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 2020 there had been more SPAC IPO’s than any year on record.
And all data is pointing towards 2021 significantly exceeding 2020’s numbers with already more than 200 SPACs having gone public as of March.
In comparison to the traditional IPO, 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.
What company will they acquire? That’s the kicker. Often the SPACs management – known as the “sponsor” – doesn’t even know.
While the SPAC may specify which industry or type of company they want to buy, there is no pre-selected acquisition target. The SPAC managers have a limited amount of time, usually 18-24 months, to get a deal done. If they can’t find a target, they have to give the money back to investors.
But SPAC sponsors returning money for lack of a deal are very rare (only two out of 29 SPACs returned money in 2020).
While the search for a deal is going on, the original capital is placed in a trust fund and invested in short term treasuries.
When the sponsors announce a deal, there are two options for individual investors in the SPAC.
- If you like the deal, you keep the SPAC shares, and your return will be based on how the transaction works out (i.e., the company that is acquired).
- If you do not like the deal, you can redeem your shares for your interest in the trust.
For investors, it’s practically a risk-free way to look at an investment.
A SPAC Bubble?
SPACs have become the newest Wall Street Superstar accessory.
Bill Ackman has one…
So does Sam Zell…
Former Speaker of the House, Paul Ryan, is also involved in a SPAC deal…
Media and entertainment SPACs are chasing some of the hottest properties in Hollywood and Silicon Valley.
Billy Bean from Moneyball is involved in a SPAC looking to invest in the sports industry.
Several Unicom companies, including DraftKings (DKNG) and Virgin Galactic (SPCE), have recently become public via a SPAC deal.
How to Make 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 trick is simple: buy as many SPACs as you can.
If possible, buy the SPACs IPO. There is usually much better availability with SPAC IPOs than hot tech or other initial offerings.
If you cannot buy the IPO, though, pay close attention to the IPO price (usually ~$10) once it begins trading. If you can’t get within a nickel or so of the IPO price, pass.
But keep an eye on the SPAC in the aftermarket. It may drift back to a safe buy level.
SPACS are sold initially as a unit with shares and warrants. The warrants allow you to buy more stock at a set price. Fifty days or so after the IPO, you can separate the shares and the warrants. As soon as you can separate the two, do so. They will then trade individually.
When the SPAC announces a deal (or announces their acquisition target), the stock and the warrants will pop in price if the market likes the proposed transaction.
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 the stock does not pop, redeem your shares for your share of the trust. That will usually get you a minimal profit from interest earned during the search period. Then sell the warrants for whatever you can get.
If you want to be more aggressive, sell the shares when a deal is announced and keep the warrants to make a longer-term, highly leveraged bet of the company’s future.
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. The collective wisdom of the market usually gets these things right.
If you understand how many ridiculously smart arb traders own SPACs, you know right away that a poorly received deal is probably hot garbage.
Your profits on well-received deals can be 10, 20, 30% or more on 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.