Hey Jeff, since I share in and appreciate your investment philosophy, I have missed your insight throughout much of the year. So, I am very pleased to continue benefitting from your research once again and am excited to hear more about your future plans at Brownridge.
One of the investment ideas that you wrote about previously was SPACs. The inflection point for public acceptance of taking companies public in this manner seems as though the timing couldn't have been worse.
Most of the active SPACs during the past few years seem to have either failed to find a viable partner or took a company public that has struggled and usually failed to avoid a plummeting share price. Some have even not survived.
That said, I love the concept and have hopes for this method to revive its reputation. Where do you now see SPACs headed? Has the market lost its trust in companies going public in this manner or have all the "good" private companies just been waiting on the sidelines for economic conditions to improve? Will this method have worthy investment candidates again? — Chuck K.
Hi Chuck, it’s great to reconnect and I really appreciate the interesting question. This is a complex topic.
I like to think of this current generation of SPACs as the third generation of these “blank check” companies.
We can think of a SPAC as a shell company that has raised capital and gone through the hassle and expense of taking the company public.
SPACs have no earnings at all… other than some interest that they might earn on their capital raised.
The goal for the SPAC management team to is find a real operating company to merge with, agree on a valuation and deal structure, and then affect a reverse merger to help the operating company go public.
The advantage of doing so for a private company is a faster, cheaper path towards accessing the public markets.
The advantage for normal investors is the ability to effectively gain pre-IPO shares in high-growth companies, something that has historically been only available to high net worth investors.
The market significantly improved for SPACs in late 2019 through 2021… But when the economy and markets suffered due to poor economic, monetary, and fiscal policy, the entire IPO market, including SPACs, dried up.
This year, there were only 30 new SPAC IPOs, and just 87 de-SPACs (companies going public via a reverse merger with a SPAC).
Not surprisingly, almost all of these companies were very unattractive.
High-quality companies simply don’t want to access public markets in these types of market conditions. This is because they won’t achieve a high valuation, so most boards will decide to postpone and wait for better market conditions.
So your instincts were correct about this. The best companies are waiting on the sidelines.
But what happens when the markets improve and IPOs roar back to life? What will that do for SPACs?
I wish there was a simple answer. But in reality, it depends.
One of the SPAC market dynamics that was revealed over the last few years was something caused by what I refer to as the “SPAC mafia.”
There is a group of financial institutions that invest heavily in SPACs only for yield. They gain large allocations to SPACs when they are formed, get the warrants, and have no intention of holding their shares until the SPAC merges with a private company.
Because of this, SPACs that had large exposure to these kinds of institutional investors suffered when they merged with their target companies.
It wasn’t unusual to see, 80%, 90%, or even 96% redemption rates prior to the mergers.
That means that if a SPAC had raised $100 million, and experienced a 96% redemption rate prior to the merger, the private company would only receive $4 million in funding (instead of the full $100 million). Feels like a bit of a bait and switch, doesn’t it?
What does this mean going forward?
I believe that SPACs will still be a great alternative to traditional IPOs for smaller companies to access the public markets. But high-quality growth companies will become a lot more picky when choosing their SPAC to merge with.
The most important thing to look for will be investors in the SPAC that intend to hold on to their shares through the merger (i.e. not redeem their shares and siphon money out of the SPAC).
They’ll also focus on the quality of the SPAC executives.
For example, if you’re a medical equipment company looking to go public, ideally you’d want the CEO of the SPAC to be a former top executive from a successful medical equipment company (i.e. someone that you’d want on your board).
To wrap up, there are still two things that are true today about SPACs that I highlighted when I first began writing about them years ago…
First, most SPACs are absolute junk. They are formed by financial “operators” (I’m being kind) with no real world operating experience. Their goal is to structure their SPACs in a way that enriches themselves at the expense of normal investors. It’s no surprise that I detest these kinds of SPACs.
The quality of the executives behind any SPAC is critical to any investment thesis in a SPAC. They must be in it for the long haul, and they have to have direct experience in the industry within which they are looking for a target.
Second, high-quality SPACs are unique investment vehicles. They share two traits that usually aren’t found together…
They have little to no downside, because an investor can always choose to sell their shares around par value (usually $10) if they don’t like the announced merger.
And if a SPAC doesn’t find a company to merge with, it is legally required to give all the money back to investors.
At the same time, SPACs have incredible upside potential. Buying a SPAC before a merger happens is the same as buying pre-IPO shares in a private company. And the added warrant that most SPACs give investors is just additional upside.
It’s hard for me to not like SPACs as it gives normal investors downside protection and access to pre-IPOs shares with great upside. As long as we’re picky and diligent about the SPACs we invest in, as well as the companies that they merge with.
Thanks again, Chuck. That was a bit long winded. But the context is really important for a subject like this.
