The SPAC Hustle

Readers beware, I’m about to get all up on my high horse in this post.

Recognizing that I’m a few months late to write an article on SPACs since they peaked in April 2021, their relevance to the industry will undoubtedly continue for years to come. In 2020 and early 2021, SPACs were vehicle du jour for taking private space companies to market, including among others ASTS SpaceMobile, Spire Global, Astra, Rocket Lab, and Planet. Headlines about SPACs promised a faster and cheaper route to market than the traditional IPO. As a characteristically skeptical person, I was indeed…skeptical.

A SPAC Explosion

SPACs are not new, but their recent proliferation is novel. Until 2020, the yearly volume of SPACs which were formed and then subsequently raised capital via IPO was in the 10s per year range. In 2020 this number jumped to nearly 250, and so far in 2021 it is nearly 400. The chart below shows the explosion in SPACs, and their present stage.¹

While many are speculating that the SPAC bubble burst in April 2021,² their impact is likely to be felt for years to come. Of the nearly 700 SPACs that IPO’d in the last 2 years, nearly half have yet to find a company to merge with and take public, representing nearly $130B in unallocated capital. What’s more is that these SPACs are obligated to execute a merger within a predefined time limit (on average 2 years from their IPO date). Private companies looking to go public via SPAC in the mid-2022 to early-2023 timeframe will likely have their pick-of-the-litter, as desperate SPAC managers race against the clock to secure a merger before they need to return investments to their shareholders (taking a meaningful loss for themselves in the process).

However, SPAC investors need to be wary. The precipitous decline in definitive agreements starting in April 2021 suggests that high-potential private companies have all been gobbled up by SPACs, leaving only bottom-barrel opportunities for this deluge of new capital. It is likely that the quality of merger targets will decrease as SPACs become more competitive and more desperate.

Is a SPAC Better than an IPO?

Private companies begrudge the IPO process for its cost. One of the largest costs incurred by the private company for a traditional IPO is the price “pop” on the first day of trading. The soon-to-be public company will agree to an IPO price with an underwriter, the latter of whom will buy shares from the former at this price only then to sell them on the public markets. This agreed-to IPO price is intentionally set low such that it will pop by around 15–30% on the first day of trading. This represents a tidy profit for the underwriter, but a cost to the company going public who otherwise stood to profit from that pop.

On the other hand, SPAC costs are more hidden, but exist nonetheless. To see a real-world example of the hidden cost of SPACs, let’s take a look at my absolute favorite company: ASTS SpaceMobile /s

A SPAC Journey with ASTS

In April 2021, ASTS SpaceMobile went public through a merger with New Providence Acquisition Corp (NPA).³ A few things happened along the way to becoming a public company which created hidden costs.

Step 1: SPAC IPO — In September 2019, NPA sold 23M shares at a price of $10 per share in an IPO, raising $230M.⁴ Simultaneously, NPA was granted around 6M shares at no cost which will eventually become the source of their return once the merger completes.

This grant of 6M shares to NPA represents a hidden cost to the shareholders. Imagine that NPA was liquidated. The result would be that of the $230M in cash available, $184M would return to the shareholders and $46M would be given to NPA. The $46M return on essentially no investment is a nice profit for NPA, but it is comes on the backs of the shareholders who bear an instantaneous 20% loss the moment they invest.

There are a few important caveats worth mentioning here:

• NPA purchased around $4.5M in warrants which are used primarily to cover transaction costs. This can be considered as NPA’s entire investment into the SPAC, and would be entirely lost if a merger is not consummated
• In the event NPA is liquidated prior to a merger, money is only returned to shareholders and not NPA. This implies that while the 20% loss is created at the time of the IPO, it is not realized until the merger

Step 2A: PIPE Investment — Simultaneous to the merger with a target company, SPACs will give large institutional investors the opportunity to invest, called a PIPE (Private Investment in Public Equity). For the NPA/ASTS merger, an additional $230M additional capital was raised via PIPE from strategic partners like Vodafone, Rakuten, American Tower, UBS, and O’Conner.⁵ This created an ownership structure on the eve of merger that looked like:

The PIPE investment represents another shot at the original IPO investors. The PIPE investment came simultaneous with the merger with ASTS in April 2021, 19 months from the SPAC IPO. PIPE investors received the same deal as the IPO shareholders, but without the 19 month opportunity cost and also did not bear the risk that no merger was to occur.

Step 2B: Merger — During the merger process, NPA and ASTS must agree on a pre-money valuation for ASTS. A pre-money valuation that allows ASTS to “pop” on the first day of public trading would compensate the IPO shareholders analogous to underwriters in a traditional IPO. However, as the negotiation takes place between ASTS and NPA, the IPO shareholders are largely powerless to create a favorable valuation.

The pre-money valuation agreed to between NPA and ASTS was $1.4B which, after the $460M investment from NPA,⁶ resulted in the following ownership structure post-merger:

ASTS benefits from this transaction because their previously private shares are now sellable in public markets. NPA makes out like a bandit, as they turned the original $4.5M investment into around $50M within 19 months.⁷ The $230M that was invested by both the IPO and PIPE shareholders has dropped to around $194M at the consummation of the merger.⁸ This 15% loss to both parties is a result of the original stock grant to NPA.

At the end of the day, of these four parties, the IPO shareholders (predominantly comprised of retail investors) have the largest loss, the largest opportunity cost, the highest risk, and ultimately the crappiest deal.

SPAC Performance

My harangue against SPACs is largely irrelevant if they outperform the market. The guaranteed 15% loss (or 20% without the PIPE) to SPAC IPO investors on the day of the merger may be a price worth bearing for above-market returns in the long run. Unfortunately, history shows that SPACs neither exceed the market, nor in most cases produce a positive return for investors. Below shows the distribution of annualized returns for SPACs whose merge date was between 2016 and 2020⁹ in comparison to the average annualized return for the S&P 500.¹⁰ Of the 85 SPACs considered, only 15 were able to beat the S&P 500. The net result is a vehicle for taking private companies to market that is lucrative for the sponsors and the targets, but simply not for the investors.

Extending an Olive Branch

I feel obligated in conclusion to extend an olive branch toward SPAC enthusiasts. There exist individual advocates for SPACs that I hold in high regard, so I’m willing to admit I may have an incomplete opinion. I religiously listen to the Masters of Scale podcast hosted by Reid Hoffman, who vouches for SPACs and has one of his own: Reinvent Technology Partners Y. Hoffman argued in a recent Masters of Scale episode¹¹ that good SPAC targets are companies that can benefit from being a public company for regulatory, branding, or public trust reasons, but may not necessarily be mature enough in their business for traditional IPOs.

I believe Hoffman makes a valid argument here, but the point remains that investors must be cautious with SPACs. Ultimately, the long-term sustainability of SPACs will depend upon the willingness of sponsors to align their value creation mechanisms with those of their shareholders. The current structure does little to incentivize sponsors to identify merger opportunities that will generate long-term shareholder value. Instead, SPACs are set up for get-in-get-out hustles, leaving retail investors holding the bag. As investors wise up to this scheme, they will become justly hesitant on SPACs as an investment vehicle, ultimately undermining SPACs purported ability to provide an alternative route to public markets.

[1] Merge complete is when the SPAC has combined with the target company. Definitive agreement is when the SPAC sponsor and target have agreed to merge. Searching is when the SPAC has IPO’d, but has yet to identify a target with which to merge.

[2] See https://www.fastcompany.com/90650043/why-investors-fell-in-love-with-spacs-and-how-the-bubble-burst

[3] For full details on the NPA/ASTS transaction, see https://sec.report/Ticker/NPA

[4] Note that for this illustration, I am ignoring the sale or grant of warrants for simplicity. Because of this, total valuations and ownership will differ slightly from reality, but the fundamental point is easier to communicate.

[5] See https://ast-science.com/2020/12/16/ast-spacemobile-to-become-public-company/

[6] In reality there was about $40M in transaction costs incurred, reducing the total NPA investment down to around $420M. I’ve ignored these transaction costs here for simplicity.

[7] NPA’s 6M shares equals 2.7% of a $1.9B company, or $50M

[8] 23M shares for each the PIPE and IPO shareholders equals 10% of a $1.9B company, or $194M

[9] Annualized return is measured from the date of SPAC IPO to present day (02 August 2021), and only SPACs whose time from merger is greater than 12 months have been included. Using these criteria, a total of 85 SPACs are used in this analysis.

[10] To calculate the average annualized S&P 500 return, the S&P 500 return is calculated for each SPAC from their respective IPO date until present day (02 August 2021). This figure is then annualized, and then averaged across all SPACs.

[11] See https://mastersofscale.com/wp-content/uploads/2021/04/mos-episode-transcript-unfiltered.pdf