The Dark Side and Upside of SPACS... Plus the Mailbag

When BuzzFeed (BZFD) went public earlier this week via a special purpose acquisition company ('SPAC'), two groups of people made money... First, there are the so-called "sponsors," who created the SPAC. While there are exceptions, they generally walk away with tens of millions of dollars' worth of stock, regardless of how well the deal does. […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] The Dark Side and Upside of SPACS... Plus the Mailbag By Herb Greenberg When BuzzFeed (BZFD) went public earlier this week via a special purpose acquisition company ('SPAC'), two groups of people made money... First, there are the so-called "sponsors," who created the SPAC. While there are exceptions, they generally walk away with tens of millions of dollars' worth of stock, regardless of how well the deal does. Second are the bargain-hunting investors, usually professional arbitragers, who make money by assuming risk in merger transactions. With SPACs, they typically pounce on those that have fallen below their IPO price, usually $10 a share... taking full advantage of one of the perks of a SPAC, which allow investors to eventually trade in their shares for $10. Since most appear to be trading below $10, the strategy has been a goldmine for the arbs, whose goal with SPACs is a bond-like yield, sometimes equal to or better than Treasuries. With BuzzFeed, if bought in January, it was about 3%. More recently, the implied yields on some are upwards of 7%. It's obviously more complicated than I've laid out, but while there are no guarantees in life, pocketing that SPAC spread is close... In SPAC lingo, the process of getting there is called "redemption." And unless the deal is genuinely a great deal, most arbitragers, hedge funds, or others who bought at a discount wind up redeeming for $10 a share. Before we go further, this warning: Before you start thinking about doing this yourself, beware... You had better have a good system for keeping track of when the redemption votes will be, otherwise, you could wind up stuck in a sinking stock... or, worse, a bad deal. Look no further than BuzzFeed. After initially trading as high as $14.40 the morning of its offering, it promptly plummeted and closed yesterday at $5.87. Here's what nobody expected... It turns out that roughly 94% of all investors took the money and ran. Redemption rates that high aren't everyday occurrences, but rates above 80% are increasingly common – especially after the recent SPAC bubble burst. Here's why that matters: The higher the redemptions, the less cash the companies get. BuzzFeed had hoped to raise nearly $300 million, but instead walked away with a measly $16 million – and that appears to be before paying around $40 million in transaction fees. In other words, it appears that from the deal itself, it really got zero. Some will argue that it got $150 million more because it simultaneously did a debt deal. To which I say... then why didn't it just do the debt deal? But I digress... What's the point of going public via a SPAC if the company is at the bottom of the totem pole? It's still a viable backdoor way for some companies to go public, even if they're willing to endure greedy sponsors. But make no mistake: SPACs have been a no-brainer cash grab for the sponsors, regardless of how well the post-SPAC company does. After all, the sponsors – you know, the ones who put up the initial money and merger opportunity – have been in the driver's seat. But that could be about to change, and it's very possible the greed of some of these sponsors could backfire... Or so says Julian Klymochko, CEO of Accelerate Financial Technologies. And if anybody should know, it's him. Canada-based Accelerate runs the Accelerate Arbitrage Fund, an exchange-traded fund that trades on the Toronto Stock Exchange and invests in the spread between a SPAC's initial price and any discount that might exist. (I have no idea why a similar fund doesn't exist in the U.S. If one does, I haven't seen it.) Julian has been investing in SPACs since 2013, when only seven deals were completed. For perspective, data on the [website]( SpacTrack shows there are roughly 560 SPACs out there searching for a deal... Or as my colleague Enrique Abeyta noted on Twitter yesterday... People say short-selling is dead but that sounds like the best short-selling opportunity in a generation to me. And despite the mania having been mashed, there seems to be a new SPAC going public every day, if not more. According to SpacTrack, there were 22 in December alone. Back in 2020 – when hardly anybody (besides Enrique!) knew what a SPAC was – there were 90. Julian is widely recognized as one of the most knowledgeable SPAC investors. As he sees it... Target companies are getting savvier, and more and more sponsors will be desperate for deals. And, on average, those deals will need to be done within 24 months, unless the deadline is extended, but there's a cost to that. If they don't do a deal, they'll have to return the initial price – that $10 plus accrued interest – to all investors. And as Julian knows from experience... It's extremely difficult to get a deal done in 15 months. The target companies will get the leverage if the sponsors get desperate. Ideally, Julian believes it would behoove sponsors to better align themselves with the investment outcome... as some already do, with some sort of performance-related payout of shares, rather than a lump-sum amount. With BuzzFeed, the sponsors walked away with roughly 7.1 million shares, which they originally bought for a paltry $25,000. Maybe better alignment will help avoid so many deals being done for the sake of doing a deal. And that's good for the companies because they'll likely wind up with more cash. But that doesn't necessarily mean they will be good investments. The more pressure they're under to do deals, the less the diligence and scrutiny. A slew of SPACs has already come under attack from short sellers with allegations of misleading investors. Perhaps the best example is Nikola (NKLA), one of last year's hottest deals, until Hindenburg Research raised serious red flags about the company. The founder was ultimately ousted and its stock plunged by roughly 90% from its highs...  Just yesterday, Securities and Exchange Commission ("SEC") Chairman Gary Gensler suggested that people behind the SPACs, including the sponsors, should be responsible for doing better due diligence into the companies they acquire. But the reality is, much like venture capital, with this many companies searching for merger partners, many or most are likely to be garbage or significantly overvalued... leaving arbitrage at this point as the best SPAC game in town. Except for those who have time frames longer than a few minutes. Once many of these post-SPAC companies crash, there is no question some will be good investments. I know some folks who already are putting together their watch lists, like Enrique is doing in Empire SPAC Investor. After all, sometimes to make what looks like fast money, you first have to go slow. In markets like these, that seems like a forgotten art. --------------------------------------------------------------- Recommended Links: [If you knew the future, how much would you invest?]( Investors always want to know – and put their money into – what's coming next. And that's exactly what I want to tell you today. I'm convinced that you'll look back in a few years and say, "Wow... that was so obvious, I wish I'd invested more before the entire world caught on." [Click here for my No. 1 pick](. --------------------------------------------------------------- [Until Midnight Tonight, Claim Six Free Months of 10X Investor [NEW!]]( For the first time ever, you can access the top 10 best small stocks to buy now, chosen by Stansberry's senior analyst Mike Barrett... using the same strategy that's allowed Mike to double his money six different times within the last year alone. These could become among the most lucrative small stocks you'll ever see, but you must act now. [Until midnight tonight only, you can claim six free months right here](. --------------------------------------------------------------- In the mailbag, several readers write in talking about valuations... As always, feel free to reach out via e-mail by [clicking here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Herb). And if you're on Twitter, feel free to follow me there at [@herbgreenberg](. My DMs are open. I look forward to hearing from you. ► "Herb – This is the first time I've ever seen a 'Total market cap of most expensive vs cheapest stocks' chart. "I love it. It's the best new chart I've seen in years. Not only does it contain a lot of information at a glance using data which can't easily be manipulated by accounting shenanigans. Not only does it show you in one second why valuations at the high end of the market are currently absurd (and can't last). "It also tells you something you didn't mention in the article – that the cheapest quintile of the market is also historically quite expensive (yes, I know that market caps should increase gradually over time as the economy grows – but U.S. GDP only grows 2%-3%/year, while on the graph it appears as though the lower quintile more than doubled in the past 2 years). "This implies that when the inevitable, large market downturn occurs, being invested in a diversified basket of (relative) value stocks might do a little better than things like ARK, but returns will still be double digit negative, unlike 2000-2001 when buying value stocks was like shooting fish in a barrel. "My guess is that the companies that hold up best will be the ones that generate very high free cash flow, enabling high dividend yields, opportunistic stock buybacks, or self-funded strategic acquisitions at very reasonable cost. Thank you for the cool chart!" – Joe G. Herb comment: Joe, thanks very much. The beauty is that I stumbled on that chart via another chart I had seen on Twitter, which was attributed to [Kailash Concepts](. After going to its website, and checking around, I realize Kailash does fantastic out-of-the-box work... with some great charts I had not seen elsewhere. (I hope to talk more with them in the very near future.) As for companies that will hold up better than others when this market has its day of reckoning... what you're suggesting is the best of the best – or certainly those with the best management. Can't argue with that. Especially since the last thing most investors appear to be looking at in this market is free cash flow. I would argue that we're at that point in the cycle where many rarely go beyond the stock symbol. "What do you think about the argument that these companies will 'grow into' their valuations?" – Michael S. Herb comment: Michael, most won't. It's mathematically improbable. (Note I didn't say impossible... in reality, I can't see the future.) My guess is that if we ever get a market wipeout, some of these high flyers will tumble down to where they should be and – assuming the market is more discriminating – stay there, unless they get acquired or prove they deserve higher valuations. A great example is Ciena (CIEN), one of the hottest stocks of the dot-com bubble. It has been in purgatory all these years, and only recently appears to be getting a new life. Twenty years is a long time to try to grow into that valuation, and even now it's nowhere near close. "Thank you again. The only way this works is if you can find a greater fool. With so many people so leveraged..." – Tim P. Herb comment: Given the breadth of this market, I'd say everybody believes it won't be them. Musical chairs, anyone? "Hi Herb – I've often wondered why some of them are so eager to go public.' Money. Private companies go public for only one reason. To make the senior executives a lot of money in a very short time. "Think UPS. Going public offers no other benefits. Ask the senior management at Mars, Cargill, or any other successful private company. This is the same reason that Mutual companies sometimes abandon their corporate commitment to their 'mutual' owners. By going public the senior managers can put significant $$ in their pockets. "But to your point, it does not make the company better. They had layers of cost associated with required regulatory reporting requirements. And they add all the stress and short-term thinking that comes with trying to keep Wall Street analysts and the Financial Media happy. "Which is not necessary with long term focused private owners. Keep up the good work." – Christian F. Herb comment: Christian, I can't disagree. That's why I often like to talk with private companies that compete with public companies. Since they don't have a stock to sell, they often know – and if you're lucky, are willing to tell you – what's really going on. But not all can, and the public markets remain a great source of cash for companies that have innovative products or services that are in demand... Starbucks (SBUX) will always be the perfect example, using the cash to expand into a market eager for its coffee. Other companies genuinely need the cash for acquisitions or purposes to fuel further growth... and being public is the best of option. And others... some, like The Container Store (TCS), will have wished it never took the investment bankers' call. Regards, Herb Greenberg December 10, 2021 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2021 Empire Financial Research. All rights reserved. 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