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A Risk-Free Way to Make Money With SPACs

It was September 2019 and Jason Robins, CEO of DraftKings, was weighing his options: 

On one hand, he knew he wanted to take the sports-betting company, that he started alone in his Boston apartment eight years earlier, public…

On the other, he wanted to bolster his company’s long-term health by acquiring SBTech, a provider of cutting-edge sports gaming technology. This would make DraftKings the only vertically-integrated pure-play sports betting company in the United States.

So Robins was in a bit of limbo… 

Going public would allow him to raise the cash to finance the SBTech acquisition. But a SBTech acquisition would help solidify his company as a behemoth in the market.

But what if there was a third option? One that would allow Robins to do both at once while also significantly reducing the risk he was foreseeing in 2020. 

That’s when Robins remembered a conversation he had with an investor years prior in which they discussed an innovative way to go public: Special Purpose Acquisition Companies (SPACs). 

Going the SPAC route (we’ll get into what SPACs are and why they are a powerful investment vehicle in a minute) would allow Robins’ to take DraftKings public and acquire SBTech at the exact same time. Not to mention he would be able to do so in the midst of the coronavirus pandemic. 

As Robins recently recounted:

“In the second half of 2020, the market was getting choppy, I thought I might not be able to do it in two transactions. I might have to get this whole thing done faster. It occurred to me a good way to do that was through a SPAC. We could basically take what would have been two transactions, put them together in one, and arguably it’s an even faster public process to do it through a SPAC.”

DraftKings began negotiating with Diamond Eagle Acquisition Corporation (DEAC), a SPAC run by Harry Sloan. 

Ultimately, the companies came to an agreement to do a three way merger between DraftKings, DEAC, and SBTech, creating one company trading under the symbol DKNG. 

The company which IPO’d at $10 has since climbed as high as $63 and is now trading at ~$45 per share with a market cap of more than $17 billion. 

To call Robin’s decision to take DraftKings public with a SPAC a success would be an understatement.

The SPAC not only allowed DraftKings to vertically integrate while going public, it allowed them to do so during a once-in-a-generation plague gripping the nation.

As Robins recently put it:

“If this were a traditional IPO, forget ringing the bell, I don’t even think we’d be able to close the transaction.”

2021: The Year of the SPAC

SPACs are all the rage these days.

Special Purpose Acquisition Companies (or SPACs), also known as “blank check companies”, have become wildly popular on Wall Street. 

So much so, that in 2021 there have been more SPAC IPOs than any year on record.

spac growth

But SPACs technically aren’t anything new.

You see, a form of the SPAC has been around since the early 80’s.

Unfortunately at that time, they were mostly used as a way for scammy penny stocks to go public. 

At the time, penny stocks did not have to be registered or have to trade on a national securities exchange. This made it easy for shady brokers to perpetuate abuse.

Boiler rooms were set up for brokers to defraud investors into investing in blank-check companies without any real revenues. Once the price got high enough, the brokers would begin dumping shares. 

Due to the rampant abuse, Congress passed the Penny Stock Reform Act of 1990. The act all but killed blank-check companies.

By 1992, the SEC clarified that in order for blank-check companies to operate, money raised in this structure would have to be put in escrow until the company identified its investment. It also ruled that the majority of the money raised had to be used for the acquisition. Most important, investors would have the option to vote on whether to participate. 

These regulations gave clarity and legitimized the once shady world of SPACs. They were reborn. 

Fast forward to today, some of the top investors in the world are raising money for SPACs.

Celebrity investors like Sam Zell and Bill Ackman have brought SPACs to market this year. 

Warren Buffets great-nephew just had a SPAC IPO completed for $200 million.

Mario Gabelli, Peter Thiel, Howard Marks… The list goes on and on.  

Even Billy Bean of Moneyball fame is part of a SPAC that looks like it may take over the Boston Red Sox.

While investors seem to be fixated on all of on the past few years chaos (the pandemic, riots, market crashes, elections, etc.)… there’s one major ongoing trend that continues to fly completely under the radar:

2021 is the year of the SPAC.

And there has never been a safer or more lucrative time for investors to get involved. 

That said, in the sections below I will reveal a no-lose strategy for at-home investors to play this corner of the market. I think it’s overdue.

It’s remarkably easy yet extremely profitable if you play your cards right.

But before I breakdown this unique strategy itself, it’s important we take a step back and explore what exactly a SPAC is and how it works…

A Unique Investment Vehicle

In comparison to the traditional IPO process, SPAC IPOs offer a much faster alternative for companies that want to go public. The model is simple: raise funds from the public markets, then find a company to acquire. 

Now what company will SPACs acquire? That’s the kicker.

Often the SPAC management team – known as the “sponsor” – doesn’t even know. 

While the SPAC has to specify which industry or type of company they want to buy, there is no pre-selected acquisition target. Once the SPAC goes public, managers have a limited amount of time, usually 18-24 months, to get a deal done. If they can’t find an acquisition target in that time frame, they have to give all the money they raised through the IPO back to investors.

But SPAC sponsors returning money for lack of a deal are very rare.

While the search for a deal is going on, 95% of the original capital is placed in a trust fund and invested in short-term treasuries (the other 5% is used for routine operating expenses, but not management commissions or salaries). 

Once the SPAC identifies a company they would like to acquire, they announce it to the shareholders of the SPAC and allow them to vote on whether they would like to participate in the deal or not. 

If “yes,” you will own shares in the new company that is acquired.

If “no,” you simply get your original investment back plus interest (from the short-term treasuries) and minus fees.

Simply put, SPACs give investors a no-lose opportunity in the markets. There is nothing quite like it.

You get the opportunity to invest in a company at its IPO price and if you don’t like it, well, you can just ask for your money back.

The Advantages of SPACs

Now that we’ve covered why SPACs are an attractive investment, let’s dig deeper as to why all three parties involved (investors, sponsors, target businesses) find these deals to be advantageous.

Advantage for Sponsors

Sponsors love SPACs because it allows them to raise money in the public markets and acquire a company quickly, easily, and lucratively. 

Although the sponsors don’t receive a salary during the 18-24 month search for a company, they have zero out of pocket costs for legal, insurance, and accounting as that comes out of the 5% of the “working capital” we covered above. 

Additionally, the sponsors will typically end up owning 20% of the business that is acquired (known as the “promote”).

Advantage for Companies (Target Businesses)

Overall, companies have the most advantages as well as the most disadvantages when it comes to SPACs.

But with increased market volatility and uncertainty (think back to our DraftKings example), the advantages begin to outweigh the disadvantages. 

Traditional IPOs are difficult. There is negotiating, a roadshow, accountants, lawyers, and more. All in all, a traditional IPO can take up to 18 months to complete. 

SPAC IPOs, on the other hand, can be negotiated and closed in under 6 months. In 2021, or during any times of economic uncertainty, the speed of these deals make it very attractive. There’s far less risk.

Companies also appreciate the proven management team of the SPAC sponsors. If you were a company going public, wouldn’t you want a proven investor like Bill Ackman supporting you? SPAC sponsors are often professionals and in it for the long-term. Companies can benefit from their experience. 

The main downside for companies is that SPACs are more expensive than a traditional IPO, but in today’s environment, many companies are willing to pay a little more for the speed, ease, and a proven management team on their side. 

Advantage for Investors

Now, for the most important part, why are SPACs something that every investor should have on their radar?

Some of the main benefits for investors is the risk-free nature of the investment. As we covered earlier, once a transaction is announced, investors can vote whether or not to partake. If not, they get their money back and potentially some interest. It’s essentially a free option to invest in the company. 

Investors are also given the opportunity to invest with proven management teams with skin in the game. It gives investors the ability to get private equity style investments without having to fork up millions of dollars. 

Investors will also receive warrants with their investment that sweeten the deal. We will cover warrants in the sections below. 

Most importantly, as shown with the DraftKings example, SPACs can result in huge profits. Investors who bought the DraftKings SPAC could have made over 500% on their investment. 

A Sweetener for SPAC Investors: Warrants

As we briefly discussed, investors will receive an extra bonus when investing in SPAC IPOs: warrants.

When investing in a SPAC IPO, what you are really buying is an “unit,” consisting of both a common share of stock as well as a warrant.

What’s a warrant?

A warrant is a security that entitles the holder to buy the underlying stock of the issuing company at a fixed price (the exercise price) until the expiry date.

Warrants and options are similar in that the two contractual financial instruments allow the holder special rights to buy securities. 

These “bonus” warrants are important.

SPAC units are almost always priced at $10. That $10 investment supplies the investor with one share of common stock and a either a full or partial warrant. The most common sized warrants in SPACs are “half-warrants”.

Using the half-warrant example, if you were to purchase 10 units of a SPAC, you would receive 10 shares of common stock and five warrants. 

Most warrants issued in SPAC deals allow the sponsor to redeem the warrants if the underlying stock trades above a specified threshold (the strike price). 

The most common strike price (the price you can buy a share of common stock in the future) for the warrants is $11.50

To show the power of warrants, imagine that you bought 100 shares of a SPAC at the $10 IPO price with half-warrants, investing a total of $1,000. 

Now let’s say that the underlying stock went to $20.

Your total return would be 42.5% ($1,000 return in the underlying stock plus $425 return on the warrants). 

How to Make Risk-Free Money With SPACs

You can make a lot of money investing in SPACS, but it is a specialized business. Just buying a SPAC because Bill Ackman or Sam Zell is involved is a coin toss.

But done correctly, SPAC investing comes very close to risk-free investing.

The strategy (or trick, in other words) is simple: Buy as many SPACs as you can.

Here are a few tips along the way…

Part 1: Buying The SPACs

If possible, buy the SPACs IPO.

There is usually much better availability with SPAC IPOs than traditional hot tech IPOs or other initial offerings. 

If you cannot buy the IPO, pay close attention to the IPO price (usually ~$10) after it begins trading.

If you can’t get within a nickel or so of the IPO price, move on. But also keep an eye on the SPAC in the aftermarket. It may eventually drift back to a safe buy level.

When the SPAC announces a deal (announces their acquisition target), the stock and the warrants typically pop in price. This happens when the market likes the proposed transaction.

But keep in mind, there’s also a chance the SPAC deal announcement won’t be well received (again, this is rare in today’s market). In this case, the stock and warrant prices may taper off.

Part 2: If The Price Jumps (well-received deals)…

The best course of action is to (usually) sell out immediately.

If you get a red hot deal like the Draft Kings (DKNG) announcement, set a 10% trailing stop and ride it as far as it goes.

When prices hit your stop, move on. This is not long-term investing. It is a businesslike approach to exploiting a hot trend that won’t probably be around for a long time.

If you want to be more aggressive, sell the shares after a well-received deal is announced and keep the warrants to make a longer-term, highly leveraged bet of the company’s future.

Part 2b: If The Price Does Not Pop (poorly-received deals)…

If the stock does not pop, redeem your shares for your share of the trust.

If you understand how many ridiculously smart arb traders own SPACs, you know right away that a poorly received deal is probably hot garbage. Selling your shares immediately will usually get you a minimal profit from interest earned during the search period.

Then sell the warrants for whatever you can get.

Some investors suggest keeping the warrants of a poorly received SPAC deal announcement as they can potentially rebound, but I personally think that’s a bad idea. Again, the collective wisdom of the market (upon the SPAC announcing their acquisition target) usually gets these things right.

Your profits on well-received deals can be 10, 20, 30% or more after an initial favorable reaction. Depending on the terms of the warrant, they will juice the returns even more.

Redeeming your interest in the trust in an unloved deal should keep you right around breakeven on the bad ones.

There are lots of stories around SPACs, especially with all the celebrities involved. While it is true that I would prefer to own a SPAC where Sam Zell is making the decisions (rather than some random guy off the street), when a deal is announced, I treat them the same. 

If the market likes the deal and the shares rally, I will sell them. 

If the market does not rally, I will redeem my share of the trust account.