Sunshine Or a Flash of Lightning
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SPACs Sunshine or a Flash of Lightning sganalytics.com CONTENTS 1 Why this whitepaper? 03 2 What is a SPAC? 04 3 The rise of SPACs in 2020 06 4 What really differentiates a SPAC IPO from a regular IPO? 09 5 Are SPACs like private equities? 11 6 What are the risks involved with SPACs? 12 7 How have the SPACs performed? 13 8 Are SPACs just another large bubble? 14 SPECIAL PURPOSE ACQUISITION COMPANY (SPACs) www.sganalytics.com 2 1 Why this whitepaper? It took me 20 years to become an overnight success ~ Eddie Cantor ~ What is the one thing that Walt Disney, Airbnb, and Apple have in common? All of them are incredible success stories of companies that have fought odds over several years and made a mark for themselves. Walt Disney was fired by a local newspaper for ‘not being too creative’. His first animation studio went bankrupt before he finally decided to move to Hollywood and start the Disney Studio. When Airbnb started in 2008, the idea was dismissed by hundreds of investors and the company resorted to basic jobs such as creating custom cereal boxes, just to make ends meet. Apple was operating in loss for a long time and approaching bankruptcy, but a massive rebranding campaign helped it become the first company to ever reach $1 trillion in market capitalization. In no way were these companies ‘overnight successes’. A similar phenomenon was witnessed in the last couple of years in the capital markets. A once forgotten method of public listing made its way into the limelight and posted two record years back-to- back, and the momentum continues. It would be only fair to say that 2020 was the year of Special Purpose Acquisition Companies or SPACs. Much like the inflation, FDI, or any other financial concept, one cannot exactly trace the genesis and resurgence of SPACs to one single point. However, broadly speaking, SPACs initially appeared on the scene in the 1990s but had a patchy run until 2018. And that got us thinking: why did SPACs become so popular suddenly? What is it that investors find so attractive about this vehicle? Hence, we decided to explore SPACs in detail through this whitepaper, where we delve into their structure, advantages, risks, comparisons with other investment routes, and our view on whether these are really a long-term success story. SPECIAL PURPOSE ACQUISITION COMPANY (SPACs) www.sganalytics.com 3 2 What is a SPAC? The mechanics A special purpose acquisition company (SPAC) is a ‘blank check’ company formed for the sole purpose of raising money through an initial public offering (IPO), and eventually using the funds to acquire another company. A SPAC does not have any operations at the time it is founded. It is generally formed by a group of investors called sponsors, with a strong background in a particular industry or business sector. These include a team of institutional investors and also Wall Street professionals from the world of private equity (PE) or hedge funds. A SPAC raises funds from the public, which sits in an interest-earning trust account for a prescribed period of time (usually 2 years). During this time, the SPAC must find a suitable target, failing which they must return the money to investors along with the interest earned. SPACs sometimes have specific mandates regarding the type of acquisitions they pursue. Their criteria can be something as specific as sector focus to something much broader. SPACs have existed broadly in the technology, healthcare, logistics, media, retail, and telecommunications industries. But today, we are witnessing PE firms in the process of raising multi-billion dollar funds via the SPAC route with focus on renewables and ESG-focused businesses, amid sustainability investments gaining traction and President Biden focusing on boosting clean tech. Similar entities in various forms such as a ‘blank check company’ or ‘public shells’ have existed since decades. However, the shells of the 1980s employed ‘pump and dump’ schemes in an effort to earn abnormal returns, which made it prone to manipulation and swindles. The laws have transformed for the better since, leading to the emergence of a new type of entity and coining of the term ‘SPAC’ in the 1990s. The SPACs from 1990s are broadly similar to the SPACs as we see today, though it has been the subject of continuous reforms to safeguard investors’ interest. SPECIAL PURPOSE ACQUISITION COMPANY (SPACs) www.sganalytics.com 4 Here is an infographic that summarizes the mechanics of a SPAC: 1 2 3 Emma wants to She launches EmCorp, files to Investors buy EmCorp units form a SPAC public, and goes on a roadshow to for $10 each find investors 4 5 6 EmCorp SPAC goes public on Emma searches for a target EmCorp decides on a company, the NYSE / Nasdaq company to acquire StartupCo, and negotiates the acquisition terms 7 8 9 Shareholders vote and agree EmCorp buys the company with StartupCo merges with to buy the company money from its IPO and additional EmCorp and officially trades funding from new investors on the NYSE / Nasdaq Source: CBInsights It is worth noting that the initial funds SPACs raise of acquisition. The acquisition was further usually cover only about 25–35% of the purchase supported by additional cash infusion from price. The sponsors may ask existing institutional PIPE investors. Pro-forma ownership at close investors (such as large funds or PE firms) or new included 74% of the seller in the form of rollover investors for additional money through a Private equity, 12% PIPE investors, and 14% SPAC Investment in Public Equity (PIPE) transaction. shareholders. A SPAC will then identify the relevant target, A SPAC would typically hire an investment bank acquire it, and in the process take it public to help with the IPO and the subsequent de- through the mechanism of a reverse merger. SPAC merger. Underwriters typically get a fee of This is known as de-SPACing (or a De-SPAC 2% of the money raised in the initial listing, and transaction). then another 3.5% when the company completes the deal with its target. While those fees can be lower than traditional IPOs, investment banks can One example would be the DraftKings IPO back also earn fees by advising a company on its sale in early 2020. DraftKings merged into Diamond to a SPAC or the SPAC raising more money for its Eagle Acquisition Corp, a SPAC vehicle with acquisition. more than $400 million in cash at the time SPECIAL PURPOSE ACQUISITION COMPANY (SPACs) www.sganalytics.com 5 3 The rise of SPACs in 2020 2019 was already a record year for SPACs. In 2019, SPAC IPOs raised $13.6 billion in gross proceeds, driving more capital than in any prior year. However, the rise of SPACs in 2020 was meteoric to say the least and was powered by a multitude of factors: (i) COVID-19 necessitating companies to seek alternate ways of raising capital, (ii) the recent success of some SPACs, (iii) public display of attraction by high-profile and well-known companies, (iv) changing investor attitudes, and (v) better regulations to protect investors. 2020 SPAC Milestones $83.2B $335.3M 248 Gross proceeds Average IPO size SPAC IPOs $4.0B $16.1B Record proceeds raised by SPAC Largest SPAC merger announced (Pershing Square Tontine) (Gores Holding IV / United Wholesale Mortgage) In the two years between Jan 2019 and Jan 2021, the Technology, Industrial, and Healthcare segments have accounted for >60% of total companies brought public via the SPAC route. Real Estate, 2% Energy, 4% Finance, 8% Consumer, 11% TMT, 34% Electric Vehicle, 12% Industrials, 16% Healthcare, 13% Source: JP Morgan Research SPECIAL PURPOSE ACQUISITION COMPANY (SPACs) www.sganalytics.com 6 It is worth pointing out how many SPACs are sidelines found its way into the markets. The targeting EV (Electric Vehicle) start-ups. This dry powder was estimated to be near $3 trillion makes sense as EV players are capital-intensive globally around March 2021, around one-third of companies that need money to grow. Raising which is reserved for SPACs and Buyouts – still a capital via a SPAC rather than traditional VCs strong number for this year. probably presents better terms as companies do not have to dilute a major chunk of their equity, More companies are now looking to realize which they generally do if they get cash infusion additional liquidity through listing publicly and from a VC firm. Major names that adopted to capitalize on the current favorable public this route include electric truck maker ‘Nikola market conditions. Private market valuations Motors’, electric bus maker ‘Proterra’, electric have trended downward, while public company truck startups ‘Xos’ and ‘Lucid Motors’, charging valuations have continued to surge amid the station ‘EVgo’, and EV company ‘Canoo’. Given pandemic-driven recession, reaching an all-time this success, we might further see more money high and widening the public-private valuation being invested in this vertical through the SPAC gap. To ride that trend, many private companies route. President Biden’s pledge of a $174 billion are now using SPACs as their vehicle of choice spend to boost the electric vehicle (EV) market for the last financing round and IPO, all-in-one. just makes it easier. Record amount of dry powder stock at PEs is a major factor that has worked in favor of SPACs, and capital that was hitherto sitting on the Private Equity Valuations Discount to the Public Market 20x 18.1x 15x 14.1x 13.2x 13.5x 12.4x 12.2x 11.8x 11.2x 11.5x 10.7x 10.2x 10.3x 10.0x 10.6x 10.6x 9.7x 10x 9.3x 9.5x 9.7x 9.1x 9.0x 8.8x 9.0x 8.8x 8.2x 8.7x 7.8x 7.7x EV/EBITDA 5x 0x 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 U.S.