, there is greater likelihood that there are not enough good private companies to go around. There is certainly a chance for SPAC unit/shareholders to redeem their units/shares for $10 plus interest before the target company is taken public if the holders are not comfortable with the target company. In this case, the target company may not be able to raise the needed capital to complete the transaction and will trade under $10 per share. Alternatively, a glut of SPACs may create a scenario where the SPACs feel pressured to complete a deal, even if the target company is not a worthwhile target, in order to deliver something to their stakeholders.
Redemption Risk for Warrants. If the target company shares trade above a certain price per share for a certain amount of time, the company has the ability to redeem the warrants for nominal consideration (e.g., $0.01 per warrant). This forces public warrants to exercise or the warrants will lose value.
Unique SPAC Considerations. While SPACs may be structured similarly, each SPAC differs slightly in regard to their terms. It is critical to read through SPAC terms and conditions in order to fully understand the risk/reward profile associated with the SPAC.
How Do You Pick SPAC Winners?
Now that we know the differences between SPACs and ICOs, and what advantages SPACs have, as well as their risks, we now need to discuss the investing process.
So, what differentiates SPAC winners from the losers?
After researching this question and lots of poking around the internet, my takeaway is this: the credibility of SPAC Sponsor is the #1 indicator of post-M&A success.
The sponsor is the company that formed the SPAC, e.g, Cowen which formed the VectoIQ SPAC and is taking Nikola public through an M&A agreement.
Let’s dig deeper on this point — after all, fundamentals were useful in predicting ICO market movement, even if they didn’t truly matter in the long term.
In contrast, as we’ve established, the credibility of a sponsor is the #1 factor to consider for investing in a SPAC. Why?
Make sure you understand this point: Until a SPAC has M&A’d, it’s a blank check with a Sponsor attached.
I can’t emphasize that enough. Everything about a SPAC is vapor and everything the SPAC touches is a commodity until the entire SPAC IPO process is finished:
– Money is a commodity.
– Rumors / speculation are a commodity.
– Rumors / speculation the money will M&A into is a commodity.
– The sponsor is the only non-commodity in the process.
This is the fundamental difference you’ll find between traditional IPOs and SPAC IPOs, or even ICOs and SPACs: you are not investing in the company going public (e.g., Nikola, Virgin Galactic), you are investing in the company taking that company public.
Here are my rule of thumb questions I found matter for considering SPACs to invest in, based on their Sponsor:
Does the Sponsor have:
– A history of allocating money well at scale?
– Experience managing and / or being on the board of public companies?
– Experience with similar bets that the SPAC is focusing on?
If a Sponsor has all three of these, they have credibility. Credibility especially matters when one is responsible for allocating a vast sum of money towards a risky situation.
I looked into the SPACs that led to DraftKings, Nikola, and Virgin Galactic. All three of these SPAC sponsors answer yes to each of these questions.
In short, credibility helps at every step of the SPAC process. The more credibility the Sponsor is, the more they will:
– Raise money
– Attract credible targets
– Get better terms from other stakeholders
Remember that credibility doesn’t help at every step.
It’s the only thing that matters.
Hopefully, by now you have some idea as to what SPACs represent, the opportunities they provide, and why they might just be Cryptomania 2.0.
We’ll be discussing SPACs in a new channel on our Discord server, so be sure to join us there!
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