SPACs: An old phenonium revived
What are SPACs and how do they work?
SPACs stands for Special Purpose Acquisition Companies (SPACs) and it’s an old phenonium that’s been revived in the context of the pandemic. Essentially it is a listed shell company with cash that is mandated to make one investment where 80% of the money raised needs to be used for that one investment. In doing so a SPAC brings a private company public, which historically have been high-growth companies. They list on a major market, primarily most of the SPAC’s are listed in the US however there are now approximately 25 in Europe listed across Amsterdam, Frankfurt, Paris and now there are rules as of August to allow for them to be listed in the UK.
The idea is you raise money from the public in the form of units which consist of shares and warrants. A warrant is a contract that gives the holder the right to purchase from the issuer a certain number of additional shares of common stock in the future at a certain price. Warrants are there so the public get a sweetener for backing a sponsor not knowing what they are going to buy. And once the money is raised they have two years to engage with the private market to find a private business to merge with the SPAC and ultimately becomes listed.
How should private companies think about these alternative ways of coming to the public market?
Fundamentally SPACs are providing an alternative way for private companies to come to the public market giving private companies options in which they can choose what makes most sense for them. SPACs is an expensive way to come public because the sponsor does get a significant promote which is ultimately funded by the dilution of the existing shareholders. However, there are unique features of the SPAC process which is compelling for some companies including the ability to provide projections to investors and to raise funds at multiple points in the process.
The average time for a sponsor to merge with a private company is 5 months
From the perspective of a private company it’s a different way to come public and from the sponsors perspective it’s an opportunity for the sponsors to have private equity capabilities to go out raise money against their reputation and bring a private company to market. While the sponsor has two years to find a private company to go public the average time is five and a half months, so the money raise is being put to work quickly.
Why have SPACs gained popularity in recent years?
SPAC IPOs made up more than 50% of US IPOs in 2020 raising $76 billion, reaching by far the highest number on record and was more than 3x any previous year. There have been several high-profile deals including Virgin Galactic, Betterware, DraftKings, Nikola and Open Lending.
SPAC IPOs made up >50% of US IPOs in 2020 raising $76 billion >3x any previous year
There are a number of reasons why SPACs have gone through a renaissance however two themes dominate their rise in popularity. Firstly, during the pandemic it was difficult for regular companies to come to the public markets given the high volatility in the market. Secondly, it has also been increasingly evident that late-stage growth private companies are a fantastic way to play a growth theme which is evident in the behaviour of recent IPOs and how they’ve performed. The thesis is very simple, if public investors can get access the those privately before they go public, there is a premium that they can be rewarded. In addition, the acceleration in retail trading activity increased investor appetite for non-traditional and early-stage business.
Investor’s growth mindset is evident with more than half of SPAC acquisitions between 2010-2019 were in the Industrials, Financials and Energy sectors while one-third were in Info Tech and Healthcare. Of the de-SPACs completed in 2020 60% were in the fast growth sectors of Info Tech, Consumer Discretionary and Healthcare with 24% in Industrials, Financials and Energy.
How can you explain the shift of investors moving earlier in the life cycle of companies and companies staying private for longer?
We are noticing a combination of different things happening at the same time. Post-Covid we have seen a digital transition accelerate whether it be through food delivery apps, Ecommerce, Online Marketplaces, FinTech or HealthTech. This is a structural shift where in our day to day lives we are seeing that acceleration towards tech nascent companies in all aspects of life, more than we did 5 years ago.
The average lifespan of a company that was going public in 2000 was 4 years and the average lifespan today of a company going public is 12 years
In parallel we are also going through a macro environment where rates are incredibly low. When rates are low people are looking for yield and the money markets and bond markets are not offering it like they did 5 years ago and one of the repercussions are people have moved up the risk curve towards assets that yield more. Equities have been one beneficiary and we have seen that in the public markets and one of the other features we have seen is a move to earlier in the corporate life cycle. One of the ways we have seen that most pressingly is in the private markets with investors moving earlier in the life cycle of companies as well as a lot of capital flowing into continuation and growth funds combined with Venture Capital and Private Equity which resulted in companies staying private for longer. The average lifespan of a company that was going public in 2000 was 4 years and the average lifespan today of a company going public is 12 years.
Investor temperament has evolved to encourage companies to prioritise growth at the expense of near-term profitability, so long as there's some commitment to a visible path to turn EBITDA or Net Income profitable. The percentage of Market Capital of YUC’s (Young Unprofitable Companies) on the stock market has been increasing, in 2020 c.80% of US IPO’s had negative earnings.
c.80% of US IPO’s in 2020 had negative earnings
The acceleration of value creation in the private space are companies that you’ve heard of like Klarna and Revolut, companies that you’re interacting with which are becoming much more interesting to public investors. To give you some statistics in Europe in 2010 there were 11 unicorns that number is now over 315.
Historically the private and public markets operated almost as two separate entities and now we are beginning to see them converge. Public markets are beginning to look at private assets before IPOs at the same time private investors are looking at companies in the public markets and holding them for longer. Ten years ago a private investor would see the IPO as the point where they divest their position where as now private investors are saying why would I do that if I believe in the company. For example, Adyen has gone up 5x versus its IPO price and Shopify has gone up 55x versus its IPO price.
It’s argued that there is a valuation gap emerging between the public and private markets we have, which factors are driving the potential dislocation?
Firstly, it’s worth commenting that the venture investing space is quite a shallow pool of capital in comparison to the global capital markets which are very broad, developed and global. Therefore, when you see a huge shift with a large amount of capital flowing into a narrow theme it has an impact on that shallow pool. However, the returns justify the valuations whether that be a 30-50% IRR on an annual basis, investors are deploying capital but are also making the returns.
Secondly, the value discrepancy is in the investing sentiment. The public markets have regular benchmarks to a certain capacity with daily marked market, weekly marked market, monthly, quarterly, annual etc. In the private market you have 3-7 year cycles or sometimes longer where what you’re investing is based on the management or the founders or the TAM (Total Available Market) so you the returns are based on strategic investments that will be proven right or wrong on a 3-to-5-to-10-year horizon. The incentives are very different in which you are betting on the dream of what a company might be rather than what the company is today and what the earnings can be in a month or a quarter.
There is an overlap of these two groups of capital and they complement and co-exist together. The transitioning of ownership will typically be from Venture Capital groups or early investors who have capped fund sizes or specific remits of product development, especially as companies are staying private for longer. This is where public organizations such as sovereign wealth funds, mutual funds or hedge funds help facilitate the capital requirements of the business. At this stage there is a discrepancy on valuation and a blend of a reasonable private valuation based on public market markers and public comparable company analysis to help frame and formulise the valuation of these businesses.
What’s your thoughts on the future of SPACs and the IPO market?
SPACs are providing an alternative way for private companies to go public and this innovation within the space will likely continue, though I expect traditional IPOs to dominate. The IPO market is extremely sensitive to the equity market performance and if the market continues to perform well expect IPO activity to remain high.
Fast growing and disruptive companies backed by solid fundamentals will continue to be attractive for investors with new issuance from tech oriented and biotech companies likely to dominate.