Special Purpose Acquisition Companies (SPAC, for short) have exploded in popularity in 2020. A PSPC is a company that only has a sum of money and a dedicated management team to find a private company with which to merge and go public.
Last year, the total PSPC registrations more than quadrupled from 2019, and the gross proceeds collected were more than six times higher year over year. So far in 2021, PSPC’s emissions and products are accelerating and are well on their way to comfortably surpassing 2020 records.
With this movement in full swing, there are a few considerations investors should take before investing in a PSPC. Here are the two most important.
1. Evaluation is tricky
Once a PSPC has selected a company to go public, it will issue investor-facing materials covering different aspects of the business such as valuation. These valuation calculations are somewhat informative but can also be difficult to evaluate. Why?
Initial market caps and enterprise values are usually calculated based on the IPO price of SPAC of $ 10. But when you look around the SPAC landscape, tickers such as Acquisition of Longview (bringing the Ultrasonic Disruptor Butterfly to the public) and many, many others are trading at a share price well above $ 10.
Knowing this, company values and proposed market caps are often underestimated due to the appreciation in the share price after the merger announcement. To properly assess the valuation, investors should use the ticker’s current stock price, not the initial benchmark of $ 10 per share.
Beyond stock price fluctuations, outstanding stocks can also be difficult to quantify. PSPCs will offer a rough tally of investor materials shares, but will also sometimes exclude some ownership from the measure. Items such as warrants and options to be exercised in the future are sometimes not factored into the total valuation of a PSPC.
The future exchange of these options and warrants for common stock would dilute the current owners and increase the market capitalization of the company. None of this is to say that a PSPC may not be a good investment (I have four), but these factors should be taken into account when evaluating a business in the PSPC world.
2. Forecasts are uncertain
Since valuations are somewhat difficult to calculate, long-term forecasts proposed by management teams are difficult to evaluate. PSPCs often publish multi-year revenue and profitability targets (I’ve seen up to five years in advance). These forecasts are valuable and should be taken into account. However, the uncertainty associated with these estimates must also be taken into account.
No one can predict with certainty future financial results. Business leaders are much better positioned than we are, but even then the estimates are still a better guess. Some long-term forecasts will be met and others exceeded. But some will never be realized.
To assess the quality of a PSPC forecast, it can be instructive to study things like leadership history as well as the size and growth rate of the industry in which the company is located. Additionally, studying its competitive landscape and the suitability of offering specific products can also indicate how realistic an organization’s ambitions are.
Only time will tell if the revenue targets in three or five years are accurate. Nonetheless, we can improve our chances of choosing a viable PSPC forecast by striving to identify a quality product, a competitive environment, and a leadership team – as with any investment.
To SPAC or not to SPAC
Having a good grasp of evaluation, management capabilities and the quality of the business is essential. After that, investors can approach the valuation of a PSPC in the same way as investing in an initial public offering.
I am personally suspicious of anyone who paints PSPCs with a wide brush, either positively or negatively. Everyone is their only unique animal and should be treated as such. Invest accordingly.
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