SPAC: Special Purpose Acquistion Company

SPAC: Special Purpose Acuisition Company, also known as "blank check companies" are companies with no commercial operations of itw own, whose sole purpose is to acquire a private company - or part of private company - so that this second company becomes a public company.

It is an alternative way for companies to go public, as they would do via a traditional IPO or a direct listing.

A SPAC is a company founded by what is known as the "sponsor team". A SPAC company does not have commercial operations of its own and at the time of the SPAC IPO it raises funds to acquire or merge with a private company. Once the acquisition/merger is completed, the name and ticker of the company is changed to reflect the newly combined entity.

The founders of the SPAC provide the initial capital to the company in usually two ways. First, they buy a certain amount of what is known as "founder shares" for generally 25.000$. Upon completion of the merger, these shares will convert into common shares in a percentage that grants the founder control of 20% of the amount raised in the IPO. The second way is by buying warrants or a certain amount of units. Usually the initial amount provided hovers around 2% of the total raised in the IPO.

Once the SPAC is created the S1 form is registered with the SEC to initiate the IPO process. In this form everything is detailed: description of securities, SPAC structure, founder shares, target and management. The capital raised in the IPO is then placed in a trust fund until the merger is completed.

SPACs have usually two years to complete a business combination, although this timeline can be extended. The business combination must be approved by the shareholder. In the event of a business combination rejection by shareholder, the sponsors may present other business combination deals.

It is common that the capital raised in the IPO is not enought to carry out a business combination with the selected target. In those situations the SPAC resorts to a PIPE investment. PIPE stands for "Private Investment in Public Equity". The markets like to see big PIPE investment from renowned investors.

If a deal isn't approved in the span of two years, the SPAC is dissolved and the money is returned back to the shareholders.

Although there are certain common elements to all SPACs, not all SPACs are created equal. There are several moving parts in all SPACs and it is important to know the detailed of each one of them. For example, Bill Ackman famous "Pershing Square Tontaine Holdings" has a particular structure, where, among other particularities, there are no founder shares.

A SPAC may be form by four securities.

  1. Units. It's generally what starts trading on IPO day. A Unit is comprised of a common share and a warrant or a fraction of a warrant. In the ticker it carries the "U" sufix. For example, Health Assurance Acquisition Corp unit sticker is "HAACU". 52 days after IPO Units, Common shares and Warrants start trading separately.

  2. Common shares. Just a regular shares, like in any other company.

  3. Founder shares: shares bought by the founders of the SPAC. Usually bought by 25.000$, once the merger is completed these shares convert to common shares in a percertage that grants the founders 20% of the capital raised in the IPO (effectively diluting shareholder).

  4. Warrants. Warrants give its holder the right, but not the obligation, to buy a share. They carry the "W" suffix. Going back, to HAAC example, its warrants trade under "HAACW". Although the Unit may grant a fractional warrants to a shareholder, only full warrants may be traded. They usually come with the following characteristics:

- Strike price is 11.5$.

- Warrants are redeemable if the shares trade above 18$ for 20 days in any 30 days period.

- Warrants are excercisable the later of 30 days after merge is completed or 12 months from SPAC IPO.

There may be some nuances to the securities and it's a good exercisable to see its description in the S1 form.

SPACs go all the way back to 2003 but they really got a name for themselves throught 2019 and 2020 thanks to companies like Virgin Galactic and Draftkings going public via SPAC. Famous investors like Michael Klein, Alec Gores or Chamath Palihapitiya have popularized SPACs after making a number of companies go public through a SPAC process.

Given the target business combination has to be approved by shareholders, sponsors try to offer an attractive valuation and that's one of the reason many SPACs surge on Definitive Agreement notice. On traditional IPOs the first day pop is said to benefit institutional investors. On SPACs, these pops are said to benefit the retail investors, thus leveling the playing field and being loved by retail.

Additionally, being SPAC sponsored by renowned investors, a large list of successful SPACs like the mentioned Draftkings or Virgin Galactic, companies going public at growth phase and a theoric floor of 10$ until the business combination is completed make investors think of SPACs as an asymmetric risk/reward investment if a position is made near NAV value.

Given all these reason and the general frothiness in the market many SPAC trade at a premium to their NAV like those of Chamath and Ackman with +50% premiums.

Benefits for the involved parties:

  • Target company

-  Raises capital to finance its operations and/or growth.

- Faster route than a traditional IPO.

- Cheaper route than a traditional IPO.

- SPACs are allowed to share revenue estimates for the coming years, which is not allowed in traditional IPOs.

- Transaction con be structured as needed to satisfy all sides of the deal, which is not allowed in a traditional IPO.

  • SPAC shareholders

- They can invest with successful investors.

- There is a theoric floor the share price, which is the raised capital.

- They have veto power on the transaction.

  • SPAC sponsors

- Access to a big base of private investors.

- Full power to operate as they see fit.

- Founder shares, that grant them 20% of the raised capital in the SPAC IPO.

- Possibility of becoming serial sponsors

Main risks on a SPAC are:

  • Opportunity risk: given there are two years to complete a deal.

  • Unsuccessful SPAC: in addition to opportunity risk, small fees have to be paid to underwritters when the SPAC is dissolved.

  • If founder shares exists, sponsors may be incentivized to carry out any deal, even if it doesn't benefit shareholders. For example, a group of shareholders of the first Tilman Ferttita SPAC sued the Rockets owner after the merger with Waitr went awry. Waitr hovers around 4$, but it went below a 1$ during the coronavirus crisis.

We'll cover the example of IPOB (Social Capital Hedosophia II), the second SPAC of Chamath, now merger and trading as Opendoor.

On IPO day, IPOB raised 414 million dollars via 41.4 million Units, and traded slightly above NAV until mid September when a Definitive Agreement with Opendoor was announced. Shortly after, IPOB traded at 22$.

As stated in the transaction overview, Opendoor was valued at 6300 million dollars. It is important to take into account that the company valuation is calculated with a 10$ share price, irrespective of the price at which the share is trading on that day.

This valuation came from:

  • 41.4 million common shares, $414M

  • 10.8 million common shares awared to the founders (for their founder shares), for $108M. This way they effectively gain control of 20% of the funds raised.

  • 60 million new common shares for the PIPE investors, for $600M.

  • 500 million new common shares for $5000M awarded to Opendoor current shareholders. This is also known as "equity rollover".

  • 18.9 million new shares for $189M as bonus for Opendoor shareholders.

This breaks down as follows:

Given the valuation is made with a 10$/share price, and that on merge day the shares traded at 30$, Opendoor was really trading at a $17bn valuation.

One of the most common errors when trading SPACs is to look at the market cap of the SPAC on the days before the merger and see that Yahoo Finance or Google Finance report a market cap way below the value of the transaction and that if we buy at that moment on meger day we will automatically have "free gains".

As we've seen SPAC don't work that way. Yahoo or Google are reporting the right data, but we have to account for the new shares that will be issued on merger day.

We are not financial advisors.

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