2 Stocks to Buy That Are Much Better Than SPACs


SPACs - 2 Stocks to Buy That Are Much Better Than SPACs

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SPAC stands for special purpose acquisition company. And SPACs are also often referred to as blank-check companies. Why? Whether during initial public offerings or in the secondary market, buyers are simply supplying cash to these SPACs — typically for undetermined or undisclosed purposes.

U.S. stock exchanges continue to welcome SPAC listings with little to no regard to shareholders. These SPACs merely provide the basic financials — just disclosing the IPO price as well as the targeted amount of capital sought in the listing.

And even post-IPO, many of the SPACs that I have been examining provide very scant details on what’s going on — if they provide any at all beyond required forms. And some of the most prominent SPACs don’t even have websites for shareholders or even provide investor relations information.

Take Utz Brands (NYSE:UTZ), which was taken public in a reverse merger by Collier Creek Holdings. Now, I have always loved Utz potato chips — particularly Grandma Utz’s chips done in lard just like the old days. I only get to have one or two these days if have been very good. And even then, they come with a lot of guilt.

Chart showing the price of Utz from December 2018 to September 2020.

Source: Utz Brands (Nee, Collier Creek, CCH) — Source: Bloomberg

Utz is a Mid-Atlantic company based in Pennsylvania with limited distribution. It is a minor national player compared to PepsiCo (NASDAQ:PEP) and its Frito Lay unit. The shares in the SPAC went from the $10 neighborhood to the current level of $16.94 — a surge of massive proportions. But 90% of the cash proceeds went to the Utz family, who also control the majority of shares. And I still can’t see reported financials on my Bloomberg Terminal so, who paid up for this thing, and why?

DraftKings (NASDAQ:DKNG) was all set to do a proper IPO when it did its reverse merger with Diamond Eagle Acquisition. The sports betting company should fare pretty well — even if sports right now are a bit of a mess. But again, how about some financials?

Chart showing the price of DraftKings (DKNG) From September 2019 to September 2020.

Source: DraftKings (Nee, Diamond Eagle Acquisition Corporation) — Source: Bloomberg

And to make it worse, Michael Jordan is getting a sweetheart deal for some equity, but the company is not disclosing it to shareholders. Sure, having a name like that on the board is a good thing — but at what cost to ordinary shareholders?

SPACs Bypass the IPO Process

The key thing about SPACs is that they side-step the IPO underwriting process. This brings banks into the picture, including all of their fees. And then bank clients get to buy shares at the issue price before they hit the exchanges — often providing effective gifts for institutional investors.

The New York Stock Exchange has been working on implementing greater transparency with an adaptation of the direct listing through the U.S. Securities & Exchange Commission. The idea would be that private companies could have shareholders place their shares on the NYSE, and the company could add new shares for additional capital. This would cut out banks and the sweetheart deals and all those costs. But it would allow investors direct access to companies at disclosed values.

This has run into a potential challenge. The Council of Institutional Investors (CII) is objecting, claiming that the process puts individual investors at risk. But my take is that the CII wants to keep the traditional IPO process to maintain its discounted access to shares. The CII has to file a formal petition, which it may not actually do on time. I’m routing for the NYSE as it will be a big step in making the public market more accessible and undercutting both the SPACs as well as private equity

But again: SPACs are getting pushed and deal makers are making hay — even at the expense of individual investors.

SPACs Are Big, and Not New

According to a group called SPAC Insider, 2020 has so far seen 84 IPOs. And this amount dwarfs the market in 2019 by multiples as the demand right now is surging.

But these SPACs are not new, as I have been involved with some directly when I was in investment banking. The structure is pretty straightforward. A bold-faced name such as Paul Ryan works with an underwriting bank to issue a blank-check SPAC, promising no more than he and his pals will buy something. There are very few other details.

They tend today to be priced at $10 a share and come with warrants. This entices folks to buy at the IPO. And the sponsors also get additional warrants at a discount to the IPO price as part of their compensation. So, buyers start out with less than $10 in reality.

Then the SPAC buys some smaller to mid-sized companies. But what is pitched now is the idea of the reverse merger, in which a highly touted company in alternative-fuel vehicles or gaming — which are in vogue right now — sells itself in part or whole and the SPAC takes its name.

This goes around the underlying company doing the IPO, along with all of the usual scrutiny involved. So, this is in part what is feeding the SPAC-tacular frenzy. But caution: These deals are pigs in a poke, unless you happen to be a company insider.

And according to Bloomberg Intelligence, out of a recent new collection of 18 of these reverse mergers, 11 of them are trading below $10 a share. So, they are far from sure things to bet on.

But it’s the lottery-esque nature of the pitch that keeps pulling in folks. And with interest rates under 1%, the idea of parking cash in a new SPAC and seeing what happens has a lower carry cost.

However, I have better alternatives that I’ve followed and recommended inside my Profitable Investing for years — some of which I have had since their IPOs years and years ago.

Better than SPACs: Holding Companies and BDCs

Like their SPAC peers, holding companies and business development companies (BDCs) are set up under the Investment Companies Act of 1940. This allows them to invest capital without having to pay corporate income taxes. But they are further codified under the Small Business Investment Incentives Act of 1980, which was passed to incentivize businesses to finance or invest in smaller companies when the U.S. banking market was in disarray.

But these are different. They come to the market with specific objectives for lending and equity investment. And they report underlying investments — and all of the rest of their financial data — just like a traditional financial company. They are also upfront with management salaries like a regular company. And in turn, they lend to or buy companies, reaping cash flows and aiding their developments.

In many ways these are like smaller versions of Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) in operation — although Berkshire is susceptible to corporate income taxes.

Compass Diversified Holdings (CODI)

I start with Compass Diversified Holdings (NYSE:CODI), which is a holding company that buys, develops and sometimes sells companies that have commonalities of strongly branded industrial or consumer products.

It currently has an impressive collection of these companies, and with piles of cash and credit, it is looking for more. Revenues have been consistently rising, with gains over the trailing five year averaging 13.2% on a compound annual growth rate (CAGR) basis.

Compass Diversified Holdings (CODI) chart showing its total return from 2006 through 2020.

Source: Compass Diversified Total Return Since IPO — Source: Bloomberg

It pays shareholders well with a yield of 8.3%. And since its IPO back in 2006, it has returned 311.1% for an average annual return of 10.4%. And I see a lot more to come.

Hercules Capital (HTGC)

Next up is Hercules Capital (NYSE:HTGC). This is more of a traditional BDC, but with a very specific focus on early to mid-stage technology companies. It is based in the U.S. tech center of Palo Alto, California.

It identifies companies in need of capital and provides both earning interest and capital gains. Hercules Capital has hundreds of companies in its current portfolio — many are bold-faced tech names.

Revenues are up by 28.9% over the past year, and this is not an abnormality. The company has been gaining revenue by an average annual rate of 34.3% on a CAGR basis since its IPO.

Chart showing the total return of Hercules Capital (HTGC) from 2005 to 2020.

Source: Hercules Capital Total Return Since IPO — Source: Bloomberg

The company’s dividend yields 11.6%, and since its IPO back in 2005, it has returned 285.4.%. This equates to an annual rate of 9.3%.

On the date of publication, Neil George did not hold (either directly or indirectly) any positions in the securities mentioned in this article. 

As the editor of Profitable Investing, Neil George helps long-term investors achieve their growth & income goals with less risk. With 30+ years of experience in the financial markets, Neil recommends undiscovered and underappreciated companies that offer subscribers double-digit yields now and triple-digit returns over time.

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