The SPAC Frenzy
Navigating the waters of the Special Purpose Acquisition Company - Common Shares
If you’ve had a conversation with any investor recently, it has probably involved the word SPAC. And you’ve probably wanted to SPAC them on the head shortly after they started talking (my wife will probably roll her eyes when she reads this but… hey… she chose to marry someone with this type of humor, so?)
But in all honesty, I am an avid advocate for SPACs. There is inherent risk, but also an opportunity for immense rewards as an investment vehicle.
What is a SPAC?
SPAC stands for Special Purpose Acquisition Company. It is a blank check company, selling shares to the public to create a cash escrow account. The management team of the SPAC will then search for a private company to affect a merger, giving the private company the cash in exchange for a percentage ownership of the business. After the merger completes, the private company will become a public company, trading on a major stock exchange and reporting regularly. Many investors liken this type of investing to late stage venture capital investing.
I believe the popularity of the SPAC has drastically increased recently because of a few factors:
Lending dollars drying up during the pandemic.
Massive disruptions occurring in many industries.
Crazy IPO (or Initial Public Offering) market where more mature private companies become public companies at high valuations.
Investors opportunity to get in earlier on a company’s business lifecycle.
Success of some recent SPACs like DraftKings (Ticker: DKNG), Virgin Galactic (Ticker: SPCE), Skillz (Ticker: SKLZ), and Opendoor (Ticker: OPEN).
The Risk of SPACs
The SEC states “if the SPAC is liquidated, shareholders at the time of the liquidation will be entitled to their pro rata share of the aggregate amount then on deposit in the trust account.” Most SPACs come to market priced at $10 per common share of stock. So if the SPAC liquidates because it can’t find a merger after two years (normal period of time given to SPACs to affect a merger), then investors will receive the proportionate allocation of the cash escrow account, normally the $10 plus any interest accrued over the two years per common share of stock.
So you might think, why the heck is this important? In essence, this process of liquidation gives a floor to the price of the SPAC. Every decision in investing has a risk/reward profile. In this case the risk is the SPAC liquidating at $10 per share (unless management has mismanaged the funds), and the reward gives investors the opportunity to own some great up-and-coming private companies.
Generally, a SPAC’s price starts to climb from the $10-$11 range as rumors swirl around a potential merger target. And if a merger occurs with a strong private company, then many times that SPAC sees a 20%-40% pop in price… sometimes even more. In the reverse, if the market doesn’t like the merger, then the share price can fall back to the $10 level. I try my best to mitigate this by finding the highest quality SPACs.
My SPAC Playbook (For Common Shares)
(1) Finding Quality SPACs
Quality management…
I look for a CEO and group of Directors/Board Members that have a strong track record of making deals and a strong pipeline of investments. Finding strong management can minimize the potential for mismanaged SPAC funds, but nothing is ever guaranteed.
Strong investment thesis…
The SPAC’s investment thesis guides the potential merger target. I make sure this thesis is in my wheelhouse and in a high growth industry. The management’s previous investments/expertise can also give potential insight into the direction they will head with their search.
Price…
I look for SPACs selling between $10-$12, thus limiting my downside risk to no more than 20%. Occasionally I will stray over the $12 price target if I find a SPAC that has successfully completed SPAC mergers in the past or has a strong management team in a high growth industry.
(2) Parking My Cash
I park most of my cash in a set of SPACs. My high interest savings account returns 0.5% per year right now. And my money market account returns next to nothing. Due to the “essential” floor in SPACs, I have transitioned my cash to these vehicles for their potential growth. If I find a company I want to buy, or add to my portfolio, then I can sell some/all of the SPAC and purchase the company. In the mean time, the SPAC has a chance to increase in price as a result of rumors or a definitive agreement to merge.
(3) My Process
Find a SPAC with quality management and a strong investment thesis.
Purchase the SPAC between $10-$12 pre-merger.
Have patience.
When a merger is announced, research the private company by reading the investor deck and checking out their website.
If I don’t like the merging company, then I will sell out of the SPAC completely and move those funds to a new SPAC.
If I do like the merging company, then I will sell my initial investment and let the rest ride.
My Current Pre-merger SPAC Portfolio
Here is a list of my current SPACs:
$AJAX -> Plans to target the internet, software, fintech, and consumer industries, focusing on companies with defensible business models, large and growing end markets, and superior unit economics.
$DMYI -> Focus on companies that have created, or enabled the creation of, compelling mobile app experiences with significant growth in segments such as gaming, entertainment, work productivity, e-commerce, dating, financial technology, and health and wellness. Currently the third SPAC from this team.
$HAAC - Partner with leading healthcare businesses leveraging technology to help them become iconic category winners that accelerate the digital transformation of healthcare into a new system of health assurance.
$IPOF -> Identifying and investing in innovative and agile technology companies. Currently the sixth SPAC from this team.
$XPOA -> Focus on established companies with leading competitive positions, strong management teams, and long-term potential for growth and profitability in the technology sector.
$ZNTE -> Identify, acquire and manage a business in the Aviation, Aerospace & Defense, Urban Mobility and Emerging Technology industries that can benefit from our differentiated and proprietary deal flow, leading brand name and global network.
$CMLF Victory!!!
Recently I had my first pre-merger SPAC announce a merger. I purchased $CMLF (CM Life Sciences) because they had high quality management with Casdin Capital, the CEO of Invitae Corporation, and the CEO of Twist Biosciences. Their investment thesis was also targeting life science companies that enable and support innovation. Due to the leadership and merger target, this was one SPAC I paid more than $12 per share, thus risking a higher downside.
They announced their merger with the private company Sema4 (a genomic data company). As of the close of business on Friday, February 12th, CMLF was trading at $25.81.
After researching Sema4 and believing them to be a long term hold, I sold a portion of my position. The remaining shares of $CMLF have been added to my “10x in 10 years” portfolio, and the cash resulting from the sale will be put into another SPAC.
My New SPAC: Lux Health Tech Acquisition Corp ($LUXA)
Current Price: $12.34 (as of the close of market on 2/12/21)
Downside Risk: 19%
Investment Thesis: Formed for the purpose of combining with one or more businesses at the intersection of the healthcare and technology industries.
Management Team:
Peter Herbert - Co-founder of Lux Capital that supports a wide range of once-impossible-sounding advancements, including 3D printing and imaging, nuclear waste cleanup, machine learning and robots that fly or conduct microsurgery. See Lux Capital’s portfolio by clicking here.
Josh DeFonzo - CEO of Lux Health Tech Acquisition Corp with former stints at Auris Health and CareDx.
Segolene Scarborough - CFO of Lux Capital’s finance department and previously a controller at Sequoia Capital.
Dr. Bijan Salehizadeh - Managing Director at NaviMed Capital, which is a healthcare focused growth capital firm focused on investing in profitable, commercial-stage companies in Health IT, Health Services, and Hospital Products. See NaviMed Capital’s portfolio by clicking here.
Senator Joseph Robert Kerrey - Former Governor and Senator from Nebraska.
Dr. Fred Moll - Considered the father of robotic surgery. Currently the Chief Development Officer of Robotics at Johnson & Johnson. Previously successful at Intuitive Surgical, Hansen Medical, and Auris Medical.
This SPAC is pre-merger as of this writing on 2/14/21.
Special Note:
The type of return I achieved on CMLF does not always happen. The market could also react poorly to the merger and the price will drop. There is always risk in investing and it is why I continuously diversify my holdings. Buying and selling also has tax implications, so make sure you set up your investing plan accordingly.
Thank You!
If you’ve made it this far, then you are an amazing human. Let me know what you think by leaving a comment. Or drop me a question. Share it with others who you think might appreciate the information. Looking forward to sending out the next issue!
**I am not a financial advisor, so please don't buy/sell anything based solely on what you read here and do your own due diligence.