SPAC Opportunities

I'm seeing a lot of 30-some year olds with experience having worked at some top PE or HF shops and maybe a top 5 MBA as CEOs of SPACs. It's unclear that they have individual investment track records that can be attributed specifically to them, so my question is, how do these guys land these roles? Are they recruited into them, or do they actually conceive the idea of doing a SPAC themselves and go raise capital? And if it's their own idea, how are they able to raise $200+ million for a shell company just to look for an acquisition - like without an investment track record, how are investors trusting that they will in fact find a good deal?

 
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Think about the SPAC product. It's an asymmetric risk-reward profile for an IPO investor. 

You purchase shares at IPO which are held in trust. The management can't do anything with it without your approval, and it earns money-market interest during the search period. 

You have two votes. One to approve a deal presented by management, and a second on whether your cash held in trust is used in the deal or returned to you with interest. If you vote to receive your cash instead of keeping it in the deal, it's called "redeeming". 

If you analyze SPAC activity over the past eight quarters (really when it boomed), you'll see that the ratio of redemptions rose over the back half of that. People weren't leaving their dollars in the deal the same way any more. 

The 'SPAC mafia' are by and large a bunch of hedge funds who use SPAC IPOs as a cash management play. It's a free option. You buy at the offering, receive interest, and have a call option on the (low) probability management finds a deal that looks like a winner.

In this light, you can see how it's possible for people with an okay but not amazing profile or track record to successfully execute a small (<$200m) SPAC IPO. It's less about them and more about the fact that the structure eliminates a lot of the risk. 

This is why it's such a different trade for a retail investor versus an institution. Buying at deal announcement is an entirely different phenomenon from buying at IPO. If your dollars aren't held in trust, you don't have the same protection.

Here's a longer comment I wrote about a year ago as a kind of primer on the product.

APAE

When thinking about a SPAC, it's helpful to make a distinction in your mind between (a) the pre-combination SPAC itself and (b) the company it eventually combines with. I'll refer to them as the SPAC and the target, respectively. For your questions:

Deal structuring:

A SPAC finds a company to merge with (the target), so it's doing the acquisition while the target being 'purchased' is the seller. T

he only capital structure element worth calling out is that generally a SPAC targets a company with an enterprise value that's a non-trivial multiple of the amount of cash-in-trust raised in its SPAC IPO. This matters because the existing shareholders of the target are sensitive to the dilution incurred by accepting the SPAC deal.

Let's take a simple example. A $500m SPAC combining with a target who has an enterprise value of $1,000m presents significant dilution to the existing ownership. That $500m SPAC combining with a target at a $2,500m enterprise value is entirely different.

You can thus think of a SPAC as a fish swallowing a (generally much) larger fish.

Valuation:

Yes, you are making a bet that the SPAC management is going to find a worthwhile target such that the future price of the SPAC stock will be greater than when you purchased it. 

There's an important delineation to make here. SPAC IPO investors are in an entirely different position than subsequent non-IPO buyers of the stock on the exchange. An IPO investor is buying a 'unit'. That unit consists of one share and one fractional warrant. Historically that fraction was one-half of a warrant. In early 2020, it became one-third, and in late 2020 there have been some one-quarter, one-fifth, and one-eighth warrant deals. We'll come back to the warrant in a second.

The SPAC receives (illustratively) $500m in cash proceeds at its IPO and hands out 50m units to the IPO investors. Its use of cash is a deposit to a trust account, where the rules of that trust are such that the monies can only be accessed in the event that management presents a proposed combination target for a vote to its entire shareholder base, and a majority (or supermajority; the threshold can theoretically vary depending on the terms of the IPO documents; it generally doesn't vary) votes in favor. 

Here's the wrinkle. The SPAC IPO investors actually have two votes. One is to vote on the deal being approved, and the second is on whether their cash actually gets used on the deal. So you'll often see SPAC mergers going through with a high-90s approval vote, but the actual dollar amount available to the combination target is lower, something like 50-70% of the total amount raised in the SPAC IPO. In our example, this would be something like $325 in cash proceeds to the target.

This is why PIPEs have become such a common term, even to retail investors, lately. A PIPE 'backstops' the SPAC deal. If the target needs $500m minimum as a financing event, the SPAC team (and its bankers) will go bring some investors over the wall and raise something like $200-250m. If 100% of the IPO investors voted yes on the deal and yes to their cash being available in the transaction, the target company would wind up with $750m. But there's almost invariably some leakage and it winds up being like $575m between the cash-in-trust that remains plus the PIPE.

Going back to the warrants, you can see why an IPO investor has a different incentive set than you the retail investor buying the ticker for your brokerage account. They are incentivized to say yes to the deal and no to their cash being used, because there's nearly invariably a significant pop in the security upon deal announcement and they for free at IPO purchase received a warrant with non-zero value.

So it's truly an arb for the IPO investor. For them, it's like taking a call option on the management team's ability to find a deal that will trade well. You receive cash interest while the SPAC searches for a target. You can vote on the deal even going through. You can vote on whether you redeem your cash or keep it in the deal (and you decide that based on how you think the stock will trade). You could even invest further in the PIPE (which always goes through at $10/share; and upon announcement these deals are often trading in the high teens or low-20s depending on how hot a sector it's in).

For the retail investor, it's less like a call option because there's downside risk to the stock without the corresponding structural elements like the double-vote feature or the non-zero value of the warrant.

That whole story didn't directly answer your question about the factors that go into how a SPAC stock is valued. The simple answer is that it's largely about perceived caliber of management plus pure sentiment: rumor about deals found. If it gets out (quietly) that someone is close on a cool company, the funds in the know pile in because they know an LOI announcement will send the thing soaring. There are funds that do nothing other than go in and out of SPAC stocks, at IPO or not.

Risks:

In the prospectus a SPAC will list out everything about its team members. That's more or less what you're buying: that group's ability to execute on an acquisition.

The valuation of the target is usually approached one of two ways. Some SPACs will have a reasoned conversation about what makes sense for the company. Other SPACs are oriented purely towards what the public market will support. That usually shows up as a significant disconnect between what people in the former camp are willing to offer to a target versus those in the latter camp. Over the course of the past year, the ratio of people in those two camps has changed considerably. 

Good luck.

I am permanently behind on PMs, it's not personal.
 

If the 30 year old sponsor raises a $200mm SPAC and subsequently gets 20% of that, does that mean they're automatically worth $40mm? And for what, spending a few grand setting up the SPAC? Not to mention ANY price appreciation. Seems like a cool gig

 

To raise a SPAC, the sponsor must invest 'risk capital'. This is typically 3-5% of the IPO raise amount. It can be made either in the form of warrants or units (the same units offered in the IPO: a share and a fraction of a warrant).

So a $200m IPO is going to require at very least $6m in cash, perhaps more depending on how large an operating budget the sponsor decides to capitalize the pubco with.

It's common for a sponsor team that is young or inexperienced in relative terms to raise external money for that risk capital exercise. In SPAC language, that is called 'syndicating', and it's nothing other than the SPAC version of a GP investment.

You're right that sponsor economics are 20% of the common equity in exchange for that risk capital investment in the private placement warrants or units. However, it doesn't automatically correlate to net worth. If the SPAC doesn't successfully close on a business combination target, that risk capital is a wasted investment (because it was spent on the offering and administrative expenses as well as the operating budget for the SPAC's search period).

If there is a successful merger, yeah, the sponsors really get paid.

I am permanently behind on PMs, it's not personal.
 

Thank you for this synopsis. But to get back to the question, who starts the chain? So does the 30-some-year old guy at Goldman decide he wants to do a SPAC, goes around to find some credible gray-haired "Chairman" and investors to pitch in the sponsor capital.... or is it usually the senior guys' idea who then say okay, let's recruit a junior guy to run this thing day to day? I guess what I'm asking is the mechanics of how that 30-some-year old ends up in that role.... I'm guessing the answer is some are done the first way and others the second way, so I'm curious which is the more common way...

 

Recently saw some 1st/2nd year IB analysts that formed a SPAC and unsurprisingly one was the heir to an oil fortune and the other a rich Peruvian. Also know a former IB analyst that works in a senior position at a SPAC and he also comes from a very wealthy family. I'm guessing the vast majority of these younger people getting into the SPAC game as execs come from wealthy/prominent families and leveraged their background.

 

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