Pitfalls and Profits: SPAC Investing
Wall Street loves a chance to make billions of dollars - as long as it makes most of the profits and transfers most of the risk. The now-popular special purpose acquisition companies (SPACs) were created just for that.
Like they used to say in the Old West, when you sit down at the poker table and don't know who the sucker is, it's you.
SPACs are on fire lately. They are nonoperating companies that get a listing on a market like the Nasdaq or NYSE.
They are also called "blank check" companies because they essentially give some well-known experts a blank check to buy nonpublic companies in their field.
They go out and buy an existing company or startup. That company starts trading through a reverse merger and the early SPAC investors make money off their warrants with less hassle and oversight than a traditional IPO.
Case in Point
For example, five years ago, Landry's Inc. billionaire Tilman Fertitta took Landcadia Holdings public for $345 million. It had no model, no income, no business, and barely any employees. Despite this, dozens of hedge funds piled in on the deal.
A few years later, Landcadia bought a DoorDash-type company called Waitr for $252 million in cash. You've probably never heard of Waitr (NASDAQ: WTRH) because the company struggled enormously. The stock price went from $14 to $0.34 before bouncing back. Late investors got hosed.
However, due to the magical alchemy of Wall Street, the hedge funds that invested in Landcadia Holdings did just fine. Virtually all recouped their initial investment - with interest - and most made money by exercising warrants in the aftermarket.
According to Forbes:
Some 97% of these hedge funds redeem or sell their IPO stock before target mergers are consummated, according to a recent study of 47 SPACs by New York University Law School professor Michael Ohlrogge and Stanford Law professor Michael Klausner. Though they're loath to talk specifics, SPAC Mafia hedge funds [returns from SPACs] currently run around 20%.
There is very little risk to the Wall Street insiders, but as usual, regular investors get the short end of the stick. It's no wonder these things are hugely popular.
Big names like Shaquille O'Neal have partnered with some ex-Disney execs and the son of Martin Luther King Jr. to create a SPAC with the idea of buying tech and media companies.
Former U.S. House of Representatives Speaker Paul Ryan and Oakland Athletics executive Billy Beane are also launching SPACs.
And they are raising money.
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Per Money For the Rest of Us, "According to SPACInsider, in 2020, 247 newly formed SPACs raised $83 billion in capital through initial public offerings."
More SPACs were created in the last two years than the previous 18 years combined.
Money For the Rest of Us continues, "The average SPAC IPO in 2020 was $336 million compared to $230 million in 2019."
The only reason SPACs exist is to get around the rules that protect IPO investors and make money for Wall Street insiders.
The chairman of the SEC, Jay Clayton, has said:
One of the areas in the SPAC space I'm particularly focused on and my colleagues are particularly focused on is the incentives and compensation to the SPAC sponsors. How much of the equity do they have now? How much of the equity do they have at the time of the IPO-like transaction? What are their incentives?
Furthermore, SPACs are poor performers. SPACs that went public between 2013 and 2015 not only didn't beat the market, but they didn't beat traditional IPOs either.
Your Cash Is Locked Up
On top of this, when you buy a SPAC the initial proceeds are put into an escrow of government bonds until the merger is closed. And after the IPO, they can be locked up for an additional 180 days or more. It can take up to two years to get your money out.
If the SPAC fails to make a merger in two years, the money is returned. In this case, you've locked up your money for two years and have nothing to show for it.
In conclusion, you should avoid SPACs unless you are an insider.
Don't get me wrong - IPOs are a great way to make money.
Shares of DoorDash flew over 80% higher on its IPO debut...
Then Airbnb roared over 110% following its first offering...
Snowflake shares spiked 115% higher on its IPO...
A good friend and associate of mine, Jeff Siegel, has figured it out. He says the real money to be made in the IPO market comes from investing in pre-IPO shares. But unless you're very wealthy or very well-connected, you won't have access to most of those opportunities.
Later this week Jeff will be announcing an investment webinar in which he will discuss the current IPO market and give details on what he calls some of the "under-the-radar" action. He says he can't give any specific information on the event just yet. But he promises something big is up his sleeve. So be on the lookout for that from Energy and Capital later this week.
All the best,
Christian DeHaemer Since 1995, Christian DeHaemer has specialized in frontier market opportunities. He has traveled extensively and invested in places as varied as Cuba, Mongolia, and Kenya. Chris believes the best way to make money is to get there first with the most. Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor's page.