2021: A SPAC Odyssey
(Not The One By Chris Hadfield)
Every year has a Word. In 2016, it was Trump. In 2017, it was Irma (as in the Hurricane). In 2018, it was Stan Lee, may he rest in Peace. In 2019, it was Kardashian. In 2020, the year of hindsight, it was Covid (which also won Virus of the Year). Our early 2021 prognostication: SPAC at least makes the finals in the 100 Meter Kitsch this year.
Virtually (literally) every meeting Prime Movers Growth Fund has hosted has garnered one common question: “SPACs? Real asset? Fake financial news? A Communist plot designed to derail the Western World?”
In fact, SPACs are none of the above. To demystify: SPAC — Special Purpose Acquisition Company. Think: Shell Corporation, one with the express purpose of holding operating companies for a variety of reasons (tax, management synergies, global regulatory changes, and on and on.)
The cabal behind the SPAC raises money from private investors. Let’s say $500M is raised for a SPAC designed to roll up online education companies with the belief that states simply won’t be able to afford in-person teaching the way they have for a couple of centuries. Or that online education turns out to be simply better, more effective when mixed with in-person pods. Or that parents grow fed up with the existing public school system and… migrated. For whatever the reason, presumably smart investors created a SPAC for this “special purpose” so as to take advantage of this prognosticated MegaTrend.
The money is wired into an escrow account, which exists inside of an OG phone book sized set of legal documents which register this shell corporation with the SEC; extant, it must behave like a public corporation, as it will trade more or less, like any other stock. That company then must find a target acquisition or suite of related acquisitions, which are valued at at least 80 percent of the cash it raised. Deals must be cut to buy those targets within a set time frame — usually a year and change. Once they are bought by the SPAC, then investors are buying, more or less, the cash that the SPAC carries in reserve, and the future discounted cash flows of the target acquisition suite that the company has bought.
This Brobdingnagian Rube Goldberg sets the stage for retail investors to be able to buy relatively risky, erstwhile private, high growth companies. We have seen this movie before. (It was just the IPO market in the ‘90s.)
Legal trivia and technicals aside — and we’re way over-simplifying here — think of a SPAC as a “clever”, relatively low friction way for a private company to “go public”. The more interesting question here, lies in the rationale of the government in allowing these vehicles to “suddenly” exist. (In fact, SPACs have been around for decades; the rules governing their ecosystem grew looser over the last half dozen years and investors have opportunistically deployed these financial vehicles to their benefit.)
For a moment, let’s enter The Wayback Machine with Mr. Peabody and Sherman, and revisit the mid-1990s when a spate of very early growth stage companies went public, under analogous angry-journalist chuffing scrutiny. (We are vastly rounding the numbers here for simplicity’s sake.)
Yahoo came public at roughly a $300 million valuation. At the time, it had barely $20 million in revenues (in its history) and looked a lot (financially) like the companies in which Prime Movers Growth seeks to invest today. The founders of Yahoo were extremely generous with stock options for their employees and the company made various acquisitions using its stock as currency; and it raised cash along the way. So it diluted itself. But had an investor spent $10,000 in YHOO at the IPO, and held the stock to its peak valuation in early 2000, she would have turned that initial investment into roughly $2 million. Roughly, a 200-bagger.
Along came AMZN not long after YHOO. It went public at roughly $600 million. (Its stock price sagged about 30% in the few weeks after Bill Gurley (today of Benchmark and Uber legend) and Deutsche Bank brought them public. Investors hated Jeff’s high pitched nervous laugh and joked about the $4 in losses per book Amazon sold, quipping that “they’d make it up in volume”. Well, scoffers, they um… did.) AMZN came public at $18 (it had stock splits along the way). Had you bought $10,000 worth of the stock at the $18 price (and not been savvy enough to pick up shares at $13 where they settled a month after the IPO’s first print), today you’d have about $20 million in AMZN.
The theme? In the mid-1990s, regulations were relatively light. Young high growth companies went public “all the time”. A company with $250 million in revenues could usually pass high-end audit inspection with a dozen accountants, three lawyers and good back-end Oracle database systems. The cost of being public was relatively light.
Then, bad things happened. WorldCom. Enron. Cendant. And a bunch of other fraudsters who used clever accounting chicanery to obfuscate with big bucks profits… and make the regulators look….incompetent, to use tactful phrasing.
The result? Massive overkill regulation. A range of new laws were enacted, roughly under the rubric of Regulation FD or Full Disclosure. Under these new mandates, even small corporations had to hire armies of accountants and lawyers; who then had to hire external auditors who had to hire yet more 3rd-party auditors for incremental oversight. And all of the sudden the few million dollars a year it cost to be public became ten or twenty or thirty for smaller companies. And well, it just was no longer worth it.
So what happened? Cue the music, “What goes up… must come down… Spinning wheels…”
Companies delayed going public. With massive and relatively liquid capital available to younger growth companies in the private markets, cash-hungry growth companies didn’t have to tap public markets for dough. Instead, an active community of wealthy private investors quickly stepped up to the plate in various forms to invest in B, C, and D rounds of this next-generation of growth companies from the then-hot Silicon Valley venture capital IPO-factories.
Google came public in 2004 at a valuation of roughly $25 billion at $85 a share. Today with the stock above two grand a pop, you’d have made a very nice 25 times your money. But that belies one little fact: In 2004, NASDAQ was a shade under 2,000 (we’re indexing here). Today it sits around 14,000. There were small dividends as well that, reinvested, would have brought your today-asset index total to about 15,000. So while GOOG was a solid stock the last 17ish years, with an up 25x score, NASDAQ was up about 8x over the same period. And as a diversified fund of many stocks, the notional risk in owning a NASDAQ ETF was way less than in owning one stock. So GOOG was good, but not great, to early IPO investors.
Facebook underwent a similar very-late-to-public-market transformation in this highly regulated world. FB came public in 2012 at a valuation of roughly $100 billion or $38 a share. With the stock sitting in the mid $250s today, investors made about 7 times their money from the IPO price. Good? Meh. In 2012, NASDAQ was around 3,000. With it sitting today at a dividends- reinvested index of about 15,000, So, had you just bought QQQQ (popular NASDAQ index fund), you’d have made 5 times your money, taking no individual-stock risk. So FB was only modestly better to public IPO investors than they would have been just buying a simple index fund.
Let’s refresh: Tons of money came to early IPO investors in Yahoo and Amazon, who existed in a very different regulatory environment. Only modest amounts of market-beating money came to investors who did the IPOs of GOOG and FB.
What happened, in fact, was that there was an equal and opposite reaction to the financial friction and gravity that regulators applied to publicly traded companies in reaction to the horrific WorldCom and Enron era scandals. Private companies remained private longer, raising money from already-wealthy investors who benefited from the rise in share prices during the much longer period of those companies remaining private.
Who lost? Joe Truckdriver who might have put 5 grand from his IRA into an early stage GOOG or FB when those companies might have gone public at a valuation closer to $1 billion than $100 billion. Replacing 200 Joe Truckdrivers was Suzy Slickrealtor who had a spare million bucks to invest in the oh-so-private $1 billion valuation rounds of GOOG or FB analogs.
Silicon Valley’s broadform movement away from early IPOs changed “who got wealthy” via taking risk and investing in growth companies. And that reticence continues today. Most companies go public in “purist” IPOs vastly later than they did in the mid 1990s.
Enter SPACs. Recall Yahoo circa 1994/5 with something like $20 million in revenues and about $12 million in losses. It was in the middle of building out massive global infrastructure, hoping to become a real brand. And it believed it needed to burn $30–40 million or so, to hit its revenue targets. In 1996, the public markets filled that gap. Today, SPACs play that role; they allow public market investors to benefit from taking risk. In essence, SPACs have democratized what was once exclusive, private market investing.
So when we get questions like, “Are SPACs good?” — it’s like asking, “Is real estate good?” Some is (gimme some Austin, TX; sell me some SF, CA). Will SPACs do well? Same answer. Will some SPACs blow up horribly with colossally bad results for investors? Absolutely. Will some risk-takers benefit massively from having rolled the dice on a vision? Absolutely. Are some valuations of SPACs crazy? Absolutely. Recall that YHOO “always” traded at the crazy multiple of 100x revenues, from its valuation at $1 billion, to its valuation of $100 billion. Crazy. Great. Momentum trade of the century, perhaps. Welcome to America — it’s a great place for capital markets to live, no matter which side of the political spectrum from which you hail.
Look at any SPAC and you’ll most likely find that the company is investing in a theme, driven by a cutting edge young company with a vision to change the world for the better for billions. Investors spray WD-40 on the train tracks of these companies, hoping to reduce friction to those goals’ achievements. That’s also what we’re hoping to achieve here at Prime Movers. We hope you’ll be part of the effort.
Prime Movers Lab invests in breakthrough scientific startups founded by Prime Movers, the inventors who transform billions of lives. We invest in companies reinventing energy, transportation, infrastructure, manufacturing, human augmentation, and agriculture.
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