By: Aman Singla, Kritika Venkateswaran, Siddharth Tripurani (NYU)
Over the past few years, private companies have been seeking the attention of Special Purpose Acquisition Companies, also known as SPACs. Commonly known as “blank check or shell companies”, SPACs are publicly listed shell corporations that raise funds for the sole purpose of acquiring or completing a reverse merger with private companies. The concept has been around for two decades but experienced major growth between 2015 and 2019, with 59 new SPACs emerging in the market in the latter year. The benefit that SPACs provide to their target firms is an easy process to make their company publicly listed. When the SPAC goes public, it has already gone through the U.S. Securities and Exchange Commission's IPO registration process. Thus, once a merger with a SPAC is completed, the target company usually does not have to take the traditional IPO route which has more arduous tasks that come along with it.
All the funds raised by investors for the SPAC are secured in a blind trust until the SPAC’s owners/management decides the acquisitions that it’s going to undertake. Additionally, SPACs are given 2 years to complete their intended acquisition or they must return the funds to the shareholders. Investors are kept in the dark about the potential acquisition so that the share prices don’t fluctuate too much in the decision making process. Previously, investors had the right to vote on a deal but over time, the access to information motivated investors to “shark” out others in the SPAC. Hence, the right to vote and the right to redeem shares are now separated, allowing the SPAC to be defined by those who manage it. Every SPAC share is usually set to $10, however, recent excitement over successful SPAC acquisitions has sent many of their share prices above $10 which also means that if an acquisition fails, those who paid the premium to buy SPAC shares will face a loss. Bill Ackman, the founder of hedge fund Pershing Capital, also founded its SPAC counterpart, Pershing Square Tontine Holdings, in 2020 amidst the pandemic. When Ackman’s SPAC went public in July, it raised over $4 billion and is claimed to raise an additional $3 billion in the foreseeable future.
II. Who is involved? Which industries are seeing a growth in SPAC?
Sponsors (SPAC Creator)
We start with the creators of the SPAC: the sponsors. For these players, incentives tend to be clear, since the sponsor acquires a special class of shares that equates to 20% of the shares in the SPAC for a nominal cash consideration, known as the “promote.” These sponsors also reap other benefits in leading the SPAC, such as the option to organize a PIPE deal concurrently with the acquisition and the chance to offer some input on the strategy of the acquired business, oftentimes through a position on the board.
The proliferation of SPACs would not be possible without newfound interest from
capital providers. Why have investors suddenly become so willing and eager to
allocate capital to these vehicles? For one, the limited flow of new companies
into the public markets has left some asset managers who had capital set aside
for new listings without any targets. Buying into a SPAC IPO is quite a different
process than a traditional IPO. Potential returns come at an undefined point in
the future when the business combination is announced, with an added kicker in
the form of warrants. Nonetheless, the SPAC backers gain access to the deal that
the sponsors eventually negotiate, which in theory would be with an innovative
company that otherwise would not have been able to list on the public markets.
Ultimately, given the high burn rate associated with R&D costs, capital
expenditures, and multi-site clinical trial management, cash on hand is the lifeblood of these companies. Public investors have been a key source of capital
for biotech companies progressing into large-scale clinical trials and those who
are negotiating licensing fees and expensive manufacturing contracts. Assuming
sponsors, investors, and private companies see eye-to-eye on valuations, SPACs
can provide them with quicker access to the public markets than a traditional
IPO and mitigate much of the dilution and valuation discounting that occurs with
crossover rounds and IPO transactions.
Currently, only a handful of SPACs are explicitly targeting technology
businesses, although similar vehicles have increasingly appeared in the last couple of months. Until recently, technology businesses had transitioned to the
public market out of necessity to continue their growth plans, scale-up,
gain access to debt markets, and legitimize their businesses. However, with
the expansion of private markets in general, and particularly the surge in
nontraditional investor involvement in VC, private technology businesses now
have the opportunity to reach essentially all of their growth targets using VC
only. This change has slowed and, in some cases, stopped the flow of new
public listings by fast-growing tech startups. In this new reality, there are now
a large host of mature and highly-valued private companies that need to find
liquidity for insiders, gain access to public debt markets, and finance longer-term
projects but may want to avoid a traditional IPO process. This could
be for myriad reasons, including the time commitment, concern about the
valuation at which the offering will price, or the financial costs. This vacuum
is why some SPACs entering this space will find success, given the universe
of target businesses continues to swell.
III. Case Studies
A. Virgin Galactic
Virgin Galactic, Richard Branson’s space tourism company, is to go public by merging with the SPAC Social Capital Hedosophia, giving them a 49% stake in the company. Rather than an IPO, Virgin Galactic can raise up to 700 million in nearly half as much time. Not only does Virgin Galactic avoid having to sell high-risk shares but this cash injection can potentially make the company’s stratosphere operations profitable.
Virgin Galactic has an estimated market value of $2.2 billion. With $674 million from the 2017 IPO and a new $100 million investment from the SPAC, Virgin Galactic plans to use about $274 million to redeem shares held by insiders and $48 million for transaction fees. This will leave the company with about $450 million in cash.
The company has already suffered one tragedy when a ship broke up during a test flight and killed one pilot. Such events scare regular investors away; however, the SPACs management evaluates that risk for investors, increasing the security for the anonymous investors. Virgin Galactic can further benefit from the access to resources that investors from a similar field choose to make available for their operations.
Since Virgin Galactic already has a reported 700 customers ready to pay $250,000 each to take the 90-minute flight to the edge of the world’s atmosphere, the SPAC has reason to believe that the investment will yield returns. Social Capital Hedosophia (SCH) priced 60 million shares at $10 in September 2017, and under usual SPAC rules had two years to invest the money raised. The management of SCH went ahead and directed all the funding to Branson’s Virgin Galactic.
"This transaction represents the next step of our exciting journey. We believe it will offer us the financial flexibility to build a thriving commercial service and invest appropriately for the future," - George Whiteside, CEO of Virgin Galactic.
DraftKings, a fantasy sports company, is going public with Diamond Eagle, another SPAC. The deal includes a $304 million equity investment from multiple investors who will help spearhead the company’s operations into other states in the United States. The transaction kept DraftKings' current management team in place, including co-founder, Chairman, and CEO Jason Robins.
Regardless of the relative shut down of live sports in the NBA and NFL, Diamond Eagle’s management is optimistic for the future of betting as more states look to legalize sports betting. However, DraftKings’s revenue was $323 million in 2019 with EBITDA loss at -$99 million; its total accumulated deficit is more than $1 billion. Investors have to cope with the initial losses in light of the expected success of the bookkeeping and betting platform.
Interestingly enough, DraftKings was seeking to go public before the IPO process opened up. Most companies would wait to avail the best offer from interested investors or SPACs. The economic downturn still needs to be navigated before DraftKings can take advantage of the reigniting sports associations.
"We have a lot of really exciting new markets that we’d like to launch, and that requires capital investment," - CEO Jason Robins
C. Nikola motor
Nikola Corporation is an American firm that has produced several concept zero-emissions vehicles since 2016 and its subsidiary, Nikola Motor Company manufactures electrical components as well as the Nikola One and Nikola Two electric semi-trucks. These vehicles are entirely electric and also have hydrogen-electric powertrains. The heavy-duty truck company had talks with VectoIQ Acquisition, a SPAC, at the end of 2019, and the companies closed a deal on June 3. The SPAC deal placed a value on the electric vehicle company at $3.3 billion before proceeds which included the $238 million in VectoIQ’s trust fund along with a $500 million investment in PE which was led by several investors including mutual fund giant Fidelity.
"We thought that by going with a SPAC we might leave some value on the table, but we also knew that it would take much longer to [do a traditional IPO]" - says Nikola CFO Kim Brady.
The transaction is hoped to accelerate vehicle production, allowing Nikola to act as a true competitor to Tesla. The legacy Nikola shareholders kept an approximately 80% stake in the company post-merger and the rest of the stake was divided between PE investors and legacy VectoIQ shareholders. The share structure has VectoIQ SPAC shareholders owning 23 million shares and 23 million warrants at $11.50. There is an additional 52.5 million shares from additional investors during the acquisition, each share at $10. Finally, Nikola’s shareholders own approximately 320 million shares.
With the investment from the SPAC and now having publicly traded stocks, Nikola anticipates 4,000 battery electric vehicles (BEV) and 30,000 fuel cell electric vehicle (FCEV) sales in 2027. They also estimate for EBITDA to be $1.35 billion at the same time. Although these forecasts are still assumptions, one thing is clear, early investors in VectoIQ that bought shares at $10 per share have profited from this acquisition, with current stock prices at $34 per share.
D. Burger king
Before Burger King merged with the Canadian food chain, Tim Hortons, it was involved in a SPAC deal with Justice Holdings, a blank check company under Ackman’s Pershing Square. The SPAC was completed in 2012 when Justice Holdings acquired a stake in Burger King, resulting in the company going public. The deal was also in partnership with 3G Capital and has been notably one of the most successful SPACs to have been completed in history. The deal came as a surprise to many as the restaurant chain had only gone private in a leveraged buyout 18 months prior to the acquisition by Justice Holdings. Thus, the deal marked Burger King going public for the second time.
The leveraged buyout that relied primarily on debt financing was by 3G Capital for $1.2 billion for a 70% stake in Burger King. 2 years later, 3G sold 30% of its stake to Justice Holdings. Bill Ackman owns 250 million shares of Burger King’s parent company, making it an extremely lucrative investment for the experienced investor. Since going public, Burger King has done extremely well through its new breakfast menus offering coffee and non-coffee drinks.
Without a doubt, SPACs are having a moment in the current environment and offer an innovative way for private companies to go public. However, while we believe the population of companies that might combine with a SPAC is growing, it still represents a small subset of private companies, limiting the potential disruption of the traditional IPO process. However, as new entrants flood the market, they are iterating upon terms and structures to make them more company friendly. That said, the hype around SPACs will likely recede once more certainty returns to the financial markets; the time it takes to go public is not accelerated enough using SPACs to simply supplant other options and make this strategy the go-to route for public listings. The process to bring companies public is certainly broken, and while we are encouraged by the momentum driving innovation around public listings, SPACs will not provide a solution for every private business. It will likely work best for capital-intensive businesses and those with a complicated or long-term story.