Inside the Exploding Market for SPACs
October 12, 2021
For a long time the traditional initial public offering (IPO) dominated how companies entered the public market. The problem with an IPO is that it leaves the company at the mercy of the underwriter. Many IPOs in recent years have seen their prices skyrocket and, while shareholders who got in early like that, it means the company left money on the table that could have gone into its coffers.
And, in reality, shareholders who are long-term investors want to see the companies they invest in maximize their price when they enter the public markets. That has led to a relative explosion in another method of taking a business public — the special purpose acquisition company (SPAC). A SPAC is where a company merges with an entity created to acquire a company and make it public.
Also called a “blank check company,” a SPAC is essentially a pool of money designed to acquire an established entity. Once that happens, the company receives the negotiated sum of money and then begins trading. SPACs, in theory, allow for companies to maximize their proceeds when they go public.
For investors, SPACs can be an opportunity, but, in many cases, they lack the transparency required by the SEC during the traditional IPO process. That doesn’t mean that some SPACs are not great investments — a lot of successful companies have come to market this way — but it does mean that investors should do their homework.
Steve Symington joined Simon Erickson on the October 11 edition of “7investing Now” to take a look at the SPAC process and how investors should view companies that go public this way. They also discuss a couple of upcoming SPACs including two in the electric vehicle (EV) space.
A full transcript follows the video.
Simon Erickson: So Steve, let’s segue. Let’s talk about the second part of today’s program, not space, but SPACs, which is a special purpose acquisition company. This is a kind of a way of raising money for companies that’s really kind of disrupting the traditional IPO. What is a SPAC and what do we need to know about this?
Steve Symington 18:33 Alright, SPAC is a remove the E from space, it is all caps. This is an acronym, it’s SPAC, special purpose acquisition company. So these are a way that companies have been using to, a slightly simpler way to go public and kind of an alternative to either a direct listing or traditional IPO. And it’s a great way for them to raise capital. And generally they find a privately held company finds a sponsor, SPAC merger vehicle, right? That is essentially a shell company that they can merge with. And in doing so become a publicly traded company, they change their ticker, usually from the SPAC merger vehicle after the merger is complete. And voila, you have a publicly-traded company.
So yeah, SPACs are they’ve kind of exploded onto the scene in the last few years, even though they’ve been around for quite a while. What were they created something like 20 years ago, but just the last couple of years, companies have realized this is a potentially attractive way and a relatively simpler, low cost way for them to go public and raise capital so yet really interesting. And there are a bunch of SPACs on the 7Investing scorecard for what it’s worth that that we believe have really interesting promise.
Simon Erickson 19:58 It really is interesting, Steve Like the way that is disrupting in many ways that traditional IPOs, you don’t have an underwriter. Right, the usual way of doing an IPO is you have an underwriter that buys your shares at a certain price. And then they release them for trading at a much, much higher price on the first day of trading, there’s always that IPO pop, we’ve gotten so used to seeing shares pop 70%, 80%, 100% of the very first day of trading, that’s money left on the table if you’re the business that’s raising that money.
And so the SPAC in many ways has been a more efficient way to put capital back into the business, right, you have a financial shell company, they go, they raise a lot of money from investors and also from other companies. And then they inject that directly into the equity of a privately held company, and then bring it to the publicly traded on the financial markets. So
Steve, there’s a lot of interesting SPACs, we can bring this conversation a bunch of different ways.
But we’re going to do this football football style, where I’m going to be Al Michaels and I’m just going to talk about the terminology and kind of make sure that everyone’s aware of what we’re looking at in the fine print. And then you’re going to be the Chris Collinsworth that’s going to get into the nitty gritty of a company and kind of talk about how we size this up. And Steve, we had a lot of options. But we actually went with Lucid Motors (NASDAQ: LCID) ticker on that $LCID. This is a company that recently went through the SPAC transaction process a few months ago. Tell us about Lucid and what this company does.
Steve Symington 21:16 Lucid is very interesting, right? And it’s funny because I saw a note from Bank of America recently that called Lucid the Tesla of startups in the EV space. I’m like, wait isn’t Tesla the Tesla of startups in the EV space? EV is electric vehicles. But Lucid recently completed its SPAC merger I think in July with Churchill Capital. And they raised four and a half billion dollars from the process. And you know, we’re looking at the first deliveries of their lucid air vehicle prices start for that I think around $77,000 numbers check out I like those sevens. But deliveries are starting before the end of this month. And I think they were they’re projecting maybe 20,000 deliveries, or so before the end of this year, assuming they can ramp pretty quickly, according to their initial kind of investor presentations.
But it’s interesting because this this $77,000 vehicle actually came out and exceeded even the range of Tesla’s longest range vehicles 520 miles between charges for the lucid air. It’s a gorgeous vehicle, and they have plans for a pickup and you know, a yet to be named sedan and some other an SUV, I believe that they have out there. So that’s something that people are very excited about. But you know, I think the challenge here is that they’re kind of following the Tesla playbook and launching some vehicles that are very expensive, gorgeous vehicles. And you might argue that even Tesla’s kind of premium vehicles have kind of suffered from maybe lack of innovation visually, like people wonder like, okay, it still looks a lot like the the premium vehicles that Tesla released a decade ago.
So there could be some refresh. And the challenge here is can they ramp sales to the extent that they are projecting while Tesla’s premium vehicle sales have stagnated? Right, because Tesla is now focusing on their model threes and potentially something like a model two, that would be even cheaper, and that’s the plant start expensive, kind of scale down and ramp production the process. So that’s the challenges is can they meet their kind of lofty growth projections and it but it’s a really interesting company with a beautiful product that’s been well reviewed and crazy range. So yeah, that’s kind of kind of the basics of what you need to know about Lucid for now,
Simon Erickson 23:44 Sam, let’s put up another chart for everyone watching it live here on the video screen. He said some lofty projections. Let’s see what that actually means. We’re talking about the forecasts we see out there. So see you mentioned on the far left, right, the average selling price of the air is $77,000. That’s definitely the high end of this market. That’s an expensive vehicle, but you kind of see a hockey stick of growth there. Right from what is that? 20,000 expected deliveries next year? Right? What are we talking 12-13 times that just four years from now? I assume that’s what you’re saying is kind of a lofty forecast or expectations for investments.
Steve Symington 24:20 Yeah, and you know that I think the trick is you look at some of the the most kind of grandiose projections from analysts on wall Street like that then Bank of America note, I noticed just recently and you know, they slapped a $30 price target on it. They said that was based on EV sales of like, enterprise value to sales of about 3x and enterprise value to EBIT of about 37x at 2025 estimates is kind of how they came to that $30 price target. But that’s a premium to Tesla’s early trading multiples and to the average multiples of kind of peers, and the Electric Vehicle space but, you know, looking at a forward five year basis, it’s actually a discount to what Tesla’s traded at recently.
Because you know, you’re looking at what what’s their market cap now for Lucid was something like 36 billion? I said, exactly. Okay. So it seems like, you know, it’s kind of a lofty business, but you also look at Tesla, which is trading at about a 780, almost $800 billion valuation, albeit with some additional optionality, which is something that lucid doesn’t really have, right, because Tesla’s goal is to kind of wean the world off of fossil fuels and, you know, kind of be a leader in the solar and energy storage with their battery technology, and electric vehicle space.
So, you know, there’s a heck of a premium that people are placing on Tesla’s business, but Tesla also has that first mover advantage, and they’ve really begun to ramp their manufacturing in earnest. And, you know, lucid is so much earlier stage, you can’t help but wonder whether this is something where those are some lofty projections for a business that hasn’t even delivered its first vehicle yet.
Simon Erickson 26:13 That’s what I want to double click on here a little bit, Steve, is is we know that this is a big opportunity. I think it’s generally agreed upon that electric vehicles has a large addressable market potential. We all know that Tesla has gone and done very well for itself and its investors. And so it seems like you said the Tesla playbook is can we recreate that at a premium price point.
Now I actually want to go into a little bit into the trenches and look at kind of what we look at with the transaction details of a SPAC like this. And apologies if anyone’s eyes glaze over when they’re looking at this with you. But I do promise it’s important, because as an investor, you want to make sure you know not only about the company itself, but also the valuation and that’s a little different for SPACs. Sam, can we put up the transaction details up – perfect, here we are.
So you’re typically when you see a SPAC that’s going to do a SPAC merger, like Steve just described that lucid did issue something like this and an investor presentation. It shows where they’re raising capital. You see on the left hand side there that lucid raised $4.5 billion from the cash that it put into that SPAC piggy bank, the financial shell company. And then also the the investment from private investors as well private investment and public equity proceeds as well. Well $4.5B is a lot of money, Steve, and an overall valuation of $16.7 billion at the valuation.
The first thing I want to point out to investors to look at is that is that 16.7, the total the total valuation and the raising of funds that you’re putting in for a merger like this, when you see something like that coming out really hot, that is so heavily weighted in future years, you almost have to count on the company performing exceptionally well. Any hiccups on the production schedule, or the deadlines that they’ve announced publicly, or personnel or anything that’s going anyway, not according to plan is going to put a company like this, it’s very frothy valuation, at risk of being very volatile, because there’s a lot of expectations baked in, especially when you have a very high implied market capitalization.
But there’s one other thing that I want to I want to look at here before we kind of talk a little bit more about this company in general. And that’s the sub notes at the very bottom right. You, you might see sub note number five there that’s talking about the 17 point 3 million shares held by the sponsor, that are subject to earn back and then there’s fear of further dilution as well. And there’s 41 million shares from public warrants and 43 million shares from founder warrants. Warrants are dilutive to equity holders, it’s like cutting a pizza that was four pieces previously into five or six pieces, we all have a smaller piece of the overall pie.
And many times when you have a SPAC transaction like this, there are warrants that are earmarking, more shares to be issued at a later date, either to the sponsors themselves, who are the financiers that are doing this transaction, or to the actual existing shareholders themselves, too. And so Steve, when you see something like that, which together this really accounted for about 5% of the overall valuation at today’s much higher market cap. That’s one pretty significant dilution. Two a lot of that is going to the sponsors dilution. And then three, a lot of that is actually going back to the existing shareholders in something called the sponsor promote, and then the earnouts over time. Maybe we don’t want to get too too, too into those trenches right now. But I think my overall takeaway for investors is you got to be aware of how much your share is going to be diluted from future warrants in a SPAC transaction in the future.
Steve Symington 29:46 Right. And one of the things we noticed, you know, we’re kind of digging in just before the show, to kind of familiarize ourselves with the terms of this transaction and you’re like that was one of the first things you’re like No wonder this is buried on page 65 of their investments. entation right and it’s like sub bullet five on that that SPAC you know Transaction Details they don’t you know want to be like here’s all the dilution you guys are gonna face
Simon Erickson 30:10 Sam pays me five cents an hour to find those details.
Steve Symington 30:14 So the the other thing I guess you have to keep in mind is they forced early dilution of the public warrant aspect of that transaction so some of that’s already kind of been accounted for which is alright we ripped off one band aid but there is additional dilution that investors are going to face which will put a lid on some of the near term returns over the next couple of years.
But yeah, it’s a it’s an interesting business but like you said any any hiccups in their growth trajectory, they don’t live up to investors you know what they’ve kind of promised as far as vehicle deliveries, if sales kind of take off especially some of the legacy auto manufacturers kind of step into this space as well in the next couple of years they’re making some heavy investments to ramp their own EV sales.
It’s gonna be one of those things where it could be quite volatile and, but you know, if they do deliver, it could also be potentially lucrative for early investors today, so kind of two sides of that coin, something to keep in mind with every SPAC transaction, you know, take some of their projections with a grain of salt and, and keep that in mind when you’re looking at the valuations that you’re buying in.
Simon Erickson 31:20 Okay, Steve, so which side of the coin Are you on here? $37 billion valuations and of course, a lot of opportunity for electric vehicles you buying Lucid at today’s market cap?
Steve Symington 31:30 Maybe, if anything, a small startup position to force myself to watch it, you know, we’ve also got Rivian coming on the market, and they’ve got an $80 billion valuation with a big fat zero on the revenue line. So you know, so you know, there’s there’s some potential in but I do think there’s some frothy valuations. I’m not going all in just yet, but potentially starting position to watch.
Simon Erickson 31:54 it. But absolutely coming from Ravi Shah here in the comment section saying he’s starting to see some Lucid vehicles on the road in the Bay Area, San Francisco, he’s test vehicles I assume she’s I think that they’ve started some production. Maybe some deliveries were starting either this month or next month. But man again, 37 billion dollars. Excuse me. You’re gonna have to see a real quick ramp up to justify that, I think
Steve Symington 32:16 Yep, yeah, most definitely. Yep.