There’s an old saying that you have no friends on Wall Street. Today, we should rephrase it: the Street is not going to do you any favors. That’s how you should approach the latest craze in the investment market, the now ubiquitous special purpose acquisition company or SPAC. And yes, caution does apply, even to Social Capital Hedosophia Holdings Corp. VI (NYSE:IPOF) stock.
I get it. IPOF stock is venture capitalist and early Facebook (NASDAQ:FB) executive Chamath Palihapitiya’s baby. Among SPAC fans, Palihapitiya is king. I’ve lost count of the many deals he’s brokered, including one of the most famous in space tourism play Virgin Galactic (NYSE:SPCE).
Frankly, that’s the appeal for IPOF. We don’t know its acquisition target yet, but we do know Palihapitiya.
Is that good enough of a reason to bet on IPOF stock? That’s going to come down to a personal decision. However, you should really think carefully before going one way or the other.
But first, let’s back up a bit. One of the main concerns I have is that with SPAC fever, people appear to be betting on how a company goes public as opposed to why. I mean, does it really matter in the long run whether a company sought an initial public offering through the front door or the back?
Yes, I understand that mechanical differences exist. But let’s demystify the sudden exoticism of SPACs. These are merely blank-check firms that go public for the sole purpose of merging with a private enterprise. Typically, they have two years to find a target and make a deal.
If a deal does go through, the public SPAC and the private target merge, effectively making the target company public. That’s why some folks refer to SPACs as reverse mergers.
It’s like backing into the playoffs, which is where my concerns lie.
IPOF Stock Is Great for the Sponsor But Not Necessarily for You
Usually, the idea of a sports team making the playoffs by virtue of some other team stumbling on the field of play irks many fans. Yes, winning ugly is still winning. However, an underlying sense of meritocracy runs through sports – call it an unwritten rule, similar to what you find in baseball.
Meritocracy, though, is a questionable concept for IPOF stock and the SPAC platform. Because the blank-check firm has no operations of its own (hence the name), it doesn’t face the same kind of regulatory scrutiny that a traditional IPO prospect does – because, you know, what is there to scrutinize?
This in part allows SPAC IPOs to shave much time and expenses relative to their traditional counterpart. On the surface, that’s great for both SPAC sponsors and investors. Smaller private equity firms have an opportunity to go public, whereas they could have been denied via a “regular” IPO. Retail investors can advantage early bird offerings they normally wouldn’t be able to access.
But that comes at the expense of numerical increases overshadowing high-quality ventures. It’s economics 101 – you increase supply, you see a decrease in demand (price). Therefore, the more SPACs that are running around, the less likely each one is the home run you’ve been looking for.
That’s not to discourage IPOF stock or any other SPAC play. But I invite you to look at the numbers. According to SpacInsider, in 2019, there were 59 SPAC IPOs. In 2020, this figure skyrocketed to 248 as the pandemic incentivized the quicker approach of SPACs versus garden variety IPOs.
In the year-to-date, SPACs number 231, which is inside 7% of all of 2020. Just from simple probabilities, the chances of any individual SPAC delivering the goods has declined significantly.
Sure enough, IPOF stock is down nearly 29% over the trailing one-month period.
Think Carefully Before You SPAC
It’s not possible to go over all the pros and cons of SPACs in a short article like this. But one factor you should always remember is that SPACs are usually not designed to benefit you, the retail investor.
As I discussed in an article for Benzinga, SPAC sponsors and retail investors are on different wavelengths of the compensation spectrum. From most of the SPACs that I’ve seen (there are exceptions), sponsors receive generous compensation for sealing a deal, not whether the deal is a good one. So, sponsors get their money early. On the other hand, you get your money if your speculation pans out favorably.
Interestingly, Palihapitiya caught some flak for exiting his entire personal stake in Virgin Galactic. While the venture capitalist defended his actions as being proper, it raises the question about whether SPAC sponsors are truly vested in building up their blank-check ventures.
I’m not suggesting that this impugns the narrative for IPOF stock. But goodness me, you need to at least think about it before you pull the trigger.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.