It's Time to Capitalize on the SPAC Scrap Heap

Raising money for an unknown purpose isn't exactly an easy sell... As I explained yesterday, 19th-century industry titan Henry Villard was only able to pull it off because he spent years establishing a reputation as a rainmaker... and people were lining up to invest alongside him. That's how Villard established the first of what would […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] It's Time to Capitalize on the SPAC Scrap Heap By Bryan Beach --------------------------------------------------------------- [Elon Musk's secret fuel?]( In addition to leading the charge for batteries, electric vehicles, and solar-powered homes, the Tesla founder is quietly working on a new type of fuel to power his SpaceX rockets. McKinsey, a leading consultancy, claims this technology will change our lives forever and create a $4 trillion industry. And one little-known company at the forefront of this industry has the potential to become "America's Next Big Monopoly." If you missed out investing in Tesla, Apple, Amazon, Google, or Netflix early on... this could be your second chance. [Get the details here](. --------------------------------------------------------------- Raising money for an unknown purpose isn't exactly an easy sell... As I explained yesterday, 19th-century industry titan Henry Villard was only able to pull it off because he spent years establishing a reputation as a rainmaker... and people were lining up to invest alongside him. That's how Villard established the first of what would now be known as a special purpose acquisition company ("SPAC"). To an extent, the same thing happens with some modern-day SPAC sponsors. Wall Street heavyweight Bill Ackman raised an incredible $4 billion for his SPAC... Although he ultimately unwound it without finding a suitable target. But most sponsors don't have Ackman's standing, so they need to entice investors with deal-sweeteners like warrants and stock rights – goodies that allow investors to buy discounted shares in the future, should the stock appreciate. And as I mentioned, if the sponsors don't find a target within two years, they return the investors' cash, plus interest. So it's a no-risk venture for the early investors. But more importantly, even if they redeem the shares, investors get to keep the warrants and stock rights free and clear. (If too many investors choose this option, it can force the sponsors to walk away from the deal or go through another round of fundraising called private investment in public equity, or "PIPE.") Once the SPAC does find a target with which to merge, it almost always debuts at $10 per share. That's not to say every SPAC is intrinsically of equal value. As with any company, the share price is merely a function of the total value of the company divided by shares outstanding. In practical terms, the sponsors simply adjust the shares outstanding to land at a $10 share price. Some of these SPACs soar right out of the gate, such as Virgin Galactic (SPCE) and DraftKings (DKNG) – both of which went public via SPAC in late 2019, both of which soared, and both of which gave back most of their gains over the next couple years. Most SPACs don't bother "booming" at all... They fall right away. According to a study by the Harvard Law School Forum on Corporate Governance, the average SPAC return is negative 3% in three months, negative 12% in six months, and negative 35% in 12 months after listing on a public exchange. And keep in mind, this study is somewhat dated. These dismal returns are from before the SPAC bubble burst – and before war broke out in Europe. Of course, these are averages... Smart speculators can make good money picking out the SPACs that have the best chances for post-merger greatness. But as a group, newly merged SPACs face price pressure from the start. --------------------------------------------------------------- Recommended Link: [Urgent Invitation from Whitney Tilson]( I'm hosting a special event I'm calling, "The Coming Inflation Shock of 2022" on Tuesday, May 17 at 8 p.m. Eastern time. I'll be revealing how you can prepare for the upcoming shock and how you can even profit from it. [Click here to see the details and save your spot now](. --------------------------------------------------------------- What's behind these lackluster results? There are a few reasons why SPACs tend to fall after going public... - SPACs are often lousy, overvalued, or both Sponsors have an outsized motivation for finding a deal – any deal. If they don't, they basically get nothing for their efforts. They'd rather own 20% of a lousy company than 20% of nothing. And they'd rather pay up for an overvalued target than lose out to the hundreds of other SPAC sponsors looking for deals. This competitive SPAC landscape is also why sponsors are willing to recruit celebrity "strategic advisers" – like professional basketball legend Shaquille O'Neal, former football quarterback and activist Colin Kaepernick, tennis star Serena Williams, and political superstars Arianna Huffington and Paul Ryan – to their management teams. They know that good companies will be hearing from loads of SPAC suitors... And being able to "partner" with someone famous instead of some stodgy Wall Street or Silicon Valley stiff is a selling point. In 2020, it was undeniably a seller's market. And sponsors were willing to do – or pay – anything to get a deal done. But just because some SPAC sponsors overpaid doesn't mean the stock market will continue to do so. If the sponsors overpaid for the target, Mr. Market will quickly push shares below $10. - Dilution isn't "free" One thing you'll often hear about SPACs is that, unlike with traditional initial public offerings ("IPOs"), there are no expensive investment banker fees. This is true, in a sense. Nobody is writing a fat check to a bank to take the company public. But there are still costs... Nothing is free. According to the aforementioned Harvard Law School study titled "A Sober Look at SPACs"... The dilution embedded in SPACs constitutes a cost roughly twice as high as the cost generally attributed to SPACs... For each share purportedly worth $10, there is $6.67 in cash and $3.33 in dilution overhanging the merger. Our own analysis showed slightly less dilution... We got back to somewhere between $2 and $3 worth of dilutive costs. But no matter how you do the math, the fact is that the "true" baseline for a post-merger SPAC is around $7 or $8 per share... not $10. So it makes sense that shares fall out of the gate. - No loyalty from early investors Remember those free goodies I mentioned above? Those warrants and rights are an effective way to entice investors to pour money into the pre-deal SPAC. But as I said, investors get to keep these goodies, even if they dump the shares right as the merger happens. This is a free option in every sense of the word. Los Angeles Times business columnist Michael Hiltzik describes these dynamics well... If the announced deal produces yawns, the SPAC investors can redeem, getting back their original investments, pocketing their risk-free interest earnings, and holding onto their warrants in case the merged company is a winner. That's risk-free leveraged upside. And when these early investors bail out, the sponsor needs to find new money to fill in the gap. This is where the second round of PIPE comes in. PIPE allows mutual funds and other institutional investors to buy preferred shares or other instruments that offer more juice than the typical common share. But in the words of Institutional Investor magazine... The problem with all these machinations is that each layer adds its own costs – and dilution to shareholders. Here's how one veteran SPAC participant summed up these dynamics in the same magazine article... You're giving a free warrant. But the kind of people interested in free warrants are hedge fund arbitrageurs. So you can raise capital, but once you identify a target, you have to raise money all over again. With all these shares sloshing around from arbitrageurs, early opportunists, and PIPE investors – to say nothing of the sponsor who may be able to dump her 20% stake at any moment – it can take Mr. Market more than a year to digest the "true" value of a company. This is yet another source of SPAC pricing pressure. - Unmet expectations When drumming up interest for the target company, a SPAC management team will introduce the business to early investors. This usually comes in the form of a slick slide deck and rehearsed presentations from polished executives. It's similar to the "road show" that management teams endure before a traditional IPO... with one important difference. In an IPO, the U.S. Securities and Exchange Commission ("SEC") strictly regulates any sort of projected numbers – including revenues and earnings. However, there are no such regulations for a merger of two companies. And in a purely technical sense, a SPAC buying a target company is a merger. Management teams have been known to wildly exaggerate a business's prospects when trying to generate buzz for a new SPAC merger... only to sheepishly scale back those estimates shortly after the merged company's shares begin trading. To provide one extreme example... Romeo Power (RMO) debuted as a merged SPAC in late December 2020, guiding to $140 million in 2021 revenue. Three months later, it pared that guidance down by around 80%, to between $18 million and $40 million – a significant adjustment in just three months. In 2021, the SEC started saber-rattling, hinting that this loophole would soon close. Until it does, reporting on SPACs that have aggressively adjusted projections has become a favorite pastime of financial bloggers and tweeters. And the share prices of SPACs that pare back projections are being pummeled. (More on this in a moment.) - Historically, SPACs have had a lousy reputation Going back to at least the 1990s, the SPAC market has earned a reputation for harboring companies that were too underhanded or shady to go public through traditional channels. This reputation was fair, to be honest. Throughout the 1990s and 2000s, many investors lost their shirts investing in SPACs. Mr. Market has a long memory. And in the five years since I first wrote about SPACs in my Stansberry Venture Value advisory, I've noticed that the market has these companies on a short leash. At the first whiff of bad news, investors throw up their hands and run away, assuming they've been bamboozled by the old SPAC curse. I've noticed this playing out over and over as I track various online investor comment boards and the "Stocktwits" Twitter platform. Thousands of investors – many of whom were inexperienced in public markets, making bets with their stimulus checks while bored during the pandemic – got excited during the SPAC boom of 2021... and are eagerly selling in 2022. That leaves us with the final reason SPACs fall... - Sometimes, SPAC babies are thrown out with the SPAC bathwater Given all the factors I've outlined, it makes sense that many SPACs quickly fall out of favor. But sometimes, shares of a perfectly good company plummet for no reason other than that it happened to go public via a SPAC merger. That's what leads to our opportunity... You see, not many decent companies have historically made it to the SPAC scrap heap. But all that changed in 2020 when the number of new SPACs exploded. In March 2022, more than 100 busted SPACS were on the scrap heap. That represents an incredible 50% of all recently completed SPACs. Right now, Mr. Market is saying that half of all SPACs are headed for disaster. Yes, many of the companies on the scrap heap belong there. But almost certainly not half of all SPACs. And the percentage grows almost every time I rerun the numbers. If you know what to look for and are willing to be patient, today's setup in SPACs could be a massively profitable opportunity. But keep in mind, not every beaten-down company is a good fit for my strategy... Many dirt-cheap SPACs belong on the scrap heap... meaning they've earned their depressed valuations. Some are headed for $0. And in order to take advantage of today's unprecedented opportunity, you need to do things the right way – or not at all. That's where my Stansberry Venture Value team and I come in... We spend hundreds of hours analyzing SPAC data and other company information, using sources that go way beyond the standard trading tools. I'm talking about sources most people have never even heard of (let alone have access to). If you don't know what you're doing, wading into SPACs could be a recipe for disaster. But with the right tools at your disposal, I believe this could be one of the most compelling stock-picking opportunities we've ever come across. I hope you'll join us in taking advantage of it... [Learn more here](. Regards, Bryan Beach May 12, 2022 Editor's note: Right now, the market is punishing companies that went public via SPACs... but Bryan says that negativity around these assets isn't new – SPACs have faced specific challenges for decades. By understanding the risks, he has been able to identify the "diamonds" amid the carnage... and these could lead some investors to 1,000%-plus gains. [Get the details here](. 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](. © 2022 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. [Unsubscribe from all future e-mails](