What is a SPAC?
By: David Ferrara
Tags: Stock Market, Economy, Personal Finance, Investing, Stocks

And why is so much money flooding into them in 2020?

Chamath Palihapitiya on CNBC photo via cnbc.com

If you follow the stock market you may have heard of these stocks. Here is probably the most famous one in 2020.

Chamath Palihapitiya, an early Facebook exec, and a guy you seemingly see all over the financial news world these days, got together with Sir Richard Branson, founder of Virgin Airlines. Where Chamath’s SPAC acquired Sir Richard’s new space exploration startup Virgin Galactic.

What exactly is a SPAC?

To explain what a SPAC is let us walk through how this one came into being. First of all a SPAC is an acronym for a Special Purpose Acquisition Company. However, frequently, they are simply referred to as “blank check” companies.

The Players:

Social Capital — this is Chamath’s Venture Capital Firm

Hedosophia — this is another Venture Capital Firm, started by a gentleman named Ian Osborne.

Social Capital Hedosophia Holdings Corp. (IPOA) — this is the SPAC itself

In the SPAC’s initial public offering (IPO) in September of 2017 they sold 69,000,000 shares of common stock for $10 a share. Raising capital of $690M. At the time this occurred the SPAC had no operations or business of any kind. The purpose of the $690M is now to go out and make an acquisition. Hence now it is simply a “blank check” waiting to make that acquisition.

So, if this all happened in 2017 why are we just hearing now

Well, because Chamath and Richard didn’t close a deal until 2019.

That “blank check” was just sitting in Chamath’s hands while he was looking around figuring out what to blow his $690M wad on.

Meanwhile, the stock was trading on the stock exchange under the IPOA ticker that whole time. Since, there is no underlying business and stockholders only hold a piece of stock entitled to some cash, the stock price shouldn’t move off of $10. And in fact generally, that’s where a SPAC’s stock price sits until they make an acquisition.

So, just one piece of advice. If you see a SPAC selling for $15 before they have made an acquisition. Just be aware if you acquire that stock you are spending $15 for $10. Not the greatest deal in my mind.

What is the benefit of a SPAC

Raising capital through a SPAC is a relatively simple process. After all there is no underlying business making things complex.

The legal and accounting hurdles to put together an IPO to go out and raise money are routine and boilerplate. The SEC filings and legal and accounting work are all routine and repeatable which all leads to lower costs.

In this SPAC, the fees paid to lawyers and accountants other was approximately $1M. Just as some comparison Zoom paid about $4.5M and Uber $15M.

And as someone who has worked through a few IPO’s let me tell you this is just fees paid to third parties. There was also a large burden from the internal labor required by management as well as the various legal, finance and accounting departments.

So, basically one giant benefit of a SPAC is that it is a way to bypass the time, energy, and cost that the typical IPO process requires of a Company.

Back to our Virgin Galactic story

So, in the meantime Virgin Galactic (SPCE) has been doing their thing without any thought to Chamath. They actually, were founded by Sir Richard in 2004 and have been working towards getting into space ever since. They were scheduled to launch their first shuttle into space in November of 2020 but have delayed it due to Covid restrictions. But sounds like they are close.

Chamath and his IPOA SPAC then came and using his blank check (which has increased to $720M by this point due to a couple of further capital commitments other companies (Boeing for one) bought Virgin Galactic. Then they simply changed the ticker symbol from IPOA to SPCE and boom Virgin Galactic is a publicly traded Company. No need for a complex IPO.

More and more SPACS

Just this fall Richard Branson announced his new (completely unrelated to Virgin Galactic) SPAC VG Acquisition Corp that is looking to raise $400M.

Chamath, Social Capital, and Hedosophia are in the meantime setting up their 4th SPAC together. This one looking for $500M.

Gary Cohn, an ex Goldman, ex Trump advisor is setting up a SPAC looking to raise $600M.

Famous pain in the ass… ahem I mean activist investor Bill Ackman has gotten his SPAC off the ground in 2020. His SPAC raising a whopping $4B alone.

In 2019 a record 59 SPACs raising $13.6B were set up.

In 2020 there have already been 165 SPACs set up through October raising $65B. And news in November seems to indicate a flood of new SPACs will be coming by the end the year.

What is going on?

Well, there are two primary factors driving this boom in SPACs.

1) The SPAC is the new IPO. Don’t get me wrong, some regulation protecting shareholders is a good thing, but when the regulation hoops that companies need to jump through get to a certain height, they will find other ways to access capital. IPO’s have simply become to much of a burden and too expensive.

2) Ok, so IPO regulations is like 10%** of the reason. 90%** of the reason is there is just a ton of money out there looking for a home. Private Equity, Venture Capital, Hedge Funds, Pension Funds, Sovereign Wealth Funds and yes even retail investors are all trying to figure out where to put their money. And when the money supply hits a certain point thing will get crazy.

** percentages may be estimates

A corollary

In 2017, Masayoshi Son launched his $100B Vision Fund. This was shocking at the time as new funds generally are not this large.

The big question at the time I remember, was not how Masayoshi was able to raise that much money. Masayoshi after all had an impressive investing history, and made multiple billions of dollars as an early investor in Companies such as Yahoo and Alibaba. So, he had a track record that people believed in.

No, the question was how he was going to find enough places to put his $100B. And that turned out to be the correct question.

When somebody asks you to invest $1K in their Company and your total net worth is $1K you are going to spend a lot of time doing your due diligence to make sure your not throwing away your life savings.

When somebody asks you to invest $1K in their Company and you have $100M then I think perhaps you might not be as thorough in your due diligence. Especially, when you have to find someplace for the other $99,999,000 to go to.

This is likely why the Vision Fund has been something of a disaster over the last few years with disasters like their WeWork Investment. If you hadn’t heard, in 2019, Softbank invested in WeWork right before their planned IPO at a valuation of $47B. This spring Softbank had to mark down that valuation for their investment to $2.9B.

There were other investments for Softbank that underperformed in 2019 as well. All in the value of the fund decreased by $17B.

The takeaway

I think Softbank’s Vision I fund is a lesson of what happens when there is too much money trying to find a place to be invested. And a SPAC is nothing but a “blank check” for a large amount of money looking for a place to be invested.

When the SPAC market blows up like it currently is, I do not see that as a good sign for the stock market. The SPACs are going to take our money, go buy an overpriced asset like Softbank with WeWork, and end up losing a bunch of money in the long run.

How to be a winner in all this?

Well, as I’ve written about before. Don’t take this as a sign of imminent implosion of the market and sell everything. But you might start taking a bit off the table.

Gain Access to Expert View — Subscribe to DDI Intel