Why SPACs are Popular Investments - YouTube

nicola motor draftkings and virgin galactic have  a lot in common for starters all these companies  

have recently gone public and are still not  profitable and while that's common for many ipos  

neither nicola or virgin galactic have actually  generated any revenue from their main service  

lines for nikola they haven't even sold any  electric vehicles and for virgin galactic they  

have still yet to deliver on their space tourism  services most people would consider these stocks  

to be early stage and incredibly risky for wall  street bets though it's a great idea perhaps the  

most important thing to understand about these  companies is how they went public and that's  

through a spec or a special purpose acquisition  company in this episode of compounded daily we're  

going to look at specs how they're structured and  answer why they become so popular among investors  

specs are by no means anything incredibly new  they've existed for a while now but have just  

recently become popular again the general  idea behind a spec is that their management  

team raises money from investors to go public  and then uses that money to buy another company  

the process through which the acquisition occurs  is called a reverse merger and how this works is  

actually pretty simple a public company buys a  private company so that the private company can  

bypass the whole process of going public for the  selling company there are tons of benefits to this  

a typical ipo can take years in preparing  reporting and then investment bankers hop on  

their jets market the newly issued shares  to a variety of institutional investors  

and negotiate the stock price a private company  going public through a spec avoids all of this  

because the only buyer is the spac itself and the  process for going public could take only a few  

weeks the spac management team just have to seek  approval from their shareholders and when a spec  

acquires a company there's limited s1 reporting  for those unfamiliar with financial reporting a  

traditional ipo process and even direct listings  require detailed s1s the document details  

important financial disclosures such as historical  financial statements and guidance for investors to  

understand how the company is planning on growing  in a way it gives investors a look under the hood  

but perhaps the biggest benefit to the selling  company is that the purchase gives them a cash  

infusion it's a capital raise in a way much like  a venture round or any other ipo this isn't always  

good though when a company ipos it's typically the  last time they end up raising equity they could do  

a season equity offering or sometimes called a  secondary equity offering but that's typically  

frowned upon and for very good reasons a study  from the journal of entrepreneurial finance found  

that on average companies that did an seo had a  negative 31.2 performance before the seo and a  

negative 77 performance the three years following  it this is because not only does it dilute  

shareholders but it also sends a rather negative  signal to the market if your company is diluting  

shareholders instead of maybe seeking debt or  perhaps you already have too much debt investors  

might be worried about the company's survival  and unlikely to invest in you now i should add  

that an seo isn't always bad if a company's stock  price is ridiculously high it's a great way to  

take advantage of the high stock price to raise  more money so spax can have their advantages and  

disadvantages for the selling company but  what are the advantages to the investors  

the rise in popularity of spax has been big this  year in 2017 almost 8 billion was raised through a  

total of 34 specs but in 2019 59 companies raised  13.6 billion dollars however and more surprising  

is that just this year 12 billion has been raised  by spax and there have only been 39 of them but  

what explains this the way that they are  structured and their terms tends to be very  

palatable for investors for example if you invest  in a spac before it goes public and then after it  

goes public you decide i want my money back you  can claim your money back for net asset value  

that means that if you put ten dollars in you get  ten dollars back plus interest that was gained on  

that money but you have to do that before the spax  management team announces a deal as an investor  

you also have the right to vote on whether or not  a spac should make an acquisition if your spax  

management team is trying to acquire a company  that you think is overpriced then you can vote not  

to go forward with it and if a spec doesn't make  an acquisition within two years then they return  

the cash to the shareholders and the company is  dissolved these check companies also provide a  

slew of upside benefits for the investors when you  invest in a spec before it makes an acquisition  

you technically own units and depending on the  stack are granted warrants these warrants are like  

call options and if you hold on to your units  they give you the option to buy shares of the  

company at a particular price so if you invested  in chamath pala hapatia's social capital ipoa spec  

then you might have the right to buy more virgin  galactic shares at eleven dollars and fifty cents  

which is great when the stock price is twenty five  dollars spax add those warrants for a good reason  

they want their investors to stay invested  remember when an investor wants out the spac  

management team has to buy that share for the  net asset value then the spac manager needs to  

make that money back so they sell it if enough  people want to sell their shares then the spec  

management team might not be able to sell it for  the net asset value so they will have to use some  

of the funds raised to make up the difference and  that of course means less money to buy a company  

another added benefit for spax is that investors  who put money into the ipo are not held up by the  

stingy lockup rule usually those who hold shares  of a company before it goes public are not allowed  

to sell those shares for a period of time after  it goes public that's not the case with smacks  

now that's a little bit on specs but who exactly  is investing in them and why perhaps one of the  

main reasons why spax have become so popular as  of late is because of a lack of good investment  

opportunities elsewhere the venture capital market  which invests in early stage companies is flooded  

with so much uninvested capital because there  seems to be an imbalance between money to invest  

and good investment opportunities this imbalance  puts venture capitalists in a tough position  

the dilemma here is that they can make investments  in poor companies and get not so good returns  

or not invest the funds and risk having to raise  a smaller fund the next time around something no  

venture capitalist ego would permit private equity  is not much different at the beginning of 2020 it  

was reported that there was over two and a half  trillion in uninvested capital or as we in the biz  

call it dry powder all of this money makes bidding  for companies more competitive and drives up the  

company valuations but that's only half the story  interest rates are incredibly low right now and in  

private equity firms use a mixture of money from  their funds and debt to buy companies and when  

that debt they use to buy companies is cheap that  means they can use more of it further driving up  

the company valuations so perhaps backs are just  another way for deep pocketed billionaires to have  

another venue to invest their money after  all harvard economist lugwood straub's paper  

discussing the savings glut of the rich emphasizes  how savings for these billionaires has increased  

over the past few years it could very well be that  they haven't had good investment opportunities so  

specs might be a new opportunity for them to  get higher returns on that money than just  

having them in a savings account if that were true  though spax would have to perform well so do they  

spax have historically performed poorly with one  study finding that since 2003 they have returned  

on average a negative 19.7 percent this might  come as a surprise to most people who've seen the  

performances of some of the most recent specs when  tortoise acquisition core acquired highly on it  

saw a 170 percent return virgin galactic posted a  62 return and nicola had over a 470 percent return  

but what explains this one thing could be that  these companies are being acquired at the right  

place at the right time for many of them they  have great ideas but need money to execute on them  

the cash raised from the spac acquisitions  could provide them that money and therefore  

their plans are more likely to become profits  this increases the likelihood of positive  

future cash flows and those in finance know that  increases a company's valuation perhaps though  

there's a different explanation when that study  looked at spack performance dating back to 2003  

there was no robin hood or wall street backed back  then allow me to explain most of these backs tend  

to be pretty small when compared to the market  caps of companies like tesla and amazon if all  

10 million robin hood users bought seven shares  of social capital hedo sofia when he was at 10  

then almost all of the 49 of shares not owned by  virgin galactic would be owned by robin hood users  

that same amount however would only purchase  about half a percent of amazon therefore the  

purchase of virgin galactic shares is going to  have a much bigger impact on the movement than  

an amazon share and when wall street bets  gets hyped up over these small cap shares  

mass buying could contribute to upwards movement  now i'm not saying bill ackman is planning on  

hiring a team of internet trolls for his three  billion dollars back but i am saying that if  

he finds a trendy enough company to buy the  internet could help him get a solid return