The Update Issue: SPACs Sputter, Cord Cutters Pay Up, Pricey Pets

By Berna Barshay

Thursday, April 1, 2021
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Editor’s note: Empire Financial Research and the market are closed tomorrow for Good Friday, so look for the next Empire Financial Daily on Monday, April 5, after the Weekend Edition.


Back in February, I warned readers about special purpose acquisition company (‘SPAC’) VG Acquisition (VGAC)

I thought the SPAC was overpaying for a declining asset with its deal to merge with genetic testing company 23andMe. There were a ton of red flags with the 23andMe deal, the most glaring of which was the fact that 2021 revenue was projected to be down 50% from 2019 levels!

Companies usually pursue initial public offerings (“IPOs”) when they are growing – and often when that growth is accelerating. If investors are going to take the risk to buy a company with a shorter operating history – or submit to buying a seasoned company with just two to three years of transparency into its financial history (which is typically the case with most traditional IPOs) – then they often look for it to be growing either its revenues or earnings at a better rate than other stocks that are already public.

I suspected 23andMe was going public via SPAC because it would never meet the scrutiny of a traditional IPO. I also saw the deal as a potential loss transfer from well-heeled venture capitalists stuck in a deal gone bad to retail investors who would be left holding the bag. I saw the rationale for the deal as follows…

First, 23andMe is likely going public through a SPAC because it might not be able to adequately address the concerns that institutional investors would raise during the road show for a traditional IPO. Second, going public via a SPAC will create a currency… and allow the investors who have been in for years a path to exiting their investment. If those insiders sell their positions, it will put pressure on the shares in the future.

Since I wrote that essay, VGAC shares have come back to earth as investors soured on the deal. As you can see in the chart below, they’re now barely trading above the $10 SPAC issuance price…

But the market hasn’t just been tough on VG Acquisition… SPACs overall are trading in bear market territory. As a group, they’ve tumbled more than 20%, and many of them are trading just above – and some just below – their issue price (typically $10). Take a look at the IPOX SPAC Index’s performance this year…

The rapid sell-off in SPACs has been partly driven by broader market forces. As interest rates moved higher, investors dumped tech and other high-growth stocks. These are more sensitive to increases in rates, as higher interest rates increase the discount applied to future cash flows.

Less profitable, high-growth stocks are long-duration assets, deriving much of their value from profits they will make far out in the future. Most SPACs have been targeting tech companies, or other high growers with little current cash flow.

Beyond the overall market rotation, there also seems to have been a recognition that this specific segment of the market had gotten way overheated.

So far, the SPAC sector has raised more than $90 billion this year. The haul during just the first quarter is larger than the entire 2020 take for SPAC raises. The amount of money raised so far this year is even more mind-blowing when you consider there was just $10 billion raised for SPACs in 2019, and less than $4 billion per year in 2018 and 2017.

We’ve seen a collective market reckoning with the fact that there are too many SPACs chasing too few deals and that not every deal will be a good one – hence more scrutiny of announced deals, like the one VG Acquisition made for 23andMe.

One other factor weighing on SPACs is the sudden recognition of how high the sponsor promotes are in these deals. Most SPACs give away 20% or 25% of the company for free to the financiers or former corporate executives who raise money for the SPAC and find the deal. This may be a fair sum if the sponsor brings considerable value to the deal, helping the targeted operating company find clients or market its products. But when sponsors bring little value or are quick to dump stock into the public market, it starts to raise eyebrows.

One of the selling points of SPACs was that they allow companies to avoid the 5% to 7% in investment banking fees paid in a typical IPO, as well as the amount of value given away to initial shareholders when stocks are priced low enough to have an “IPO pop.”

But when you factor in the cost of sponsor promotes with the costs to raise the initial SPAC’s funding, it shows that SPACs aren’t really a cheap back door to going public… in most instances, merging into a SPAC will be more expensive than an IPO (at least for non-sponsor shareholders).

Perhaps the biggest difference between a SPAC and a traditional IPO is really the amount of disclosure – and more specifically projections – permitted…

When a company has a traditional IPO, its communications to shareholders – as well as those of its bankers to shareholders – are highly regulated.

Companies going public aren’t allowed to make highly specific projections about future earnings, and they certainly aren’t allowed to give specific earnings guidance. Investment banks doing the IPO aren’t allowed to publish research or estimates, although institutional investors are sometimes walked through the forecasts of sell-side analysts orally only… Nothing can ever go in writing or be widely disseminated.

The regulation on SPACs is much lighter, and the targeted operating companies are allowed to offer very specific guidance, which can be accessed online by anyone – including retail investors. This is supposed to be a selling point of a SPAC versus an IPO… They’re more transparent, and retail investors are on equal footing with institutional ones.

But more transparency is only a positive when the information being conveyed is accurate. When sponsors promote pie-in-the-sky forecasts, which has been happening with increasing frequency during this boom, investors can be duped into losses.

We saw this happen on Tuesday this week with Romeo Power (RMO), which is the product of SPAC RMG Acquisition merging with a battery maker for electric vehicles. Shortly after the deal was announced last October, the SPAC issued 2021 revenue guidance of $140 million. This week, citing a shortage of battery cells, it slashed its revenue projection to a range of $18 million to $40 million. RMO shares dropped 20% on Wednesday and are currently 75% lower than their post-deal high.

With the SPAC structure, unrealistic projections aren’t regulated… You could even argue they are incentivized, given large sponsor equity positions with limited lock ups.

Time is the enemy of most lies, as the truth usually comes to roost. SPACs that set unrealistic expectations eventually blow up, dragging down overall sector returns.

A study of SPAC performance at the Harvard Law School Forum on Corporate Governance found that overall SPAC performance has been underwhelming.

The study looked at SPACs that merged into their target between January of 2019 and June of 2020. They broke the SPACs into two groups… “high quality” (basically larger SPACs and ones with sponsors who were formerly CEOs or senior officers at big corporations) and “non-high-quality” (everything else). High quality outperformed, but neither group had impressive performance…

Source: Seeking Alpha, Harvard Law

But this doesn’t mean you can’t find great SPAC investments out there…

My colleague Enrique Abeyta is picking good ones in his Empire SPAC Investor newsletter (which you can learn more about here) and I’m also a fan of the ones we’ve included in our Empire Investment Report. For my upcoming newsletter launch, I’m excited about a post-deal SPAC company as well.

It’s popular to kick a dog when it’s down, so there are no shortage of articles trashing the SPAC sector right now. The wholesale dumping of this category of stocks makes it a more attractive place to go looking for opportunities than it was a couple of months ago, when it was white-hot.

There are SPACs out there buying real companies with real revenues and growth prospects, where the sponsors have extensive experience as corporate leaders or private equity rainmakers and can bring a lot to the acquisition.

But there are also an increasing number of entities led by less reputable execs… or celebrities with no investment experience, whose fame is meant to reel in retail investors. I’ll pass on the SPACs from former NFL quarterback Colin Kaepernick, former House Speaker Paul Ryan, and basketball legend Shaquille O’Neal (yes, there’s a Shaq SPAC)… and I would recommend you do the same.

The cost of ‘cord cutting’ continues to increase…

Last July, I wrote about how the 30% price hike at Alphabet’s (GOOGL) YouTube TV pushed the cost for streaming TV service ever closer to the price of cable TV.

This week, Bloomberg did the math on what a highly comprehensive bundle of streaming services would cost you… Turns out the answer is $92 per month. That’s just a hair below the cost of a typical cable TV subscription, which S&P Global Market Intelligence estimates at $93.50 monthly.

Take a look at how Bloomberg adds it up…

Source: Bloomberg

This isn’t a very compelling deal versus cable, and it’s a lot of passwords to manage as well.

I don’t think this means cord cutters will be running back to their cable companies, but I do think it makes it impossible for all of these services to make it in their current paid incarnations.

We’ll probably see consumers migrate from at least some of these to the cheaper, ad-supported formats, which exist already for Comcast’s (CMCSA) Peacock and ViacomCBS’ (VIAC) Paramount+, and is coming soon for AT&T’s (T) HBO Max.

There’s been much hand-wringing about inflation, but here’s one area that I hadn’t heard about before where prices are up 100% or more…

Purebred puppies, according to BBC reporting…

Source: BBC

Fortunately for me, I have always been an #AdoptDontShop person (I have two purebreds and one terrific mutt… two rescues and one rehomed).

Speaking of dogs, check out this article from the New York Times this morning that I was 100% convinced is an April Fool’s joke… but apparently, it’s real. Dog charcuterie boards are a thing… 

Source: Instagram.com/corgcuterie

In the mailbag, readers share their travel plans… It sounds like folks are eager to get packing!

Would you like to see SPAC sponsors have longer lockups on their shares or for the forecasts they make to be more regulated? How much is too much when it comes to monthly streaming video bills? Should I publish a picture of my motley canine crew next week? Share your thoughts in an e-mail to [email protected].

“Hey Berna, Unfortunately, Canadians are being held prisoner in Canada by our nanny government. The only uninhibited travel is domestic, so a trip out west to Vancouver in July is in the works. Vegas will have to wait, although we keep receiving outrageously low room rates for major casinos there. As a note, Canadians are the most numerous foreigners in Vegas, when the border opens you can expect a flood of CANUCKS.” – Arnold B.

Berna comment: Arnold, I’m well aware of the restrictions on international travel in and out of Canada. I have both close friends and family up there, feeling like you, very stuck.

At least you have Vancouver to look forward to, which is a gorgeous and culturally amazing city. Both my step kids live in Vancouver, and I had a trip there scheduled for April 2020, which obviously got canceled. I can’t wait until I can reschedule it!

Like you, I’ve also been bombarded with cheap offers for Las Vegas. Vegas will bounce back, but midweek occupancy will be tough until conventions resume. There was also significant room supply growth of 9% expected from 2020 through 2023… Room growth had flattened out after a building boom that peaked with 2009 openings. Some of that new supply probably got pushed out a bit, but if you can go midweek, there will probably be deals to be had in Vegas for some time.

“I run a vacation rental business in beautiful Costa Rica. We were shut down entirely for almost a year. We started to see a return of travelers starting in December, with a few brave souls starting to venture out. In just the past two weeks, the floodgates have opened back up with incredible bookings and inquiries. People are fed up and want to get back to living and enjoying life.” – Randy D.

Berna comment: I’m glad business is coming back for you, Randy!

“CDC still recommends no travel other than ‘must’ even if vaccinated: https://www.cdc.gov/coronavirus/2019-ncov/travelers/travel-during-covid19.html

“Thought you might like some climbing pics of my son. He lives in Arvada, CO. Just got back from Moab area. He used to live in Bend, and lots of climbing there. He is 28. We were visiting him in Frisco last March, the resort of course closed after our first day on the mountain, and I haven’t seen him in person since. Soon enough I hope.” – Ron R.

Berna comment: Ron, I hope you are reunited soon with your son. Thanks for the pictures. Both Moab and Bend are beautiful places.

Given this week’s news that fully vaccinated people are highly unlikely to carry and spread COVID-19 – based on new data communicated by the CDC director herself – I wonder if that CDC guideline about not traveling will change soon, for the fully vaccinated at least.

“Just booked flight to Lisbon in October, hoping to drive across Portugal and Spain to pick up a long booked transatlantic cruise from Barcelona, arriving back in Fort Lauderdale after the CDC stupid no sail Nov 1 deadline.

“Hoping!!!!” – Alison F.

Regards… and Happy Easter,

Berna Barshay
April 1, 2021

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About Whitney Tilson

Prior to creating Empire Financial Research, Whitney Tilson founded and ran Kase Capital Management, which managed three value-oriented hedge funds and two mutual funds. Starting out of his bedroom with only $1 million, Tilson grew assets under management to nearly $200 million.

Tilson graduated magna cum laude from Harvard College with a bachelor’s degree in government in 1989. After college, he helped Wendy Kopp launch Teach for America and then spent two years as a consultant at the Boston Consulting Group. He earned his MBA from Harvard Business School in 1994, where he graduated in the top 5% of his class and was named a Baker Scholar.

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