SPACs: A Better Way to Buy In

SPACs, or Special-Purpose Acquisition Companies, offer investors a phenomenal way to take a position in newly-public companies without having to wait in line behind large funds as in a traditional IPO. They can also be called "blank-check companies."

In a traditional Initial Public Offering (IPO), private companies decide to make their shares available to the public. Large funds and institutions get first licks. This usually drives up the share price before retail investors can take a position. Traditional IPOs are also a huge pain for the business going public. SPACs break that cycle to deliver quality for the company and the investor.

A SPAC is a company with no operations. It forms when a small group of directors, called a sponsor, with extensive experience in a particular industry establishes a shell company that performs no business on its own. SPACs form explicitly to raise money from investors so that it may merge (really, buy out) a private company that intends to go public. Going public through a SPAC provides incentives for the private business owner, for the SPAC directors, and for the SPAC investors.

tl;dr: SPACs are an alternative to investing in traditional IPOs. They typically offer better prices than the trader would get at IPO. Invest in SPACs with experienced and reliable directors. Leadership is the most important factor when selecting a SPAC in which to invest. Read the SPAC's S-1 forms to determine how you will receive shares. Do not use Robinhood to invest in SPACs (though you can use Rh for short-term trades). Use spactrack.net to find SPAC information.

What is a SPAC?

As stated above, a SPAC is a company that has no operations and exists specifically to raise money from investors so that it may buy a private company and take it public. 

A SPAC is a real company on its own despite having no function. Therefore, it can sell shares or units to investors. Units are similar to shares, but serve 2 functions for investors. When the SPAC completes a merger with its target company, the units will convert into shares and warrants of the new company. When you own SPAC units, you will receive both shares and warrants for each unit you hold.

1) Units represent (usually) 1 share of the merged company, but this is occasionally different. If you're investing in a SPAC, check the comapny's S-1 filing to be sure. SPAC units typically IPO at $10. 

2) The units will also convert into warrants or a fraction of a warrant. Warrants are contracts that allow the holder to buy more shares of the new company at a certain price (usually $11.50) before a future expiration date. Or, the warrants can be sold to other people. Warrants are very similar to call options.

In other words, if you buy SPAC units and hold until the company completes the merger, you will receive shares of the new company AND warrants (which are similar to calls). Alternatively, you can buy common shares or warrants separately, rather than buy both at the same time with units. 

Units will typically end with ".U," and warrants end with ".W" or ".WS." For example, units of IPOF trade as IPOF.U. Warrants trade as IPOF.WS. Common shares have no ending tag and are just IPOF.

The money a SPAC raises through its IPO goes into interest-bearing funds so that it may raise additional capital. This keeps the investor's money safe, and also adds some sauce to the SPAC's balance sheet so it can buy more valuable private companies.

SPAC directors/sponsors will identify a private company they would like to take public with the consent of that business. That is, SPACs are not hostile takeovers. Once the SPAC identifies a company it would like to merge with, it will work with that company to establish the terms of the merger and release them to the public in a Purchase Agreement. SPAC investors always get to vote on the acquisition and can reject it if they do not like it, forcing the directors to target a different company or to liquidate. If the SPAC liquidates, investors get their money returned to them at $10/share (usually; check the S-1 filing to be sure).

Sometimes, the directors will have a merger candidate in mind from the beginning, but they typically do not release that target to the public until they have coordinated with that entity to establish terms.

Why Should I Invest in a SPAC?

1) As state above, SPACs offer advantages to the investor in that you get more than just your share when you hold through the merger. First, SPACs primarily trade in units, not shares. A unit usually represents 1 share of the new company, and also a warrant or portion thereof. Check the company's SEC filings on their website to determine how many shares and how many warrants each unit represents. Warrants allow the investor to purchase additional shares of the merged company after the acquisition is complete. Traditionally, warrants let the investor buy more shares at $11.50/ea, but check the SPAC's website and S-1 filing to be sure. This is published well in advance of any merger. This is quite similar to being awarded a call option, although warrants usually have a time restriction on them to prevent people from cashing them in within 30 days after the merger. Warrants and shares can also be bought or sold separately. As a result, after a merger, you have a share of the new company, and a "free" warrant that you can sell or use to buy more shares. You would need to contact your broker to do so.

Keep in mind that you buy common shares with no end tag. Warrants with a ".W" or ".WS" tag, and units with a ".U" tag. You can also use nasdaq.com to easily find tickers.

2) Beyond that, SPACs give you the opportunity to buy into a company at a lower price than you would get by waiting for one of these company's to IPO through the traditional route. Recall the SNOW IPO. Investors were promised an IPO price of something like $100. Institutional investors got first licks, and they drove the price up to about $250 before the retail investor could get in on it. Shenanigans. SPACs allow the investor to buy shares and calls through units in a pre-IPO-esque state, often granting a better price.

Compare the SNOW IPO to the QS SPAC-facilitated merger. Retail investors got a raw deal on SNOW. But investors in Kensington Capital Acquisition Corp (KCAC) were able to buy units at IPO for $10. By the time KCAC selected QuantumScape (QS) as their acquisition target, the units were trading for about $20. Those who held through the merger watched their fresh shares rise to >$130, plus they owned warrants (1/2 warrant per unit) that allowed them to buy additional shares at $11.50. If you got in at $10, your investment would have exploded ~15x. Retail investors don't get that opportunity through IPOs.

3) SPACs are often managed by well-known experts in their industry. This gives you the opportunity to invest in that management team while they determine a healthy target for acquisition. While this is normally a good thing, it also means your largest investment is not in the SPAC or the company it will merge with. Your largest investment is that management team. Ensure you are not trusting your money to someone with limited experience but a big name like Paul Ryan. Trust someone like Chamath Palihapitiya.

4) Your investment is largely protected. At any point up to 2 days before the shareholder vote that accepts or rejects the terms of the proposed merger, the investor can cash-in his units for the SPAC's IPO price (usually $10). This right usually goes away 2 days before that vote, although some SPACs allow the investor to cash-in their units if they vote "no" (achieved virtually through broker facilitation- you don't actually have to go to a meeting). Fortunately, this is rarely an issue because SPAC units usually trade above $10 and can just be sold on the open market rather than cashed-in, even after the vote but before the merger is complete.

Why Would a Company Go Public Through a SPAC?

IPOs for an established company are a pain for that company and the underwriters (the bank that helps the company IPO). IPOs involve roadshows, extensive filings, and a thorough underwriting circus.

SPACs themselves go through easy IPOs. They do not need a roadshow because they have no operations. Underwriting is simpler because they have no assets. The company's business practices are not interrupted because there are no business practices. It is "an IPO of nothing." 

When the SPAC targets a company to acquire, that company can now sell literally everything it owns to the SPAC without having to go through the whole IPO process.

The SPAC directors say, "here is $200,000,000, 2 seats on the board, and rights to acquire shares." The business owner walks away with a massive payday without the complicated IPO process.

This may sound vulnerable to scams on the part of the SPAC directors. It is true that traditional reverse-mergers (merging with a dying company) or the 1980s-esque blind pools were prone to scams. Fortunately, a lot has changed since then. There are pretty tight regulations on what the SPAC can do, deliberately making a poor merger would not benefit the directors, and just running off with the money instead of merging at all would almost certainly send them to jail. SEC regulations, investor voting rights, and multiple directors on each board prevent the most obtuse fraud. Achieving fraud is possible, but would take a far-reaching conspiracy. For this reason, make sure you trust the SPAC directors.

Where Should I Find SPACs to Purchase and What Should I Look For?

There are a lot of important factors in choosing a SPAC. I am new to this, but I perform extensive research before investing in a new instrument. I hope these best practices are helpful while I continue to develop them.

1) You can find just about any SPAC you want at https://spactrack.net/. The site has news releases, full lists of SPACs, and completed mergers. Note that it is not very mobile friendly and could probably use some HTML+CSS retouch. I'm looking at you to hit them up, Vehicom.

2) Remember that the most important investment you're making into a SPAC is the investment you're making into its management team. Look for companies with management teams that have a solid history and track record. I am a big fan of Chamath Palihapitiya (Sri Lankan name) and his Social Capital Hedosophia Holdings companies, using tickers IPOA/B/C/D/E/F. For some context, Chamath recommended Bitcoin and Tesla between 2011-2014, and his first SPAC (IPOA) became Virgin Galactic (SPCE). He's got a strong track record, his SPACs have options trading on them, and we can generally trust his judgment.

Avoid people with sketchy track records, famous people with no relationship to the finance community, or people who have litigation surrounding them. Since the Due Diligence regarding acquisitions falls heavily on the SPAC directors, you need to trust them. There are protections in place to prevent outright fraud which include ensuring there are no conflicts of interest between directors and the company being acquired (ie, they cannot buy their friend's company without tightly-controlled approval from the SEC). However, anyone motivated enough who is seeking a quick buck by making a bad acquisition can probably find a way. If the directors have been involved in alleged fraud before, just leave it alone and invest elsewhere.

3) SPACs have a pretty strong floor at $10. Prior to 2 days before the vote approving the terms of a merger, the investor can cash-in units at their Net Asset Value price (usually the traditional IPO price of $10) at any time. The 2-day rule exists because the units must be settled in the investor's brokerage to be cashed-in. Settlement usually takes 2 business days after purchase. If the units were to fall below $10 (or other NAV- check the company's website) at any time before the vote, the investor could swap those units for cash through their broker. If the SPAC does not find a suitable acquisition target within usually 2 years, they must return their money to shareholders minus a nominal fee in a process called liquidation. This is one of the reasons SPACs hold investor money in escrow. They must ensure they have enough money to return to shareholders.

Purchasing units near the SPAC's NAV of usually $10 offers large potential rewards with minimal risk. However, keep in mind that SPACs usually float around $10 NAV for a while, and therefore you might be tying up money that you could have used for more profit elsewhere. You can find a list of SPACs trading near NAV at spactrac.net.

4) If you want to buy SPACs but are not sure how to approach them, you can always buy the ETF SPCX. It captures a wide variety of SPACs in one ticker. Be aware the ETF is very new and began trading on 18 Dec 2020. Therefore, it does not have a long track record to evaluate. It does hold many of the big SPACs with exciting directors, but offers little history. 

Can I Sell Puts at NAV for Free Money?

This was one of my first thoughts. It is an option, and as far as I can tell, the risk ought to be pretty low. 

Is it likely free money? Maybe. Sort of. Most SPACs don't have options. Some have options but little volume. The IPO[x] SPACs do appear to have adequate volume, and some even do offer interesting opportunities on their $10 puts. On IPOF, for example, you can sell the Dec 17 $10 puts for about $165/ea. Presumably, the stock should not go that low, and if it does go below your $8.45 breakeven, you'd have a good shot at either taking assignment and cashing-in shares, rolling, or holding through the merger and seeing more value. The real risk would be that IPOF investors vote "yes" to a bad acquisition, and the company to be merged with ends up in a really bad financial situation between the vote and the merger. That would cause the SPAC unit price to tank going into merger. After the vote, they cannot be cashed-in for $10/ea, eliminating that floor.

I'd like to do more evaluation on this, but so far I have not seen en example where a company actually decreased in price well below its NAV, whether before or after the merger vote. There is certainly no pure arbitrage opportunity with 0 risk that we will stumble upon. However, this seems close. I intend to try this with 1 short call with premium reinvested into shares. I'll let you know how this goes.

Any Final Thoughts or Warnings?

1) You need a serious broker to get the most out of SPACs. When your SPAC merges, you are entitled to common shares and warrants. Robinhood does not support warrants. If you intend to hold your SPAC through merger, then you need to use a proper broker to ensure you get all you are entitled to. TastyWorks is a great service that supports warrants, although other fully-functional brokerages are fine too. Just don't use Robinhood.

2) Utilize the SPAC's website to find filings, determine the exact conversion ratio of units to shares and warrants (usually 1:1 at $10, with warrants at $11.50). Some units will convert to 1 share and 1 warrant. Some will convert to 3/4 share and 1/2 warrant. This is all critical information, and it will be visible on the SPAC's website and SEC filings. If the SPAC does not have a website, invest elsewhere. You can also use nasdaq.com to quickly find the breakdown of tickers.

3) I can't emphasize this enough so I will say it again: you are investing in the directors/sponsor when you invest in the SPAC. Identifying a successful SPAC means identifying a successful team of directors. Since many steps of the IPO process are eliminated through SPACs, you are putting more faith in the director for performing due diligence than when you invest in a traditional IPO. If you are not familiar with SPAC managers, don't worry. None of us are. Just invest in IPO(x) companies with Social Capital and Chamath Palihapitiya and you can't go wrong.

Warning: Don't get overly hyped about a SPAC reaching high prices shortly after the merger is complete. We saw HYLN and NKLA go flying, meanwhile both have had significant drops since then. HYLN is back down to pre-merger prices around $16. NKLA is targeted with fraud allegations (note that the merged company is under investigation, not the SPAC it came from). QS also went up to ~$130 before coming back down hard. The point is: don't be afraid to cash in some profit if irrational exuberance is sending your new shares to the moon. Alternatively, sell the warrants instead.