What are SPACs and why don’t people know about them?
Updated: Jul 3, 2020
In last month’s post, I wrote about how I was planning to purchase VTIQ and DKNG and sell them in June for a quick profit. An update on that will be out soon, but what really caught my attention when researching into these 2 particular stocks were Special Purpose Acquisition Companies, SPACs for short and how they have become quite common, without being too popular in the larger retail investing market.
What is a SPAC?
SPACs are companies that are created with the specific objective of acquiring another business. SPACs will undergo the standard IPO process but all the money generated will go into a trust fund, which will hold on to that cash until the SPAC has found a target company to acquire. The SPAC will then start looking for potential companies to acquire. Many SPACs, when they start out, will declare what type of industry they are looking at in order to attract investors. There are specialised SPACs for Energy, Technology, Consumables etc. The whole process normally takes about 2 years from start to finish. Once the target has been acquired, the stocks starts trading as just like any other stock, most of the time undergoing a change in ticker symbol as well.
Some notable companies currently being traded on the stock exchanges that started off as SPACs are Virgin Galactic (SPCE), Nikola (NKLA), Draft Kings (DKNG).
While SPACs started appearing in the 1990s, its only recently started getting more attention from the larger investment banks. Citigroup, Goldman Sachs and Credit Suisse have all been underwriters for SPACs recently. Other than the funding, SPACs are also now managed by executives with years of experience in Fortune 500 companies. This has greatly increased the legitimacy of SPACs over the years and most of them end up becoming successful.
If buying a company share during an IPO is starting off at the first floor, then SPACs are basically the equivalent of getting on at the basement floor of the same company. Sure, there are some obvious differences, but the strategy is similar. I see, SPACs as mostly short to medium term investments.
These are the things that one should consider before investing in a SPAC:
Does the company have a good track record of mergers and acuisitions? What are their past SPAC successes?
What is the background of the leadership team and do they have sufficient industry expertise?
What industry is the SPAC targetting
Is the target company a brand that will generate hype and demand around it?
SPACs: The Good and The Bad
As I mentioned above, whenever a SPAC confirms an acquisition the hype and interest in the company goes through the roof. It is especially obvious if the company being acquired is also one that has a lot of media presence. This makes conditions ripe for a short term but high margin trade. When you invest in a SPAC, what you are investing on is basically the leadership team’s ability to find a smart and high value acquisition. You are also hoping that they will market the acquisition and drive up hype, just as investment banks do before a company IPOs. SPACs basically allow you to get in before the announcement of the IPO itself and sell when the interest is high. If you choose the right one, then the returns are pretty good, just check out NKLA and DKNG.
As you can already figure, not all SPACs end up acquiring a company. There could be various reasons for this. But, according to SEC rules, the SPAC has about 24 months to actually merge with an actual business and sometimes they just run out of time to find one. So what happens then? Well, they are forced to liquidate and return the cash to the investors and while you do not lose all your money, you can lose from 20%-40% of your investment.
Also, not all SPACs see success after the merger. There could be little interest in the new company or the stock market might be falling during the merger which means that you could lose value.
Upcoming SPAC mergers
Since trading on the last 2 SPACs has made me some considerable profits, I began researching on the next high profile SPAC. For NKLA and DKNG, I got in really late, i.e. months after the merger announcement, and it was still profitable. So I am quite excited by the prospect of getting in early on one of these "faux IPOs".
The one that has piqued my interest is Forum Merger II Corporation (FMCI). In mid May, FMCI announced that “it has signed a letter of intent and expects to sign a definitive agreement to acquire a high-growth, plant-based food company with a broad portfolio of innovative products that are aligned with major food trends and sold through leading retailers and distributors across the United States”. Source: Forum Merger website. Their June update on the merger states that "its discussions with the Target remain active, and the Company expects to sign a definitive agreement in the coming weeks"
Soon after the announcement, the stock price took off:
So, they have not yet named the company that they are going to merge with but the only clue that they have dropped is that its is a plant based food company with a disruptive product. We have seen the success of the Beyond Meat IPO, and there is no other similar company that is public right now. So I think this SPAC is a great way to get in before another IPO of a disruptive plant based food company.
Of course there remains the risk that the merger might not actually materialise, because as of now, the only confirmation we have is that of a letter of intent, which is not a legally binding contract. However, the potentially astronomical returns comes at a cost and hence this is the risk. So definitely, do your research on this one, or even wait till something more concrete is released, but FMCI is something I will be watching closely.
There are many other aspects of SPACs that I have not covered in this post. However, this is an area that many are not paying too much attention to right now, and hence is a potentially high profit space. Once the masses get in on this, it will end up like all high margin products, it will turn into a bubble.
Some reading materials on SPACS to get started:
Bloomberg: Risk of SPACs
Disclaimer: This post should not be interpreted as investment advice as I am not a professional financial consultant. The objective of this blog is to share my experiences with others and receive feedback. I will provide links to my information sources to the best of my abilities, but the reader is responsible for their own due diligence