SPACs Explained (and Why You Might Want to Avoid Them)

this video is sponsored by noaa and not by abuse for this video the first 100 people to visit the link in the description below will get a week for free of the service to listen to articles from the economist bloomberg and the financial times plus 50 off you've probably seen at least a few articles now talking about spax the fancy alternative to the ipo that's starting to make waves in financial markets despite having been around for decades investors are now using spax more than ever before bringing a number of notable firms to the public market from virgin galactic to draftkings to tesla challenger nicola we've even started to see celebrities entering the space with jay-z partnering with the cannabis back in california despite its recent popularity however the spack is not without its flaws while it can benefit those who organize and carry out the offering it has a history of disappointing investors and before you decide to invest in one you should probably know what it is how it works and why they're only now starting to take off so let's go over this back on today's hub you know plain bagel abbreviated never mind when a company with an established business is looking to take its operations to the next level its founders often consider taking it public that is selling all or a portion of their stake in the company to investors in the open market doing so can allow the company to more easily raise capital since they can sell shares to the wider population rather than relying on a few wealthy private investors and as a result the company may be able to achieve growth that was previously not possible conventionally to go public a company would need to go through what's called an initial public offering or ipo making sure they meet all regulatory requirements and eventually debuting their shares on an exchange the problem is that the ipo process is a pretty painful one for the founders companies need to file mountains of paperwork with regulatory bodies go on lengthy roadshows to court institutional investors and pay butt loads of money to invest in bankers to help them through the process underwriting fees alone often take anywhere from three to seven percent of the raised proceeds sometimes even more but what if you could take a company public without spending all your time filing paperwork marketing your business best of all without paying a fortune to those investment bankers enter the spac or special purpose acquisition company here's the basic idea a manager with expertise in a particular field or industry will set up a shell company with no assets and no core operation this is our spac and the manager known as the sponsor will then go around and try to convince public investors to invest in this new company now the public investors are well aware that this back doesn't have much going on if anything but the manager will promise them that if they fund the company they will go out and find a private firm to acquire what the proceeds raised if they are successful in garnering interest the sponsor will then ipo the spac with no assets it's a much cheaper and more straightforward process than ipoint a proper company from there the spac will approach the private company they want to take public and offer to buy them with the investor funds raise also sometimes supplemented with debt if the private company agrees and investors approve it then they will merge with the spac and take its place on the public market voila you've now taken a private company public without going through the ipo process sort of now while a sponsor may have a particular target company in mind when they're setting up the spac initially one of the crazy things about this vehicle is that it's not often disclosed to investors who they plan on purchasing since doing so would complicate the ipo process in other words investors who purchase spac shares don't actually know where their money is going to end up this is why spax are often referred to as blank check companies investors are more or less funding an unknown initiative putting their faith behind the skills of the spax sponsor to find an attractive acquisition target on their behalf another thing worth highlighting about a spack on the technical side is that they're often issued with a stock as well as a partial warrant to their initial investors a warrant is simply a right to buy a stock at some point in the future for a predetermined price most back shares start off at a price of 10 a share and the warrant will often let you buy more shares for 11.50 with a partial warrant simply meaning that you need more than one share perhaps two or three to purchase one additional share through the warrant this warrant is added as an incentive to the initial investors if the spac announces an attractive acquisition and shoots up in price the incumbent investors can exercise their warrants to buy shares for 11.50 cents which would be lower than the market price so that is the spec in a nutshell and it's something that's been around for decades as we previously mentioned but it's recently surged in popularity as of september over 41 billion dollars has been raised by spax more than the last 10 years combined why the sudden interest well it comes down to a few things for one in a year where companies have seen their stock prices double and triple after going public spax arguably offer private companies a better method for capturing this value because when you think about it a stock rising after its debut sort of represents a lost opportunity and value for the owners since that growth represents a higher price they could have sold their initial shares for now they're missing out the problem is that with an ipo it's usually unclear what the price will be until further down the process not to mention that shares are often first sold at a discount to the institutional investors who buy the first batch largely thanks to their massive bargaining power with the spack however the private owners of the company are provided a simple fixed dollar offer that they can either accept turn down or negotiate meaning they can more easily capture the value of their company through the smack all the while skipping the massive underwriting fees they would normally be paying to the investment bankers secondly with the pandemic currently ravaging the economy the spak is often seen as a less risky route for the private owners it's unclear whether there will still be demand for new ipo six months from now so many companies may be more comfortable opting for the faster lower costs back route than starting the lengthy and costly ipo process only to find that interest may have possibly dried up by the time they finally hit the stock exchange but while some are coming to claim that the spac is here to replace the old and out of touch ipo process this alternative is not without its flaws so before you consider buying a spack make sure you consider the following points first of all while spax may save the private owners some money they can still cost investors quite a bit of cash sponsors that set up the vehicle often take a large chunk of the company's shares typically 20 as a promote for setting everything up in other words sponsors treat themselves to a fifth of the company while paying only a nominal amount for this ownership on a 100 million dollar company that's effectively a 20 million compensation package paid by other investors secondly many stocks have a built-in mechanism whereby the funds raised must be returned to investors if the sponsor is unable to acquire a company within two years typically now this function makes sense and it's there to protect investors and ensure that they see their money put to use rather than sitting around doing nothing but it can incentivize a sponsor to move forward with an unattractive acquisition after all if a sponsor can't find an appropriate acquisition target they may go for a less attractive company just make sure they get their compensation even if the company ends up flopping they get more than they would have received if no deal went through and while investors do get to vote on these acquisitions they've already put their faith behind the sponsor buying the spac in the first place so they may be inclined to defer their judgment to whatever the manager decides finally the spac doesn't have a great historical track record by bypassing many of the regulatory and legal hurdles associated with standard ipos spax have attracted many dodgy companies over the years we've seen instances of spax acquiring private firms that have been fabricating aspects of their business leading to large losses for investors later down the road on top of this the spat track record for 2020 has been less than optimal according to renaissance capital stack mergers achieved an average return of 13.1 from january 1st to july 21st of 2020 which is a pretty good return but excluding the big names of draftkings and nicola that average falls down to negative 10.5 percent compared to the ipo average of 6.5 so maybe the spec isn't as perfect as solution as it's been made out to be by some but it's nonetheless something we may see more of moving forward so as an investor it's important to understand the key features and drawbacks of the vehicle there will likely be both very successful and very unfortunate specs in the future so as with any other investment make sure you do your due diligence and consider all benefits and costs if you're considering buying one hopefully spax start to garner a better more trustworthy reputation but in the meantime be careful with them while taking a company to market quickly certainly has its pros for the founders it can be at the detriment of investors if corners are cut in the process so i'll be honest before 2020 i had no idea what a spack was sure i could guess from the name how it worked but i never analyzed the spack at my workplace and it's something that never came up in my studies so i made sure to do the research before putting the script together and today's sponsor noah actually played a pretty big role in that noaa is an app that procures and professionally narrates articles with the goal of helping listeners learn about various subjects in economics finance and a number of other topics the handy thing too is that articles are grouped into series to provide listeners a well-rounded understanding of their subjects of interest for this video for example noaa had a great series called wisebacks or all the buzz on wall street which featured helpful articles on the topic from the financial times in bloomberg which speaking of the publishers you can see that noah has a pretty impressive slate of news outlets on its platform including bloomberg the economist and harvard business review all sources that i read regularly as an analyst it's a really unique audio service that i thoroughly enjoyed using and if you want to try it out for yourself the first 100 people to visit the link in the description below or use coupon code bagel 50 we'll get one week of the premium tier service for free plus 50 off the annual subscription fee so if you've been looking for ways to stay informed on the world of investing in finance i recommend you check out noaa you

Channel: The Plain Bagel

Views: 164,197

Rating: 4.9060483 out of 5

Keywords: The Plain Bagel, SPAC, Virgin Galactic, Draft Kings, Nikola

Id: AAJTkL99anI

Length: 11min 13sec (673 seconds)

Published: Fri Dec 04 2020