Are SPAC Stocks Worth The Hype?

Summary

• In 2020 and 2021, there have been more than five hundred SPAC IPOs brought to market - a truly huge break from the historic trend.
• Many investors have made big on SPAC stocks in this period, and many more expect to be able to do so going forward.
• In truth, any SPAC deal is only as good as its sponsors, the small print in the securities documents, and the quality of the target operating company itself.
• We dive deeper below.
• Looking for more investing ideas like this one? Get them exclusively at The Fundamentals. Learn More »

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What Is A SPAC Stock?

SPACs have gone from a niche method of making money for money-folk, to a dirty word amongst those commentators sat lobbing fireballs from atop the self-appointed moral high ground, to a very common method of bringing young companies to market whereupon their securities can be devoured by those growth-hungry investors who have themselves yet to be devoured by Q1 2021 margin calls.

As with all things in financial services, most folks like to make this stuff sound a lot more complicated than it is. Let's do SPAC 101 for a moment. We can dive into more detail some other time. For now, this is what long term investors need to know about SPACs.

'SPAC' is an acronym of Special Purpose Acquisition Company. The clue is in the title. The company exists with the special, sole in fact, purpose of acquiring something else. You can think of a SPAC as a bag of money looking for something to buy. The founding shareholders in the SPAC buy new shares in the company prior to its public listing, the same as the founders of any private company before its IPO. The company is usually set up with a memorandum to go looking for acquisitions of a certain kind - you can read what kind in the SEC documents for each SPAC - but the company is also given huge leeway to buy something else if it is deemed appropriate by, er, the company itself. So don't be surprised to see a SPAC set up to make cannabis acquisitions instead buying a space company. The memorandum also usually gives the SPAC so many years to conclude an acquisition; after the period expires, if no acquisition has been made, investors in the SPAC receive back their cash that the SPAC has raised by selling newly-issued shares - until that time, said cash is held in trust for those investors. We don't know of too many test cases where investors have had to sue to find out whether that return of cash is really available or not. So if you see any reference to "oh, I bought shares in SPAC X, it hasn't concluded an acquisition yet but my money is in trust so I get it all back if no deal happens", be concerned. As always with securities, you have your money in your pocket when your money is actually in your pocket, and not before.

If a deal is to be done, you'll see a first press release trumpeting that "Dogsbody Vulture Acquisition Corp Has Agreed To Acquire Moribund Aero Corporation" or similar. Sometimes this is an outright 100% acquisition and sometimes this is just a minority stake in MoribundCo.

What Happens to SPAC Stocks After a Merger Agreement

By the time you see that press release, the SPAC is generally already an established entity with its securities trading on the public market already. When the SPAC management team, usually some combination of financial folk and managers with experience in the target sector, happen upon their quarry, the SPAC has to negotiate and agree a 'merger agreement'. The merger agreement and associated documents - which have to be filed with the SEC, you can find them in the Edgar filings associated with the SPAC - determines things like, what % of the target company will be owned by the SPAC post transaction, and in what securities (eg. will the SPAC own regular shares in the target, or some form of shares with enhanced economics or enhanced protections). Each case is different - some SPACs will acquire say 49% of the target operating company, some 7% - different every time.

If you choose to buy securities issued by the SPAC before the merger deal is completed, be aware that what you are buying is securities in a cash shell that might end up owning x% of the target company, if the deal completes as intended. If the deal is renegotiated or doesn't happen at all, you just own a piece of a cash shell. So be aware on the way in. And if you believe that you will surely get all your money back if no deal completes, well, we congratulate you on your rosy world-view and we trust that it serves you well.

Securities Salad

The pattern in the last year or two for listed SPACs has been to issue three flavors of security. (We are going to ignore options here as options are outside the purview of our work. We suggest you read someone smarter than us if you want to get smart on SPAC options). They are typically as follows - we are going to use the worked example of the fictional SPAC, Youth Inspired Kickstarter Engines (YIKES).

• Shares - usually with the name convention YIKES. Usually common stock. As with all common stock, it could be junior to debt and / or preferred stock. If you buy AT&T common stock, your money is sat underneath a huge pile of debt and preferred shares. So even the "safest" of stocks can have complex structures atop them. Most SPACs have simple stock structures with no preferreds and little debt. So as a rule of thumb, stocks are stocks. But again - always read the small print.

• Warrants - usually with the name convention YIKES.W. A warrant in the current crop of SPACs is usually the right to buy a share of YIKES in the future, before the warrant expires, for a set price (the "strike price"). For no reason other than convention, the current crop of SPACs seems to launch with a day 1 undisturbed stock price of around $10; and warrants come with a strike price of $11.50 and an expiry some years out. We cannot say clearly enough with warrants that if you want to know what you own, you have to read the specific terms of that security. For instance, if you assume that warrants in all recent space SPACs with strike prices of $11.50 are the same - you could come badly unstuck. The time period matters. The longer dated the warrant expiry, the more time you have available for the stock to move up in price. Because for the, let's say, $2 you spend on one of those warrants, what you are buying is the right to buy the relevant share for $11.50; a total outlay of $2 (for the warrant) + $11.50 (for the share). So unless the stock price reaches $13.50, you are out of pocket. And if the warrant expires in a year or two, your risk of losing your money on the warrants is higher, all other things being equal. We are cautious folks here at Cestrian and we ourselves prefer longer dated warrants, because we think it will give us more shots on goal.
• Units - usually with the naming convention YIKES.U. Units consist of some combination of shares and warrants - usually but not always 1 share and say 1/2 or 1/3 of one warrant. As time goes by - the exact time of which will, again, you guessed it, depend on the small print - the units will cease to trade and be split into the stock and the warrants.

These tickers can be hard to find and some brokers are better than others at having them available to trade. Check with your broker if there is a specific instrument you are interested in. Naming conventions for units and warrants do sometimes vary from broker to broker.

All the above are tradable on public markets. Whether your account has permissions for the warrants and/or the units will depend on your arrangement with your broker and, again, you should check ahead of time.

The very rough logic as to which of these securities to own runs as follows but, you guessed it, you should check the particular security in each case that you're interested in.

Stocks - are common stocks. They have a claim on the assets of the company - the SPAC company only before the merger, the combined entity after the merger. They usually are entitled to dividends, not that you are likely to see any dividends from this type of company. And they carry a vote, again, a vote at SPAC level pre merger and combined level post merger.

Warrants - are rights to buy a common stock at price X before date Y. They have no claim to anything save that right.

Units - are a combination of the above.

There is a major difference in liquidity between these instruments in our experience. Stocks are the most liquid, warrants and units the least. Liquidity is good - it means you can trade in and out quickly when you want to, and the bid/ask spread offered by your broker is usually very small. Illiquidity is bad; it can take time to fill orders, market orders are risky b/c the price can move against you before filling, and the bid/ask spread can be wide, meaning you are just giving money away.

In short: SPACs are complex instruments and should be treated as such. The simple fact of them providing free money to shareholders in these instruments lately most certainly does not mean that SPACs as a class will continue to do so.

The SPACs Craze In 2020 and 2021

When we say there have been a lot of SPAC deals these last couple years, we mean, a LOT. The site SpacTrack offers a nice way to try to stay abreast. Here's their estimate on the numbers we are talking about. Not small.

Image source: SpacTrack.net

Just in our own world of space and tech we can point to 10-15 such deals that have come across our desk in the last few months without us going looking. That they have become so popular can only be, in our view, a matter of fashion or sentiment. After all if scores of money-folk walked by your front door saying hi, can you put some money in this brown bag here, I plan to buy a really great company, hey you will get shares in that company when I do, and, if I don't, I'll walk back this way and toss that money right back on your porch - you probably wouldn't think this was such a great idea.

Should You Invest In SPACs?

So what should long-term investors consider and in what situations might it make sense to include SPACs in a portfolio?

As we note above, if you are investing in companies that are yet to go public, you have to be careful. And if you are investing in them via SPACs, you have to be even more careful. And if you own complex instruments - warrants, units and those options we haven't even talked about here - in SPACs, you have to be more careful again. In case we aren't clear - none of this is like owning Microsoft stock.

The flip side is upside. The companies themselves are mainly young and so can grow quickly and demand for their securities even more so. So you have big upside potential. As to downside? Our own personal approach is to treat SPAC warrants as having 100% downside and the stocks also maybe 50% downside. No science to that. And the units, again, big downside. No science to that either.

SPACs are, in short, venture capital deals that you can hold in your public-securities account. If you consider how venture capital investors - meaning the folks with the money, not the folks spraying the money around startups like it's 1999 - handle their accounts, you might see that as a kind of inspiration. Your average US state retirement system or other kind of pension investor allocates some money to VC funds in times of boom and times of bust. A little pixie dust to juice returns every now and then. They don't expect their VC allocations to form the bedrock of the retirement obligations they have to meet, and they don't expect any kind of steady-Eddie performance from their VC investments either. They tend to play VC for the upside, knowing they are likely to get solid but less exciting returns from elsewhere in the asset-allocation stack. Contrary to popular perception, venture capital investing is a long way from a free-money-machine. VC deals tend to take longer to come to fruition than one expects, require more money than one first plans on, and rarely hit the big time without at least a couple of brushes with the End of Days.

So we ourselves, in staff personal accounts, treat our SPAC investments a little like your neighborhood retirement system treats their VC portfolio. Some happy juice in the good times, but not so much allocation at work that it can do too much harm in the bad times. We keep our allocations to SPACs small as an overall % of our accounts, and we know that those holdings could head south quickly and moreover be difficult to realize if they do. We choose the underlying companies with care, and we cast more than a beady eye over the backgrounds of the SPAC sponsor executives too. With that set of filters in place, we're happy to own our favorite SPAC names for the long and short term.

Cestrian Capital Research, Inc - 7 April 2021

Analyst’s Disclosure: I am/we are long SPCE, NSH, SFTW, ASTS, VACQ.

Business relationship disclosure: See disclaimer text at the top of this article.

Cestrian Capital Research, Inc staff personal accounts hold long positions in, inter alia, SPCE, NSH, NSH.W, VACQ.U, VACQ.W, ASTS.W and other SPAC stocks.

Comments

[roccosun]

No Momentus (SRAC) investment?

[Cestrian Capital Research]

@rogosun Held it early on and made very good money from the units. Sold out when it looked like the CEO was going to get replaced. No plans to buy back in just yet.

[roccosun]

@Cestrian Capital Research

I see. It's quite cheap again, so I consider putting it in my alternative/speculative basket. Long term conviction bets, not much trading here. I read/heard that the CEO's Russian descent could have caused regulatory problems...

I wasn't into space/SPAC before I read your piece on Spire (thank you!) and did some more research on it resulting in a buy. (I only bought Dragoneer DGNR & Altimeter AGC for the sponsors pre announcements before and still own them.) Then I got into BlackSky as well. Now I'm researching Momentus, Rocket Lab, Redwire and AST and many more non space related SPACs. Otonomo is an interesting company but has almost no existing revenue. Any thoughts on Redwire?

[roccosun]

@Cestrian Capital Research

SpaceNews' SPACs in Space ft. Spire, BlackSky, Rocket Lab, AST CEOs just released. Might be of interest. I'll watch it now.
https://youtu.be/hhcNFeqCVLs