SPACs, or special purpose acquisition companies, have been on fire in 2020. The SPAC structure has been around for close to three decades, but its popularity has exploded recently.
There are a number of reasons why. Perhaps the most salient is the unprecedented volatility in public markets. The traditional initial public offering process requires the investment banks involved to price orders across hundreds of market participants.
During a year in which the S&P 500 dropped 34% in less than five weeks, and then rallied 50% in less than five months, that process became highly risky. Companies that needed capital instead turned to SPACs, which had already raised that capital through their own IPOs. The terms of a SPAC merger only need to be negotiated with the SPAC itself, adding certainty to the process of going public.
SPACs have raced to fill the demand. In 2009, only one SPAC went public, and it raised just $36 million. So far this year, according to SPACInsider, 182 SPAC IPOs have raised a staggering $65 billion — nearly five times last year’s total.
Of course, with such a flood of capital, there are bound to be some duds. Particularly with the likes of Snowflake (NYSE:SNOW) and Lemonade (NYSE:LMND) highlighting the health of the IPO market, private companies don’t have to go the SPAC route. Those that do might not have the best reasons for doing so.
This is not to say that investors should avoid SPACs entirely. But they need to be careful: Not all SPACs are created equal. These seven look like ones to avoid:
- Social Capital Hedosophia II (NYSE:IPOB)
- dMY Technology Group (NYSE:DMYT)
- Landcadia Holdings II (NASDAQ:LCA)
- South Mountain Merger (NASDAQ:SMMC)
- Jaws Acquisition (NYSE:JWS)
- Novus Capital (NASDAQ:NOVS)
- HL Acquisitions (NASDAQ:HCCH)
SPACs to Avoid: Social Capital Hedosophia II (IPOB)
Venture capitalist Chamath Palihapitiya, the founder and chairman of Social Capital Hedosophia, might be the closest thing SPACs have to a celebrity. Through social media and podcasts, Palihapitiya has pushed the virtues not just of SPACs, but of long-term, high-minded tech investments.
He has been prolific, too. His first SPAC, Social Capital Hedosophia, helped jumpstart the trend through its combination with Virgin Galactic (NYSE:SPCE). His second vehicle was one of the biggest SPACs so far. IPOB is merging with real estate pioneer Opendoor, which InvestorPlace Markets Analyst Luke Lango has called the future Amazon (NASDAQ:AMZN) of the housing market.
Lango admittedly makes an intriguing case. But there are significant risks as well. Valuation is one. The current IPOB stock price implies a market capitalization for Opendoor just shy of $12 billion. Revenue for this year is projected at $2.5 billion.
A price-revenue multiple below 5x sounds cheap in this market. But Opendoor’s targeted EBITDA (earnings before interest, taxes, depreciation and amortization) margin range is just 4% to 6%. In that context, valuation is a big-time risk.
So is competition. Zillow (NASDAQ:Z, NASDAQ:ZG) is taking a similar approach. So are myriad startups. It is not even guaranteed that the Opendoor model will work, but if it does, the company will have to outperform numerous rivals.
It is a narrow path. And while Palihapitiya talks up the value of his firm’s sponsorship in providing expertise and experience, SCH now has launched its fifth SPAC. The firm will be spread awfully thin.
Over the long haul, Lango may be proven right. But it’s not an easy road to Amazon-like returns, and even with a recent pullback, investors at least can be patient with IPOB stock.
dMY Technology Group (DMYT)
One of two SPACs entering the online gambling space, dMY is merging with Chicago-based Rush Street Interactive. RSI operates iGaming and online sports betting sites in several states and the nation of Colombia under the BetRivers.com, PlaySugarHouse.com and RushBet.co banners.
On its face, it seems like a hugely attractive business. Online sports betting is a hot sector at the moment. DraftKings (NASDAQ:DKNG) went public via the same SPAC route and has more than quadrupled from its merger price. State-level election results were hugely favorable for the industry as well.
But there are real concerns here. One is the nature of the company’s product. The BetRivers.com app in Illinois, which I have used repeatedly, is a disaster. It is slow and clunky, and App Store reviews highlight complaints from other users as well.
Competition is a larger issue. BetRivers was first to market in Illinois, which led it to 84% share in August. The figure dropped below 40% a month later. RSI saw similar performance in Pennsylvania, where an early lead evaporated.
Both states highlight the biggest risk: Every other operator has an intrinsic edge.
DraftKings and Flutter Entertainment (OTCMKTS:PDYPY) unit FanDuel have massive existing user bases from their daily fantasy sports offering. Caesars Entertainment (NASDAQ:CZR) has the largest loyalty database and is acquiring William Hill (OTCMKTS:WIMHY). Penn National Gaming (NASDAQ:PENN) has a large database itself, and can drive user acquisition through its stake in Barstool Sports.
RSI has none of those advantages, which means its execution needs to be perfect, or close. So far, it has not been.
SPACs to Avoid: Landcadia Holdings II (LCA)
Much of the same argument holds for Landcadia Holdings II, albeit in a slightly different market. Landcadia is merging with Golden Nugget Online Gaming, which is focusing solely on the online gambling business.
That focus does not allow Landcadia to escape the same competitors facing Rush Street, all of whom are targeting online gambling in states like New Jersey and Pennsylvania. GNOG is the early leader in the New Jersey market, but its brand has value on the East Coast thanks to the longstanding presence of its namesake casino in Atlantic City. It will be difficult to replicate that success in new markets like Michigan.
LCA stock admittedly is cheaper than peers relative to revenue. But as I argued last month, investors in a growth market like online gambling shouldn’t be looking for the cheapest play. They should be looking for the best play. It still seems highly unlikely that Golden Nugget will be that play.
South Mountain Merger (SMMC)
South Mountain Merger is combining with Billtrust, a digital provider of accounts receivable solutions for business-to-business commerce. There is an interesting model here, but some very real questions looking closer.
Here, too, valuation is an issue. A current share price of $12.60 values Billtrust, excluding an expected $200 million in cash post-merger, at about $1.8 billion. That is over 14x its projection of 2021 revenue of $123 million.
Admittedly, 14x sales is not an onerous multiple in tech right now. In its merger presentation, Billtrust compared itself to Bill.com (NYSE:BILL). Based on trailing 12-month figures, BILL trades at over 40x revenue.
But Bill.com is growing at a far faster clip. In its fiscal 2020 (ending June 30), revenue increased 45%. Billtrust’s top line rose 20% in 2019, and just 11% in the first half of this year. Slower growth ostensibly merits a lower valuation.
The lack of growth also raises competitive concerns. After all, if AR is as big a market as Billtrust claims — the company cites $280 billion in global payment volume — surely larger fintech leaders would be interested. And if Billtrust can’t drive growth in that market now, it would seem to have little chance of holding off better-heeled rivals.
The Billtrust story simply doesn’t seem quite attractive enough, nor SMMC stock quite cheap enough.
SPACs to Avoid: Jaws Acquisition (JWS)
There are good reasons for a company to go public via the SPAC route. When a company does not seem to have those reasons, that invites skepticism.
Such appears to be the case for Cano Health, which is tying up with Jaws Acquisition. Cano operates primary care centers that serve seniors via so-called value-based care, a fast-growing segment of the healthcare industry.
The question, however, is why. Cano has been owned by private equity firm InTandem Capital Partners since 2016. As recently as last month, InTandem reportedly was taking bids from other private equity firms. Now, InTandem is looking to exit by taking Cano public — with a good chunk of the proceeds from Jaws going to pay down debt.
Jaws itself was founded by billionaire Barry Sternlicht, a prolific and successful investor, but one with little experience in the industry.
To be fair, Cano could prove to be a winner. Value-based care is going to grow over time, and could get a boost from President-elect Joe Biden. But it is not clear why InTandem changed tack. Sternlicht doesn’t seem to offer the industry-specific expertise touted by many sponsors. Those are real questions that suggest real caution toward JWS.
Novus Capital (NOVS)
Novus is bringing AppHarvest to market. AppHarvest aims to build sustainable, large-scale greenhouses to grow produce beginning next year. The capital raised in the merger, along with a coincidental private placement, will back those growth plans.
If the business plan works, NOVS stock will see upside. Figures from the merger presentation suggest NOVS is trading at about 11.6x AppHarvest’s projected 2024 adjusted EBITDA. Assuming that target is hit, it is not difficult to imagine the out-year multiple being far higher. NOVS stock easily could be a double or better.
But again, that is if it all works out. And that seems like a huge “if.” AppHarvest essentially is a startup. Its board of directors has some big names — Martha Stewart, Hillbilly Elegy author J.D. Vance and the CFO of plant-based meat developer Impossible Foods — but not a ton of direct agricultural experience. Nor is the demand from grocers necessarily going to materialize. AppHarvest plans to disrupt imports, but cost well could be an issue.
Again, the potential rewards are big. The potential risks seem even bigger.
SPACs to Avoid: HL Acquisitions (HCCH)
HL Acquisitions is one of the smaller SPACs on the market, and one of the older ones. The company raised $55 million all the way back in June 2018.
It finally found a target in March, signing an agreement with Portugal-based Fusion Fuel S.A. Fusion Fuel aims to produce “green hydrogen,” eschewing the traditional hydrocarbon-based method.
So Fusion Fuel now is facing a far stronger competitor. HL Acquisitions doesn’t offer much, if anything, in the way of industry expertise, and searched for a target for nearly two years. Even the merger itself has been delayed. Fusion Fuel is serving an attractive market, but so far we don’t have much evidence that it will be able to capitalize on the opportunity.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.