Steer Clear of SPACulative Investments

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Access to the public stock market is arguably modern capitalism's most substantial wealth-creation event.

It allows everyday investors and institutions to get in on owning a piece of a business and participating in its growth.

It has minted the most billionaires, and you’d be hard-pressed to find anyone atop the Forbes list without most of their wealth concentrated in a single equity position.

We’re all familiar with Initial Public Offerings (IPOs), whereby a private company sells a portion of its shares on the public market in exchange for cash at a specific valuation. This also provides liquidity for early investors to cash in on providing capital to early-stage companies. It's a beautiful machine.

However, the recent boom in a different kind of financial engineering has left investors with a bad taste in bringing companies public.

Special Purpose Acquisition Companies (SPACs) are shell companies with no commercial operations, created solely to raise capital through an IPO to acquire an existing company. After raising the funds, the SPAC has a fixed period (typically two years) to complete an acquisition or merger, or it must return the capital to investors. The popularity of SPACs has increased significantly over the years, especially in the 2020s, when they became a significant trend in public equity markets.

The term "de-SPAC" refers to the process where a Special Purpose Acquisition Company (SPAC) completes its intended purpose by merging with a target company, thereby publicizing the private company. The initial SPAC price is typically around $10, but the actual price at which an SPAC de-SPACs can be quite different due to the hype around the name at the time of de-SPAC.

I’m here to tell you that this recent wave has been terrible for investors. SPACs have lined the pockets of sponsors to the detriment of the public. Want some examples? Oh boy, I’ve got plenty.

• Nikola Corporation (NKLA): This fraud was perpetuated by bubble-like euphoria. It involved EVs and a founder sentenced to four years in prison. The stock went from $10 to $80 and now trades at $0.71, representing a loss of 93%.

• Clover Health (CLOV): In 2021, Clover Health merged with Chamath’s Social Capital Hedosophia Holdings Corp. III. Shortly after the merger, Hindenburg Research released a critical report accusing it of misleading investors, which greatly affected its stock price. The stock went from $10 to $22 and now trades at $0.71, representing a loss of 93%.

• Virgin Galactic (SPCE): In 2019, Virgin Galactic went public via a SPAC with Chamath’s Social Capital, Hedosophia. Despite high expectations, the stock has experienced significant volatility and has struggled with delays in its commercial spaceflight operations. The stock went from $10 to $60 and now trades at $1.12, representing a loss of 89%.

• Katapult Holdings (KPLT): Katapult, an e-commerce financing company, went public in 2021 via a merger with FinServ Acquisition Corp. Its share price plummeted post-merger due to worse-than-expected financial performance and market competition. The adjusted share price went from $250 to $477, and the stock now trades at $9.64, representing a loss of 96%.

• BarkBox (BARK): BarkBox merged with Northern Star Acquisition Corp. in 2021. The company faced profitability challenges in scaling its operations, which impacted its stock performance. The stock went from $10 to $18.50 and now trades at $1.17, representing a loss of 88%.

You get the point. There are dozens more of these examples. The only way to make money from a SPAC is either shorting it (if you can find a reasonable borrow), day trading it post-SPAC, or being one of the select few sponsors who lined their pockets.

To be fair, there is one successful SPAC that I could find - DraftKings. The stock went from $10 to $70, then back to $10, and now trades at $45. It’s probably one of the only ones with an actual business model behind it, and I’m sure they deeply regret using the SPAC mechanism. The SPAC graveyard has many more companies than there are on the SPAC podium.

This post's why-now section focuses on the Trump SPAC, Trump Media & Technology Group (DJT), which will suffer a similar fate.

At the end of March, shell company Digital World Acquisition Corp (DWAC) shareholders approved a two-and-a-half-year-old plan to merge with the private firm that owns Donald Trump’s social media platform, Truth Social, to take it public.

You can see a runup into this period purely on speculation. Many DJT investors aren’t institutional or professional ones but small-time traders. The stock popped thanks primarily to individual Trump fans, who bought up shares as a show of support…not out of faith in the company’s success.

Spoiler alert: this will end in a sub-$1 stock price.

But there’s some good news. The SEC has finally woken up and decided that investors need more protection, as new rules took effect on January 24, 2024.

The new rules and amendments require, among other things, enhanced disclosures about conflicts of interest, SPAC sponsor compensation, dilution, and other information that is important to investors in SPAC IPOs and de-SPAC transactions. The rules also require registrants to provide additional information about the target company to investors that will help investors make more informed voting and investment decisions in connection with a de-SPAC transaction.

“Just because a company uses an alternative method to go public does not mean that its investors are any less deserving of time-tested investor protections,” said SEC Chair Gary Gensler. “Today’s adoption will help ensure that the rules for SPACs are substantially aligned with those of traditional IPOs, enhancing investor protection through disclosure, use of projections, and issuer obligations. These steps will help protect investors by addressing information asymmetries, misleading information, and conflicts of interest in SPAC and de-SPAC transactions.”

It’s too late for that…

There seems to be a selection bias that causes companies that can’t properly go public to resort to this hype mechanism, which already sets them up for failure.

Steer well clear of these flaming piles of garbage.

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Cheers,

The GRIT Alpha Team

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