A SPAC (Special Purpose Acquisition Company) is a great way to make money…if you’re one of the managers of the SPAC. Otherwise, stay away.
The idea that gave birth to the SPAC is not a bad one. The formation of capital to invest in a company is nothing new, and can be very profitable for the investors. But more often than not, the SPAC structure makes for an unsavory deal for investors.
There are four reasons the SPAC structure is flawed.
- The managers are given a bag full of money to shop with, and have no incentive to give it back,
- A deal is completed to ensure employment for the managers and their cronies,
- The management of the company being purchased often has an incentive to make the company appear healthier than it actually is, and
- The company being purchased is usually for sale for a good reason.
A Bag Full of Money Helps the Medicine Go Down
Human nature dictates that in the majority of cases the managers of a SPAC are going to find a company to purchase. If I gave you a bag of money and told you to go invest it, very few of you would come back and say they couldn’t find anything in which to invest.
Once the SPAC is funded it is the “job” of the manager(s) to find an investment in which to place the money. If he doesn’t find an investment in the (usually) two year time frame, then he has failed at his job.
Do you know many individuals who would give back the money and be labeled a failure? I don’t. And I’d be willing to bet that the percentage of individuals on Wall Street who would admit failure is even smaller than that same percentage among mere mortals.
Very rarely does a SPAC return funds to investors. With money already in hand the deal, good or bad, will be done.
So as Long as I Find a Company I Can Add CEO to My Resume? Got It
The SPAC management, or employees of the SPAC, more often than not becomes the management of the entity they purchase with the SPAC funds. Empirically this makes sense. After all, they identified the opportunity, have done a ton of research, and believe they can better run the target company to make it more valuable.
In reality they’ve guaranteed themselves a paycheck. The company that is purchased can do better, or not, but management has pretty much guaranteed a paycheck for themselves for the next few years at a minimum. Turnarounds take time.
Often the “name” on the SPAC (that’s the person who everyone in the business community knows and is willing to invest with) will not take a management roll in the new company. But if you check the footnotes carefully you’ll find that either they, or their management company, will have a consulting agreement with the new company that ensures they get a fat paycheck for a few hours work each month. Nice work if you can get it.
You’ll Pay Me How Much to Leave? You’re Getting a REAL Bargain
Have you ever had a job that you hated? Maybe it’s with a company that is constantly struggling to stay above water, and as the rats leave the sinking ship the rats that stay behind just have to bail faster and faster. What if you were in that job and an angel descended and said they would pay you five times your annual salary and all you had to do was leave?
Scrreeeech…the sound of your tires as you peal out of the parking lot.
In many cases that’s the position the management of a company targeted by a SPAC finds themselves in. They’ve been struggling with a company for many years, and now the turnaround gurus are there to save the day. Never mind that the current management has been trying their best to get the company profitable for years.
The SPAC guys are smarter, right? And what’s a few million extra in the hands of ex-management to get them to make the company look like a hidden gem, praise the expertise of the new management in what they “know will be a spectacular new age” for the company, and sneak off into the night with their new found treasure.
I’m not implying anything nefarious here. The selling company, in any takeover in which they are trying to sell the company, will try to make the company look like a gem during the due diligence process.
But, I do believe it’s easier for the SPAC managers to spend more than they should. Since they are already holding the bag of money in their hands when they show up at the target company’s door, they are more likely to let a few of the negatives slip through the cracks.
Have I Got a Bridge for You
Keeping our focus on the company being acquired, I have rarely seen a SPAC acquisition in which the stock of the newly formed company has increased in value immediately after the close of the acquisition. (And that’s kinda the point of the title, and the whole article here.) What kind of shape are the companies in that most SPACs acquire?
Are these cutting edge, whether it’s technology or new business model, companies that are growing like weeds and can’t produce enough of their product to meet demand? Not likely. While there can certainly be exceptions to the rule, SPACs generally buy down- on-their-luck companies that can’t wait for someone to throw money at them.
These companies are “projects.” There is nothing wrong with owning a “project” company, practicing some patience, and having that company stock nicely reward you over time. You can make some great money that way when you correctly value the company and pay the right price for it. But the SPAC structure makes it more likely than not that the target company will not be bought at a bargain price.
If you show up at a car dealership with $50,000 and tell the dealer you have $50,000 to buy a car, guess what…you just bought a $50,000 car. Maybe the last person into the dealership paid only $45,000 for that same car, but you had $50,000 to spend. Why is the dealer going to sell for less than that $5o,000.
SPACs are publicly traded, file public statements with the SEC, and EVERYONE knows exactly how much they have to spend on a deal. As a prudent businessman, if I get a call from a SPAC that is interested in looking at my company as a possible acquisition the first thing I’m doing is pulling up the SEC filings to see how much the SPAC has to spend.
Next, I’m running the valuation numbers for my company to come up with what I think is a fair price. Assuming the SPAC has $100 million to spend my very complicated free cash flow / price to sales / return on investment / book value / lick my finger and stick it up in the wind valuation looks something like this: X + Y + Z = $100 million. I’ll fill in the X, Y, and Z later this evening in between drinking champagne and visiting the Ferrari dealership. (Where, btw, I tell them I’m on a VERY tight budget, and think I can only afford a used Ferrari.)
So, Are SPACs Inherently Evil?…Yes, and No
Investing is a game of percentages and probabilities. Nothing in investing “always” works this way or that. And once something assumes the moniker of “always” there is usually hell to pay, e.g. housing prices “always” go up.
SPACs are no different. While the structure of SPACs encourages bad decision making on the part of the SPAC management, that is not to say that all SPACs end in flames after making an acquisition. Some actually do quite well. Check out TTS and BKW after they closed their respective acquisitions.
But the more likely outcome is something like NETE. Net Element is the poster child for everything described above, and more. Play the probabilities and don’t invest in a vehicle that is weighted against the initial investor.
Finally, if there is a SPAC you’re interested in, just wait until the acquisition is completed before becoming an investor. You’ll have more information, and you’ll no longer be investing in a SPAC, but in an actual company. And, even with some of the better SPACs, such as BKW mentioned above, you could have gotten in around 18% cheaper a short time after the acquisition was completed.
In addition to investing after the acquisition, there are certain trading strategies which can be employed around a SPAC acquisition announcement. If you are nimble in your trading, these strategies can produce a substantial profit in a very short time.