August 17, 2021

Good SPAC, Bad SPAC: How the Jiffy IPO Method Is Regaining Favor

Ever since the SEC’s spring crackdown, these once-popular investments have wilted. But their excesses are being leached away.

Reported by Larry Light

Art by Miriam Martincic

Special purpose acquisition companies, or SPACs, have gotten an awful rap due to their over-hyped projections. But now they are looking up after a rough spell and actually appear to have a pretty decent future. Reason: These so-called blank check companies are ridding themselves of excesses that prompted a regulatory crackdown to prevent long-term threats to investors.

Issuing outlandish outlooks is no longer acceptable to the Securities and Exchange Commission (SEC). So a SPAC shake-out is underway. That’s why, after a big drawdown in SPAC activity, the prospect of more solid financial foundations seems to be prompting a moderate comeback.

To see the contrast between the more solid SPACs that pass SEC muster and the freewheeling variety that don’t, let’s look at how two of them have conducted themselves: electronic security firm Latch, the more modest kind, and electric vehicle (EV) maker Canoo, which has forecast extraordinary future sales. With mounting bookings and revenue, Latch has a promising business in commercial security systems. Think: the card readers that let you open a door. Yet Canoo, at its outset last year as a SPAC acquisition, announced very optimistic projections for its EVs, despite uncertain prospects. Since then, Canoo has suffered management turnover, a dismaying lack of revenue, no vehicles for sale—and an SEC investigation.

“There has been a lot of hype in SPAC investor presentations,” said Jay Ritter, a University of Florida professor and the eminent authority on public offerings.

The appeal of SPACs is that they are a quick and relatively cheap way to take a company public. They start out as shell companies that do initial public offerings (IPOs) to gather funding for a future buyout. Over the next two years, they must use the IPO capital to purchase a functioning business; they can’t just sit on the money. If they don’t make an acquisition within those two years, they have to return the funds to investors.

Last year and in 2021’s first quarter, SPACs were so popular that they dominated the IPO market. In 2020, 248 went public, raising $83.4 billion. In the January–March period this year, the number doing an IPO was close to 2020’s full-year tally.

Then in April came SPACs’ sudden and wrenching fall from grace, when the SEC charged that too many of them make unrealistic financial and operational performance estimates as they start out—a practice that is banned among conventional IPOs. The agency also objected to how SPACs account for warrants they award investors. Thus, the acquisition entities now are saddled with costly and time-consuming bookkeeping revamps. After that federal broadside, SPAC offerings shrank to almost nothing: a mere 12 went public in April, versus 98 in March.

But, tellingly, these entities are staging a modest comeback, according to SPAC Research. In July, there were 30 IPOs. And for the first half of August, through last Friday, 23 IPOs were hatched, suggesting that this month should outpace July’s showing.

That betokens a good comeback for these organizations, yet one well short of the acclaim the space enjoyed before, many Wall Street analysts say. “SPACs are here to stay, although at a lower volume,” said Ronald Temple, co-head of multi-asset investing and head of US equity at Lazard Asset Management. “The air’s now out of the balloon. What that means is that better companies will go public.”

To Jonathan Glidden, CIO at Delta Air Lines, which has invested in them, SPACs have a good profit potential going forward. At CIO’s 2021 Symposium in May, he outlined the many ways investors can do well with SPACs. For one thing, Glidden noted, they must approve an acquisition proposed by the SPAC general partners, the folks who sponsored the fund and did the IPO.

While a lot of institutional money is in SPACs, they are far from being a significant holding, likely due to their novelty or to doubts about their staying power. Among pension and endowment funds, just four hold multimillion-dollar stakes in SPACs, although the vehicles are merely a small part of the portfolios. Three of them are Canadian. The quartet of major holders are Albert Investment Management Corporation (AIMCo), the California Public Employees’ Retirement System (CalPERS), the Public Sector Pension Investment Board (PSP Investments), and Healthcare of Ontario Pension Plan Trust Fund (HOOPP).

A recent flurry of fresh SPAC deals likely heralds the new, more sober look for them. Digital publisher BuzzFeed, grocery courier Boxed, robotics platform Bright Machines, and vaccine developer Greenlight Biosciences all recently disclosed plans to be bought out by SPACs. Meanwhile, in a signal that SPACs can evolve, hedge fund titan Bill Ackman has debuted his own form, which only gathers investor money once a deal is in hand, not upfront in an IPO, and isn’t confined to a two-year deadline. This would give flexibility to find the right target, instead of rushing and ending up with a clunker.

SPACs do retain a certain glamor. Some SPACs have famous people behind them, such as aviation-entertainment mogul Richard Branson, head of the Virgin Galactic SPAC, and basketball legend Michael Jordan, an investor and board member at DraftKings, the online sports betting service.

Beyond their celeb cachet, these two SPACs differ in terms of business prospects. Going public via a SPAC in 2017, Virgin Galactic last month was the first to independently send private citizens into outer space, Branson among them. The stock is up 150% since the SPAC deal happened. Nonetheless, the firm is far behind other space companies in terms of satellite launching, rocket manufacturing, and the like. Plus, deeply unprofitable Virgin Galactic’s business flight path is unclear. How many space tourists will emerge?

On the positive side, DraftKings benefits from more and more states legalizing digital wagering. In its just-reported June-ending quarter, revenue shot up 326% and losses came in lower than analysts’ estimates. Since Diamond Eagle Acquisition took over DraftKings in April 2020, the stock has almost tripled.

Bad SPAC: Canoo Takes on Water

Electric vehicle companies have flocked to SPACs, although with less than wonderful results. The best-known is Nikola, whose ex-chief is under indictment for allegedly issuing false statements about the company. One damning report, from short-seller Hindenburg Research, contended that a Nikola promotional video misleadingly showed one of its trucks in motion, when the rig really was rolling down an incline in neutral using gravity, not its own power. The company labeled that report false. The harsh reality is that startup EV companies are in a crowded arena and face tough competition from well-funded, established rivals like Tesla, not to mention General Motors and Ford Motor.

Canoo went public in December following a merger with a SPAC, Hennessy Capital Acquisition, amid plans to produce delivery vans and pickup trucks starting in 2023. Alas, problems have plagued the company: a string of executive departures, sudden changes to its business model, and class-action shareholder lawsuits.

Then came the SEC probe. Canoo’s Form 10-Q for the first quarter stated that an SEC “fact-finding inquiry” will cover Hennessy’s IPO and merger with Canoo, in addition to Canoo’s “operations, business model, revenues, revenue strategy, customer agreements, earnings, and other related topics.” Canoo declared that the investigation doesn’t mean that anyone has violated the law and that it would cooperate with the agency.

Meantime, the company is mired in the red. In its investor presentation late last year, Canoo said it would turn profitable in 2024, and in a mere two years that would expand to $964 million. Revenue, now non-existent, would come in at $120 million in 2021 and balloon to $4.1 billion in 2026, according to the company estimate then. Canoo withdrew that sunny forecast in its first quarter earnings (or lack of earnings) report. It has also switched business plans: Bafflingly, Canoo now wants to manufacture the goods itself, instead of relying on third parties as before. Last year, Hyundai Motor announced it would partner with Canoo to co-develop EVs, then the agreement disintegrated in early 2021 after the startup decided to switch to doing its own manufacturing.

In Canoo’s second quarter, the business missed Wall Street’s estimates that it would lose 36 cents a share. Instead, the company lost 50 cents. Non-binding pre-orders for its EVs rose to 9,500, up from 9,000 before. A request for company comment was not immediately returned.

Good SPAC: Latch Could Unlock Profits

Latch began publicly trading in June, after its acquisition by a SPAC called TS Innovation Acquisitions, whose sponsor is real estate goliath Tishman Speyer. So Latch has a big pockets backer with far-ranging connections in commercial real estate. The SPAC buyout gives it ample capital. This pumped $510 million into the business, and then came extra side financing of $190 million from a PIPE (that’s private investment in public equity).

The difference with Canoo is that Latch has an already-successful product in a less-competitive, even booming, field. Its card readers and key-punch pads increasingly are favored over old-fashioned metal keys to unlock doors. In its June-ending quarter, Latch’s revenue rose 227% compared with the prior-year period. Bookings for future sales are way up, too. While still unprofitable, the company should be in the black in a couple of years, Wall Street believes.

Its investor presentation earlier this year was sanguine—the company claimed its estimated 2021 revenue would increase sevenfold by 2026—although reasonable, given Latch’s sales explosion. With a concentration on apartment buildings, a growing real estate sub-sector, and Tishman’s domestic and international clout, this momentum has strong odds of continuing. The company’s debt is small, with assets overshadowing liabilities by a factor of 10.

True, Latch’s stock is flat since its merger with the Tishman unit. Still, the company’s spirit of innovation in a growing market should serve it well over time, analysts say. For instance, it harnessed its technological prowess to allow prospective tenants of AvalonBay, one of the nation’s biggest apartment real estate investment trusts (REITs), to take virtual tours of the trust’s new 238-unit Kanso Twinbrook development in Rockville, Maryland.

In all, Latch is an example of how the SPAC concept can be used well. Before the SEC bombshell, SPAC “volume was unsustainable,” Professor Ritter observed. In all likelihood, you can liken SPACs’ probable future to junk bonds’ historical trajectory. These non-investment grade obligations were hot in the takeover-crazed 1980s, then went south in the early 1990s amid vast defaults. High-yield bonds today, however, are a recognized and widely used asset class.