Attack of the SPAC
How did a relatively unknown electric vehicle company with no revenue, no product, and without owning a single factory become more valuable¹ than Ford (F)?
As a stock market and investment nerd this question bothered me, so I did some digging. The answer lies in a bit of market mania, message boards such as WallStreetBets, and heightened interest in finding the next “Tesla”.
But, none of this would have been possible without an increasingly popular financial vehicle called a Special Purpose Acquisition Company or SPAC for short.
First, What’s a SPAC?
A SPAC is basically a pile of money that goes public with the promise to make a single acquisition in the next 24 months. SPACs are typically managed by professional investors and seasoned executives that raise several hundred million dollars (or more) via the public markets with the sole purpose of acquiring a private company. Once a private company is acquired by the SPAC it becomes publicly traded, providing a “back door” to the public market without going through the typical rigamarole associated with an IPO.
The SPAC has become increasingly popular in the last 12 months with several splashy companies going public like DraftKings and Virgin Galactic. In the first half of 2020 over $13B raised on SPACs, nearly eclipsing the total from all of 2019.
How Did Nikola Become More Valuable than Ford?
Nikola Motors (NKLA) is a 6-year-old electric and hydrogen truck manufacturer based in Utah that has been pre-selling their trucks since 2016, but has yet to deliver any vehicles. The company is pushing hydrogen technology which will require Nikola to build out a network of hydrogen fueling stations across the country - these do not exist yet. Nikola also has almost no revenue today. Nonetheless, Nikola is now a $19.2B company that completed its public listing via a SPAC in early June and has seen its share price rise from $10 in early March to a peak of nearly $80 in June.
So what is driving this price action?:
1) Tesla FOMO: Tesla is one of the top performing stocks of 2020, already up over 200% on the year and up a staggering ~7,700% since its IPO in July 2010. The excitement around electric vehicles hit a crescendo in 2020 with Tesla expected to turn a profit for the first time in its history. FOMO is a very powerful driver of the stock market and now investors and speculators alike are looking for the next Tesla. One doesn’t need to look too far to understand the parallels between the companies given both are electric vehicle companies and pay homage to the same American inventor — Nikola Tesla.
2) The WallStreetBets Effect: Some of NKLA’s wild price appreciation can be linked to the stock becoming a favorite on the now 1.3M member strong Reddit channel WallStreetBets. For the uninitiated, r/WallStreetBets is a subreddit where retail investors share speculative investment ideas and YOLO on expiring call options while calling each other names and using offensive language. They also can appear to make concerted efforts to pump illiquid stocks, as seen with Hertz (HTZ) and Chesapeake Energy (CHK). NKLA became popular amongst this investor community as early as March. Posts in the subreddit included encouraging posts like “QUICK DON’T MISS OUT” or “Next Meme Stock [NKLA]”, and even some others called out this behavior with a post saying “[NKLA] is a pump and you know it”.
3) SPAC’d Into Existence: As SPAC fundraising increased so has attention on the asset class from speculators looking for a quick return. I was shocked to find that there is already a subreddit dedicated specifically to SPACs (r/SPACs) that has accumulated nearly 12,000 members in less than two months! The channel is very active with traders discussing how to play and time new SPAC issuances.
Ultimately, the SPAC provided a unique opportunity for NKLA to go public in 2020 that likely would not have been possible via a traditional IPO. While many technology companies go public as unprofitable entities, very few non-biotech companies go public with de minimis revenue like Nikola Motors did. As a result, a new class of investors have exposure to an electric vehicle maker that is valued nearly as high as Ford without having delivered a single vehicle.
So far, the value creation of NKLA has far outweighed the losses of some investors who piled in at the top and are now down 20–30%. The founder is now a billionaire and the stock price is being lifted by the high hopes of investors… now the company just needs to prove they can actually make trucks and build a business. 🤷♂️
But take away the hype and the FOMO…should Nikola Motors, an upstart electric vehicle company that hasn’t delivered any product and competes in a notoriously tough industry for new entrants, be valued nearly as high as Ford, a company that generated $156B of revenue in 2019?
I don’t think so and I worry about how this story will end for the 160,000 Robinhood investors that are still holding NKLA in their accounts. To say this stock is priced for perfection would be an understatement.
To SPAC or IPO?
A SPAC provides some advantages over a traditional IPO, such as much quicker process to go public, a negotiated value of company that is agreed upon upfront by the SPAC manager (no market pricing risk), and reduced underwriting fees. However, while these benefits may have some incremental positives for the company, they do absolutely nothing to protect investors and have the potential to cause harm.
While going the traditional route for an IPO is a more cumbersome process, often taking over a year from start to finish, I believe it is fundamental to fostering a highly functioning equity market. Unlike a SPAC, the IPO requires substantial disclosures in a prospectus (S-1 Filing), comprehensive preparation from the entire company, robust dialogues with market participants (investors & analysts), and importantly pricing that is ultimately determined by the market (not a single individual).
Beauty is in the Eye of the Beholder
There have been some prominent detractors of IPOs, such as Bill Gurley, who criticizes how companies are priced to benefit new investors — and he has valid criticisms. While I agree that there is room for improvement, I find that the IPO process itself is very valuable not only for investors but also for the company itself. Getting ready for an Initial Public Offering forces a management team to truly crystallize their company’s story and professionalize the organization. This is a process that I have seen from both sides — as a hedge fund investor meeting with management teams on their roadshow and also as a member of the finance team at Square preparing the company for our IPO in November 2015.
The Initial Public Offering also marks an important moment in time — when a company begins the process of rebuilding its cap table with new public market investors that will be with the company for decades to come. I believe this final hurdle of the IPO — selling the company’s story and convincing institutional investors to buy shares at a reasonable price is absolutely essential. Many companies with bad business models, weak management teams, or poor growth prospects are not able to cross the chasm and as a result remain private. And rightfully so, the average investor benefits when a thorough vetting process has taken place and is thus better protected from the prospect of value destroying businesses becoming publicly traded.
An IPO is more than a liquidity event for the founders, employees, and investors — it is an open offering of an ownership stake in a company to the general public that can now buy shares with a tap on their phone.
SPACs are not inherently good or bad, but they do avoid the standard IPO process that requires extensive financial and legal disclosures as well as vetting by institutional investors — all important forms of investor protections. By investing in a SPAC, you are putting your trust in the SPAC managers to invest in a great business on your behalf. SPAC managers can choose to acquire a high quality business that promises strong future cash flow or select a completely unproven business, like NKLA, that plays into a market fad in search of a “pop” and quick payday.
While there is money to be made investing in SPACs, they are risky investment vehicles that circumvent many of the guardrails that exist in the IPO process. SPACs should come with a giant BUYER BEWARE warning — because this vehicle lowers the bar to make it easier for companies to go public that also means that lower quality businesses are the most likely to use them.
Closing Thought: Remember WeWork?
In September 2019, WeWork’s IPO failed because the company could not convince institutional (professional) investors to buy its shares at seemingly any price. Perhaps if WeWork had utilized a SPAC they could have successfully made it to the public market, although I think their fate would likely be the same (albeit with a different set of investors, likely many retail investors, holding the bag).
While the failed IPO was unfortunate for Adam Neumann (no tears shed), WeWork employees, and early investors — this event proved to me that our capital markets and the rigamarole of the IPO process are an important form of investor protection. If the hurdle of convincing professional investors that a business creates value and is reasonably priced proves to be too high…then that company should not be available to purchase on the open market.
What’s Next in SPAC-land?
- When the Ducks are Quacking….Apollo announced it will be taking Electric Vehicle startup, Fisker, public via a SPAC valued at $2.9B. Yet another Electric Vehicle company that has no product and doesn’t anticipate their first vehicle going into production until “late 2022”. If the name Fisker sounds oddly familiar, then you are correctly remembering that this is actually the same Fisker that went bankrupt in 2013!
- Bill Ackman, the billionaire founder of hedge fund Pershing Square Capital, announced he is raising the largest SPAC of all-time at $4B focused on acquiring a “mature unicorn”, otherwise known as a private company valued over $1B.
- Chamath Palihapitiya, founder of Social Capital and early Facebook employee, has now raised two additional public SPACs after successfully taking Virgin Galactic (SPCE) public via his first SPAC in October 2019.
- Velodyne, the largest producer of Lidar for autonomous vehicles, announced that it will be going public this year via a SPAC.
[1] Comparing the equity value between Nikola and Ford