Unlike traditional initial public offering (IPO) tips, finding and investing in special purpose acquisition companies, or SPAC IPOs, has less to do with fundamentals and more to do with industry and mergers and acquisition experience.
Experts are calling 2020 the year of the SPAC. These investment vehicles are considered a hybrid between traditional IPOs and venture capital or private equity.
According to SPACInsider, there have been 189 SPACs year-to-date through Oct. 2. Of this number, approximately 113 are currently searching for a potential combination. Based on an average deal size for SPACs in 2020 of $382 million, approximately $43.2 billion of capital is searching for a target company to merge with.
Between future private placements and the issuance of stock, the deals post-combination value will be many times this number. For example, in September, Bill Ackman’s SPAC, Pershing Square Tontine Holdings (NYSE:PSTH), approached Airbnb about a combination but was turned away by the home-rental site’s management team.
Instead, Airbnb will pursue a traditional IPO that values the company at more than $30 billion. It is one of the most anticipated IPOs of the year.
It’s impossible to say for certain, but Airbnb’s rejection of the hedge fund billionaire could end up being a blessing in disguise. That’s because the hardest part of identifying the winners and losers in the SPAC game is understanding what you’re actually investing in.
To help readers be successful, here are seven IPO tips based on a total score of 100, to pick big SPAC IPOs.
IPO Tips to Pick Big SPAC IPOs: Quality Management Team – 40 Points
Investing in SPAC IPOs has everything to do with the management team behind the investment vehicle. It’s all about the jockey and little to do with the horse using a horse racing analogy.
That’s because the typical SPAC has between 18-24 months to find a target company to merge with. If the management doesn’t have the expertise to source attractive combinations and a deal isn’t found, the money raised and kept in the trust will be returned to investors, with accrued interest payable.
More importantly, valuable time will have been wasted that could have been used for other opportunities. It’s why you’re seeing a lot of private equity firms, hedge funds, and alternative asset managers entering the fray.
“SPACs are often viewed as an alternative to a traditional IPO or a merger. There is, however, another way of thinking about them: as a new form of asset management, similar to private equity or hedge funds,” stated Stephen Fraidin, a partner at Cadwalader, a global law firm.
“SPACs started out not generally accepted as a legitimate form of asset management, but now they are regarded as totally legitimate.”
Bill Ackman, arguably one of the most successful hedge fund managers in recent years, recently got into the game with a massive $4-billion raise in July that is going after a unicorn (private startups valued at more than $1 billion) looking to grow.
When evaluating the management team behind a SPAC, it’s important to consider what each officer and director brings to the table to add value to the search process.
For example, if a SPAC were looking to combine with a restaurant chain, you’d likely consider restaurant operations and ownership experience to be a critical skill for finding the right business.
Of all the IPO tips in this article, don’t skrimp on the talent.
Specific Industry and/or Sector – 20 Points
Almost as important as the management team is a laser-like focus on the kind of company sought in a combination.
It’s not enough to say the SPAC will look at businesses earning between $100 million and $500 million in adjusted EBITDA with enterprise values of $1 billion or more. It’s got to have an industry or sector in mind, one where the officers and directors have a tangible advantage over other SPAC IPOs when finding a target company.
So, an example of a specific focus would be the RedBall Acquisition Corp. (NYSE:RBAC.U), which raised gross proceeds of $570 million in August. It is focusing on sports-related businesses. One of its directors is Billy Beane, the longtime Oakland A’s executive. He serves as RedBall’s Co-Chairman of the Board with Gerald Cardinale, an industry leader in sports-related private equity.
“[W]e intend to focus on businesses in the sports, media and data analytics sectors, with a focus on professional sports franchises, which complement our management team’s expertise and will benefit from our strategic and hands-on operational leadership,” states RedBall’s IPO prospectus.
“… This group has a strong track record of creating value for shareholders in multiple sports, media and data analytics companies that we have led, managed and/or invested in.”
While there’s no guarantee that RedBall will be more successful than other SPACs, it has a specific focus that makes it easier to hone in on an appropriate target, complete the deal, and help grow the business post-combination.
Investing In SPAC IPOs: Previous SPAC Experience – 10 points
What got lost in the news about Bill Ackman’s $4-billion SPAC this past summer was the fact he’d already done one in 2012. Financiers Martin Franklin and Nicolas Berggruen created Justice Holdings, a London-listed SPAC that merged with Burger King, now part of Restaurant Brands International (NYSE:QSR). Ackman owned 10% of Burger King post-merger.
Ackman was so happy with how the Justice deal turned out he’d been looking to do another one ever since.
A big positive from his previous experience, combined with the fact that Pershing Square was late to the SPAC game in 2020, is that Ackman created a fairer SPAC template to the average investor. For example, Pershing Square Tontine Holdings didn’t have founder shares.
What are founder shares?
“For a small fee of $25,000, he explained in a recent letter to investors in his hedge fund, ‘a sponsor that raises a $400 million SPAC [the average size this year] will receive 20 percent of its common stock, initially worth $100 million, if they complete a deal, whether the newly merged company’s stock goes up or down when the transaction closes.’”
“Even if the stock falls 50 percent after the deal closes, ‘the sponsor’s common stock will be worth $50 million, a 2,000 times multiple of the $25,000 invested by the sponsor, a remarkable return for a failed deal.’”
Ackman knew from his previous experience that SPAC IPOs were slanted in the founders’ favor. His IPO looked to change things for the better.
The Amount of Capital Raised From SPAC IPO – 10 Points
As stated in the introduction, the average SPAC IPO in 2020 is $382 million. SPAC IPOs will often go out and raise additional funds through a private offering of public equity, or PIPE for short.
Once the target company is found, it will issue the shares necessary to complete the combination. The size of the combination is often several times the amount of cash raised by the SPAC.
For example, Switchback Energy Acquisition (NYSE:SBE) recently announced it would combine with Chargepoint Inc., one of the largest U.S. charging networks. Switchback raised $300 million in July 2019, with an additional $225 million from a PIPE. The combination’s enterprise value is $2.4 billion or 4.5 times the original cash raised in 2019.
So, a larger amount of cash raised from the SPAC IPO (PIPE’s included) is helpful because it widens the field of potential targets.
Bigger is often better.
Investing In SPAC IPOs: Sponsor’s Total Investment – 10 Points
As Bill Ackman’s SPAC demonstrates, you can make an offering without putting yourself ahead of regular IPO investors.
In Ackman’s case, he committed to investing slightly more than $1 billion in Pershing Square Tontine Holdings. Also, he paid $65 million for the warrants it received as part of the SPACs IPO.
As a result, there was no need to do a PIPE, and he did away with the traditional $25,000 purchase of founder’s shares, which is great for those directors and officers, but not so good for the IPO investors.
Ackman’s provided real skin in the game. Where possible, investors should look for arrangements such as this one. In the future, expect more SPACs to be structured like Ackman’s.
The Warrants Available – 5 Points
Once upon a time, investors in SPAC IPOs couldn’t vote on approving a target combination if they opted to redeem their charges. In 2010, the rules were changed so that the vote was decoupled from the redemptions.
This allowed investors to vote on a combination, redeem their shares, and keep their warrants for future exercise. Since then, SPACs have continued to grow in popularity.
A typical SPAC sells units at $10 per share. With the unit comes one common share and a fraction of a warrant to buy another share at $11.50 at some time in the future. Ackman believes that the warrant only complicates matters.
So, to keep investors onboard beyond a combination, most of the warrant offered won’t be distributed to his investors until after the redemption date. The upside of this is that the SPAC has more cash to complete the combination.
You’ll want to think long and hard about the warrant structure of a SPAC. The real reason for investing is that you believe in the SPAC officers and directors finding a target that will grow over time. Not to get a sweet deal.
Investing In SPAC IPOs: Interest Rate on Trust Account – 5 Points
Once a SPAC raise is completed, the funds are deposited into a trust account. While it might seem insignificant to worry about the rate of interest paid, every little bit counts. In the case of Ackman’s SPAC, it estimates the trust account will generate $4 million in interest annually or 1/10 of 1% of the approximately $4 billion deposit.
I’m not suggesting that the trust account is a make or break item when evaluating a SPAC because it’s not. However, should you be considering two SPACs and the previous six points have them tied, it can’t hurt to break the tie by going with the SPAC projected to pay a higher rate of interest.
That said, I highly doubt an evaluation of two SPAC IPOs would ever come down to this last point to break a tie.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.