Editor’s Note: This article is a part of our “If You Only Buy One Stock” series where we look at 2021’s most popular investing trends and have our top financial journalists make their very best pick. Click here to see more names for your must-buy list.
SPACs, or special purpose acquisition companies, were one of the hottest investing trends in 2020 and early 2021. These types of entities, also known as blank-check companies, are shell companies that initially go public via a regular initial public offering, and raise capital.
The difference is, instead of raising cash to finance an existing business, SPACs raise money to buy another privately held company. A SPAC chooses a target, then strikes a deal. Once complete, the “deSPACing” happens. The SPAC takes on the target’s name and morphs into a purely publicly traded operating company.
SPACs may be a recent trend. But, they’re not a new Wall Street creation. This have been an alternative method for taking companies public for decades. Yet, it’s only been in the past year or so that investor interest in them has skyrocketed.
Why? Namely, due to the most high-profile SPACs as of late merging with companies in hot sectors. Think electric vehicles (EVs), and online gambling. Many “unicorns” (startups worth at least $1 billion) have gone this route to go public as well.
As a result, some SPAC stocks have produced tremendous gains for investors. For example, online sportsbook giant DraftKings (NASDAQ:DKNG) has soared nearly six-fold from its SPAC offering price of $10 per share. But, since February, the mania behind these types of stocks has cooled considerably.
Going forward, fewer SPACs are going to experience such jaw-dropping upward surges. Yet, filtering through the plethora of blank-check companies, you can still find worthwhile opportunities.
Finding Potential Winning SPAC Stocks
When it comes to filtering for promising SPACs, what should be your key criteria? It should be the stock’s current valuation, relative to its long-term prospects. For “de-SPACed” former blank-check stocks, like Draftkings, all you need to do is look up its valuation metrics. With sports wagering exploding across the U.S., the industry first-mover may have massive growth ahead. But at its current valuation (around 28.4x sales), said growth may already be accounted for in its stock price.
When it comes to a SPAC stock whose merger is still pending, it’s trickier to figure out its valuation. To do so, you need to look up its transaction summary. For example, with VG Acquisition Corp (NYSE:VGAC), which is set to merge with genetic testing company 23andMe, you can find this on slide 37 of its merger presentation.
Transaction overviews typically use the blank-check stock’s initial offering price (usually $10 per share). If the SPAC has rallied from this offering price, there’s more math involved. But, luckily here, VGAC stock today trades around its offering price. Comparing the post-merger valuation ($4.5 billion), against its current year sales ($218 million), we get a more than 20x price-to-sales ratio. In short, this may be overpriced.
Admittedly, with SPACs mainly being “growth stories,” you have to lean more on projected growth numbers. For 23andMe, valuation may look reasonable at first glance. Sales are set to soar over the next few years. But looking at the slide in its revenue over the past few years, the company looks more like it’s rebounding back to its high-water mark. In short, instead of a bona fide “growth story,” it may be more of an overvalued “turnaround story.”
If You Could Only Buy One: THCB Stock
The two examples above don’t appear to be great buys at their current prices. So, what is a good example of a SPAC stock where future growth may help justify a premium valuation today? Consider Tuscan Holdings (NASDAQ:THCB) stock to be such an opportunity.
What’s the “story” behind this blank-check company?
As I broke it down back in March, Tuscan Holdings is in the process of merging with Microvast, an EV battery company. Over the past few months, investor interest in EV and EV-related plays has cooled off considerably. When I last wrote about it, I recommended waiting for another pullback. At the time, shares traded for around $13.75 per share.
But, now, following its pullback to around $11 per share, there’s a bit more margin of safety. Sure, even now, THCB stock appears very pricey. At today’s valuation, the implied post-deal market cap for it is around $3.3 billion. Compared to this year’s estimated sales ($230 million), that’s a big premium.
Yet, given future projections, it may be worth it. Sales are set to rise to $460 million next year. By 2025, this could be a $2.35 billion per year business. And with it going after a fast-growing market, revenues could top $6.8 billion by 2030.
Granted, projections aren’t the same as a sure thing. But, considering this EV battery company is focusing on the commercial vehicle niche, it may face less competitive pressures. Add in the fact it has locked down partnerships with major truck makers like Oshkosh (NYSE:OSK), THCB stock could live up to expectations, and become a long-term winner.
On the date of publication, Thomas Niel did not (either directly or indirectly) hold any positions in the securities mentioned in this article.
Thomas Niel, a contributor to InvestorPlace, has written single stock analysis since 2016.