This post originated from a reddit discussion.
Blank Check Companies (so-called Special Purpose Acquisition Companies, SPACs) offer several profit-earning opportunities. They also provide protections distinctly different from investing in private equity, crowd-funding opportunities, and other seed and early stage firms.
Like all investments or speculative trades, you need to have rules and a process for sticking to your time horizon. SPAC sponsors must list the period of time in which they intend to complete a business combination. The ordinary time frames they select are 12-, 18-, and 24-months. If they fail to find a business to merge with, they can ask their shareholders to vote for an extension. This is the first time horizon you need to think about. It could be that the SPAC goes public and then absolutely nothing happens for months or even a couple of years.
Receiving and selling public warrants from the initial units is the first profit-earning opportunity. SPACs securities most often consist of a unit made up of a common share and a warrant. Sometimes you will see SPAC units also include a right. The warrants usually equate to a fraction of a common share. I have only seen warrants with fractional shares. Shortly after the units go public the holders have the right to split the shares and the warrants. This allows you to sell the rights or warrants (or shares) any time you see a price premium over your cost basis.
The second profit-earning opportunity happens when there is price appreciation related to news on a potential business combination. Once the news is announced there is usually an investor presentation and then on-going news from the target. Each of these disclosures can drive the market to increase the value of the units or common shares.
The third profit-earning opportunity happens when there is mispricing between the warrants, the common shares, or the units. Even after some of the original holders of the units decide to split their shares and warrants, there are some holders who do not split. Therefore you can still buy any of them on the market. There is an intrinsic relationship between all three, but supply and demand factors can lead to mispricing, e.g., the common moves up but the warrants do not move up as much. These securities have an intrinsic relationship with a positive correlation. If you believe in the SPAC’s management team or the story around the business combination, watch for mispricing in one of the securities until the merger.
The next profit-earning opportunity happens around the business combination vote. When shareholders affirm the vote this removes any final uncertainty in the business combination and that draws in more investors looking to take a long position. Most firms begin trading in the new security relatively quickly after the vote, but that is not always the case. The longer the period between the vote and the new listing, the more potential for another price fade.
Once the merger happens the SPAC unit holders get their units converted to new warrants and common shares of the merger target. I have seen at least one target try to retire the warrants immediately by converting them to shares and cash. The warrant agreements also have basic conversion rules and liquidation preference values.
The final profit-earning opportunity is the long-term appreciation of the merger target. The story of VectoIQ’s merger with Nikola illustrates several of the profit-earning moves.
Now to the distinct protections a SPAC offers. First, the proceeds of the IPO are held in trust. The SPAC sponsors can’t touch these funds. If they fail to find a business combination or get one approved then they have to return these funds to investors. Their could be transaction costs that reduce the actual value of the proceeds, but these should be nominal. So there is a floor for preserving your capital. Venture capital’s floor is zero.
The second relative protection is SPACs are investing in higher quality, established firms. Yes, there are some companies SPACs merge with that are a business plan and a prototype (e.g., Nikola), but there are others that are highly diversified, successful, established businesses (e.g., Haymaker Acquisition Corp II pending merger with Arko which has $1.5B in revenue from 1,400 US gas stations.)
Finally, SPAC targets get audited and then get turned over to public directors who have fiduciary duties to protect common shareholders. The merger targets also get significant recapitalization from the SPAC’s trust fund and any public investment in private equity (e.g., PIPE) follow-on offerings. So the liquidity risks of these firms are significantly mitigated.