Virgin Galactic began trading on the New York Stock Exchange on Oct. 28, 2019. The company went public by merging with a special purpose acquisitions company launched by Social Capital LP’s founder and CEO, Chamath Palihapitiya. (Matt Hartman via AP, File)Matt Hartman/The Associated Press
Virgin Galactic Holdings Inc. (SPCE-N) plans to fly tourists into space. DraftKings Inc. (DKNG-Q) offers online sports betting and casino games. And Nikola Corp. (NKLA-Q) is an electric-truck start-up with ambitions to build hydrogen refuelling stations.
These U.S.-listed firms are among various companies that have gone public by merging with a special purpose acquisition company (SPAC) instead of doing a traditional initial public offering (IPO). Although SPACs have exploded this year, with some stocks surging and others tanking – such as Nikola, amid fraud allegations, postdeal – individual investors need to tread carefully in this space or consider a lower-risk SPAC arbitrage strategy.
“SPACs are hot and a lot have sexy themes,” says David Kaufman, chief executive officer of Westcourt Capital Corp. in Toronto. “But investors need to be aware that there is nothing magical about them, and their stocks don’t necessarily go up after a transaction. … But these days, there is FOMO.”
A SPAC, or so-called “blank-cheque” company, raises capital through an IPO of units, typically priced at US$10 each and consisting of one common share and a full or partial warrant that will trade separately. The cash sits in trust collecting interest until the SPAC buys a private operating company.
A transaction usually must be done in two years. If not, the management team or “sponsor” loses its investment to set up the SPAC and the institutional investors get their money back plus accrued interest. These investors must also approve a merger, but those who don’t can get their cash back with interest. More money needed to complete a deal can also come from new institutional investors.
SPACs are not new but have regained popularity recently as a way for firms to go public faster and with less regulatory scrutiny. There are now about 255 U.S.-listed SPACs and also nine in Canada, which are focused mainly on the cannabis industry. U.S. cannabis players have been attracted to Canadian SPACs because they can’t go public south of the border where marijuana is still illegal federally.
This space has also attracted high-profile U.S. financiers, including Social Capital LP’s founder and CEO Chamath Palihapitiya, whose first of several SPACs merged with Virgin Galactic. Its shares soared, indicating an appetite in the public market for emerging-growth companies, and how lucrative it can be for sponsors who earn up to 20 per cent of the postmerger company.
“SPACs are a bull market activity,” but there are too many chasing deals that will push up valuations in the private market, says Greg Taylor, chief investment officer at Purpose Investments Inc. “There’s going to be fewer home-run deals.”
However, he has bought some SPACs, which have merged with U.S. cannabis companies, for the Purpose Marijuana Opportunities Fund (MJJ-NE) exchange-traded fund (ETF) that Mr. Taylor co-manages. The ETF holds shares of U.S. multistate cannabis operators AYR Strategies Inc. (AYR.A-CN) and Columbia Care Inc. (CCHW-CN).
The ETF also owns warrants expiring in 2024 from Subversive Capital Acquisition Corp. (SVC.A.U-NE). It just struck a deal to buy a U.S. entertainment company founded by rapper Shawn Carter (a.k.a. Jay-Z) and two California cannabis firms to form TPCO Holding Co.
“It could be an interesting merger” given developments south of the border, he says. “We are bullish on U.S. cannabis for 2021 with the new government [led by U.S. president-elect Joe Biden]. There could be a lot of advancements in legalization and the changing of some rules.”
Beyond the cannabis sector, domestic SPACs have been slow to gain traction in Canada – and that’s probably because of their poor track record from a few years ago, Mr. Taylor says. Some of them failed to do a transaction, so investors got their IPO money back and “missed out on opportunities in the rest of the market,” or lost money if they paid above the IPO price.
Investing in a SPAC is a bet on the deal-making track record of the sponsors, but that didn’t work with Acasta Enterprises Inc., a Canadian SPAC which listed in 2015. Its backers included a former Onex Corp. executive and Belinda Stronach, whose family founded Magna International Inc.
Acasta, now known as Apollo Healthcare Corp. (AHC-T), struggled financially after acquiring three companies, and its stock still trades well below the IPO price. “People have to be aware that there is still a lot of risks in SPACs,” Mr. Taylor says.
A way to minimize risk is through SPAC arbitrage – a trade that some hedge funds use. But retail investors can get access to this strategy through Canadian-listed Accelerate Arbitrage Fund (ARB-T). This ETF allocates 80 per cent of its assets to SPAC arbitrage and 20 per cent to merger arbitrage.
SPAC arbitrage “is a very low-risk trade if done correctly,” says Julian Klymochko, CEO of Accelerate Financial Technologies Inc., a provider of ETF liquid alternative investments.
The strategy is to generate a return by buying a SPAC at or below net asset value (the IPO price plus accrued interest) and getting that cash back, plus interest, if the SPAC does not get a deal done, or by redeeming the shares prior to the vote on a proposed business combination, he says.
“As long as you buy the SPAC at or below the cash value, we are guaranteed a return in any scenario,” Mr. Klymochko says. “The true upside comes if [SPACs] announce a deal and the shares trade up dramatically. That’s where we would exit. … We never hold the SPAC after the transaction closes.”
Historically, the returns from SPACs after a merger are similar to those of venture capital, in which there are “a few big winners, but mostly losers,” he says.
Accelerate Arbitrage Fund holds 116 U.S.-listed SPACs. The ETF, which uses modest leverage, targets a total annual return of 7 per cent to 8 per cent. It has risen by more than 20 per cent, including distributions, since its April 7 debut.
The ETF’s most successful SPAC exit was DiamondPeak Holdings Corp., which acquired Lordstown Motors (RIDE-Q). “We were able to buy [DiamondPeak] below US$10 a share, … but we exited at between US$20 to US$30 a share,” Mr. Klymochko says.
Mr. Kaufman of Westcourt Capital is also a fan of SPAC arbitrage and has recommended three pure-play funds focused on this strategy to clients. They are sold by offering memorandum, which also outlines limits on leverage, to accredited investors.
The funds have target annual returns of 6 per cent to 8 per cent but are up more than 20 per cent year to date due to their ability to manage the heightened volatility, he says.
“SPAC arbitrage has been a significant part of our portfolio construction for more than three years,” Mr. Kaufman adds. “Until recently, [with the introduction of an ETF in this space], it was not possible for a retail investor to invest in this strategy. It’s almost impossible for an individual to participate in the purchase of SPAC [offerings directly].”