Updated: Jul 22, 2020
SPACs have grown in popularity during COVID because of uncertainty in the markets
SPAC. That’s a hot word you might have been hearing more recently in the investing world. SPAC stands for special-purpose acquisition company and some of the most recent IPO’s have been through SPACs. Notable companies that IPO’d through SPACs include DraftKings, Nikola, and Virgin Galactic, which had seen upwards of 300% returns in just weeks after IPO. SPACs have become more popular during COVID because it’s a better guarantee of raising capital than through a traditional IPO. Here’s what you need to know about SPACs to invest in them:
What are SPACs?
SPACs stand for special-purpose acquisition company. SPACs are blank-check companies that IPO in order to raise money solely for the purpose of acquiring a private company to take public. Most SPACs seek to acquire a company within two-years before the money raised from the IPO is returned to shareholders. When a SPAC IPO’s, it cannot have a target in mind otherwise the process will end up similar to a traditional IPO.
Why are SPACs doing so well during COVID?
SPACs attract high-potential companies that draw significant attention, but have not yet demonstrated profitability. In a traditional IPO, the amount of money a company raises is dependent on how the market values the company. However, when companies IPO via SPAC, they have a much better sense of the amount of money they can expect to raise since part of the money will come from the SPAC’s IPO fund. Moon-shot companies like DraftKings, Virgin Galactic, and Nikola have attracted significant interest from retail investors driving share prices upwards of 300% in some cases.
How do SPAC units convert to target company shares and warrants post-acquisition?
Most SPAC tickers will have a “U” at the end representing the SPAC’s “units,” which usually comprise of one share of common stock and a fraction of a warrant to purchase a share of common stock in the future. Almost all SPACs IPO at $10 per unit with warrants that have a strike price of $11.50 (or 15% above the $10 per unit IPO price). One thing to consider is that only whole warrants can be exercised. Around 52 days after the SPAC’s IPO, the common stock and warrants can be traded separately, so investors can trade units, the common stock (not denoted w/ “U”) and/or warrants (denoted w/ “WS” or “W”). For example, after VTIQ’s IPO, its units traded under VTIQU, the common stock traded under the ticker VTIQ, and its warrants traded under VTIQW. Upon merging with Nikola, the target company, all VTIQ stock and warrants traded under NKLA or NKLAW. Any appreciation in the SPAC units or shares price is equivalent to appreciation in the target company value.
What are the advantages of investing in SPACs?
High upside potential with limited downside risk. SPAC investors can reap significant upside depending on the target company and know the downside risk is capped near or slightly under the SPAC’s IPO price. In Nikola’s example, VectoIQ Acquisition Corp (VTIQ) traded at or around $10 per share before ramping up significantly after it announced that it was going to take Nikola (NKLA) public. Weeks after NKLA went public, its shares traded near $80 per share, 8-fold higher than what VTIQ’s units were worth at IPO. If VTIQ was not able to find a target company, then shareholders would be paid back near $10 per share, capping the downside risk.
Exercising warrants can add significant upside. If a SPAC goes particularly well, exercising warrants can bring significant upside to the run-up seen with the common stock. For example, NKLA traded near $80 per share. Exercising whole warrants would provide you additional common stock at a price of $11.50 per share. Selling the shares after exercising the warrants would have generated nearly 600% returns.
What are the risks of investing in SPACs?
Opportunity Cost. Because SPACs have ~2 years to find a company, there is associated opportunity cost to holding SPAC units. During the search, the SPAC’s unit price will not change much from around $10 per unit. The investor’s capital could have been used better elsewhere, generating greater returns. However, some SPACs identify a target company within months of IPO’ing the SPAC, so this risk does not necessarily exist with all SPACs.
Unable to Find Target Company. Most SPAC units trade at a premium once the SPAC IPO’s. Investors may pay $11, $12 or more per unit. If the SPAC is unable to find a target and decides to liquidate the trust, then unit holders will be paid at the SPAC’s IPO price, which is likely ~$10 per share, so investors may take a 10%+ loss is they paid a premium for the units.
Too Many SPACs, Not Enough Target Companies. Not all SPAC acquisitions are successful. If there are too many SPACs seeking to take private companies public, there is greater likelihood that there are not enough good private companies to go around. There is certainly a chance for SPAC unit holders to redeem their units for $10 per unit before the target company is taken public if the unit holders are not comfortable with the target company. In this case, the target company may not be able to raise needed capital and trade under $10 per share.
Redemption Risk for Warrants. If the target company share trades above a certain price per share for a certain amount of time, the company has the ability to the warrants for a nominal consideration (e.g., $0.01 per warrant). This forces public warrants to exercise or the warrants will lose value.
Unique SPAC Considerations. While SPACs may be structured similarly, each SPAC differs slightly in regards to their terms. It is critical to read through SPAC terms and conditions in order to fully understand the risk/reward profile associated with the SPAC.
What are some notable SPACs available right now?
Pershing Square Tontine Holdings seeking to raise $4B in largest SPAC IPO to date
Plans to list on NYSE under PSTH.U
Spartan Energy Acquisition Corp (NYSE: SPAQ) seeks to acquire Fisker, a potential EV competitor to Tesla
Announced target company acquisition on 7/13/2020
Therapeutics Acquisition Corp. (NASDAQ: TXAC), sponsored by RA Capital, raised $118M IPO and traded at a 60% premium last week.
RA Capital is a prominent healthcare and life sciences focused investment manager
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Disclaimer: I/we currently have positions in SPAQ. I/we have no positions in any other stocks or units mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I have no business relationship with and was not paid by any company whose stock is mentioned in this article.
WX Capital and the members of its team are not registered investment advisors, so this article should only be taken as our opinion and not individualized investment advice. Please conduct proper research before investing in any security because any financial investment may result in significant financial losses.