Special Purpose or Special Risk?

Special Purpose Acquisition Companies, commonly known as SPACs, provide private companies with another option to go public without the difficulties brought on by taking the route of Initial Public Offerings, or IPO, which can provide higher valuations with increased scrutiny.

So, what do we make of SPACs and how do we choose which ones of the many out there to invest in? Here is the upside of investing in a SPAC, you get into a company at a far reduced price from the expected valuation if you invest before the merger is announced. I like to use the example of Fisker (FSR), an electric vehicle maker set up to challenge Tesla (TSLA) for a share of the market. I am not going to go into a deep dive on Fisker today, but it provides what is likely a good example of the overall principle.

I bought into the SPAC, Spartan Energy Acquisition Corp (SPAQ), when it was trading below $10 back in the spring. I had no idea what they were going to buy, essentially they conducted an IPO with a target of a certain amount of money to invest in a to be determined company. The announcement of the merger with Fisker came up in the fall and the price jumped somewhat and by the date that it was complete and Fisker took over the stock of SPAQ it was trading near $15, not too shabby at all. Well, for those who have not followed this particular position it surged as high as $23 within days of going public.

You might say, “As long-term investors what do we care about immediate surges?” and that is where we get into investing in young companies. We would all love the opportunity to get in on the ground floor of a Google or Tesla or Amazon but investing in young companies is essentially gambling. That isn’t a bad thing if it is part of your trading strategy to be distinctly different from your investing strategy which we believe is best found by investing in mature companies where we can see a history of financials and get a solid valuation on. I think that young companies have a place in a portfolio, but again make it a part of your risky business 10%.

Now, I get the feeling of FOMO (fear of missing out, as I learned recently) when you think you’ve identified the next home run ball. However, once you’ve swung on a pitch and missed or fouled it off, you can’t get it back and you will likely strike out a lot of times before you hit the one fat pitch, if you ever get one. So, I will get off the soapbox, but exhort you to remember that a disciplined approach to your Investing portfolio will serve you much better in the long run.

Back to SPACs which have merged and gone public, there are two real strategies at this point. If they are a marketable company, they will surge post-public offering whether IPO or SPAC initiated. Option 1 is that you identify a level during the initial surge where you feel good about taking profits and getting out of the position. Option 2 is that you hold it knowing that it will surge and peak and then fall back to earth and bounce several times as the market tries to figure out what they think the value of the company is. I don’t like using market price as value, but in the case of a company who you can’t see the financials on for a long enough period of time we have to rely on market price.

I will tell you that my personal methodology is to take a bit of both. If I see that my SPAC has made a good choice of merger (I loved the Fisker deal!) I will take profits on part of my position while holding the rest believing that the company has far greater upside than the initial surge indicated. When it came to this deal you remember I bought into the SPAC under $10 in the spring, that provided me with a nice 130% profit at the surge. Even with it falling back to earth the rest of my investment is at a 70% gain.

Not every SPAC will manage this, and some will merge with companies you don’t see a great market for simply because they are time limited. Yes, SPACs cannot stay SPACs forever. They must find a partner before their time runs out and some of them will not choose great dance partners for fear of not finding one at all. Then how do we choose which ones to back? I’ll tell you my search criteria, it’s simply who is backing the SPAC?

My favorite still pre-merger SPAC is Pershing Square Tontine Holdings (PSTH). This is Bill Ackman’s SPAC, an investor who I have an incredible amount of respect for, and who has been highly successful. This as an investor makes me much more confident that the SPAC will be successful in finding a partner and more likely to find a partner who will be worth more than I paid for my shares. We do know that he approached AirBnb and could not come to an agreement as they are set to go IPO this week. However, I still have full confidence that Bill is working hard and will provide great value to investors in the future.

SPAQ itself was sponsored by Apollo Management Group who has helped launch or bought out companies such as ADT, QDOBA, CKE restaurants, Hostess and Lyondell-bassell amongst others. It’s all about tracing the company back to someone with a successful track record. Apollo is in the midst of starting another fund which I am watching with interest.

Interestingly, Social Captial Hedosophia Holdings Corp II (IPOB), backed by Chamath Palihapitiya a renowned venture capitalist (VC), is merging with Opendoor. Opendoor is a disruptor in the real estate industry which boasts their virtual services as a no hassle way to buy or sell houses. You should do your own investigation of the good and bad of every company, but Opendoor has been called by some the Amazon of real estate. I won’t speak to my opinion one way or another, but it is a company likely to generate a large amount of excitement in the market.

Why am I so interested in what Chamath Palihapitiya is doing? His first SPAC merger you might have heard of, a company called Virgin Galactic (SPCE). What has Virgin done since going public? It went from a start of $11.75 to $31.85 as of the time of this writing. That is a 170% gain over the span of a little over a year, and that is if you bought when the merger was complete and SPCE went public. The SPAC that launched it Social Captial Hedosophia Holdings Corp I started at $10.10 in 2017 and ended at $11.79 at the time of the merger.

SPACs are a risky business, there is no way around it, but if you are confident enough of your ability to judge investors or companies and willing to do the homework, it can be a great way to get in on a rocketship company at rock bottom prices. I won’t ever risk much more than 10% of my kitty on them, but at the return rate of 100% or greater…well I’m making that 10% work for me. Until next time I’m off to stalk my next SPAC.

-Daddicus Rex

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