SPAC stands for special purpose acquisition company and is created for the sole purpose of acquiring a private company and taking it public.
As a simplified example, a SPAC might complete an IPO and raise $300 million. It could then "acquire" a private company, which would then get the $300 million as growth capital. The combined company would then assume the name of the acquisition target and change its ticker symbol to reflect the change.
One key detail to keep in mind is that when a SPAC first goes public, it doesn't have a business. It completes an IPO and puts the proceeds in a trust account. For this reason, SPACs are also commonly known as "blank check" companies. Investors are essentially giving the SPAC's managers a blank check to go shopping for an acquisition target.
Why are SPACs such a big trend?
SPACs are often talked about as an alternative to the traditional IPO process and a way to democratize IPOs for more investors. And there can be tremendous upside potential for investors when a SPAC IPO is well received by the market, which has happened in several high-profile cases in the past couple of years. In practice, there are some pretty big advantages to using SPACs to take companies public, both for the company being acquired and the SPAC's sponsor.
Advantages of going public through a SPAC
For companies, there are two big advantages to using a SPAC to go public, as opposed to using a traditional IPO or direct listing, the two other common ways companies go public.
First, the process is significantly easier and more cost-effective. Since the SPAC is already a public company, the regulatory requirements are much easier than if the target company had decided to do its own IPO. The process can happen quickly and without costly and complicated steps like an IPO roadshow.
Second, going public via SPAC can provide a huge amount of growth capital for the company being acquired. In addition to the money held in the SPAC's escrow account, there's typically a private investment round (known as a PIPE) that occurs at the same time. For example, when Opendoor (NASDAQ: OPEN) agreed to go public by SPAC merger, the company received more than $1 billion in cash. That's far more than the company (which had a valuation of less than $4 billion at the time) would have likely been able to raise in an IPO.
In a nutshell, the economics of sponsoring a SPAC are great for the sponsor, and that's especially true if they are able to create shareholder value with their business combination.
While the exact structure varies between SPACs, the most common arrangement is that the sponsor owns 20% of the SPAC's shares, essentially for free. They also typically purchase a large chunk of warrants, which gives them some skin in the game and aligns their financial interests with those of investors.
For example, consider the SPAC known as Yellowstone Acquisition Co. (NASDAQ: YSAC), which is sponsored by Boston Omaha Corp. (NASDAQ: BOMN). When Yellowstone went public, Boston Omaha:
- Received 3,593,750 shares of common stock for a nominal contribution of just $25,000.
- Purchased 7,500,000 warrants for $1 each, which gives Boston Omaha the right to buy common stock at a predetermined price of $11.50 per share within five years.
Here's the point: Boston Omaha is risking $7.5 million of its capital. But the upside can be enormous. Consider the case of Virgin Galactic (NYSE: SPCE), a successful SPAC IPO. A similar number of shares and warrants in Virgin Galactic would be worth nearly $500 million today. In a nutshell, the downside risk is quite limited for a sponsor relative to the massive upside potential from a successful acquisition.
How to analyze a SPAC
It can seem like an impossible task to try to analyze a SPAC before it identifies an acquisition target. After all, you don't even know what business you're investing in or if you're going to like it from a long-term perspective. And to be clear, that's one of the biggest risks of SPAC investing.
However, it's certainly possible to analyze pre-deal SPACs. I recently did a rundown of how to analyze a SPAC's registration statement (known as an S-1) on Fool Live, so check it out if you're interested. But here are some key points to keep in mind:
- First and foremost, a SPAC that hasn't yet identified its acquisition target is a bet on management. You're banking on the ability of the SPAC's sponsors, executives, and board members to find an acquisition target that will create long-term value for investors. Most of your analysis should focus on the management team -- their backgrounds, skin in the game, etc.
- Figure out the SPAC's unit structure, which I'll explain in the next section. SPACs initially go public as units, which consist of some combination of common stock and warrants.
- Identify the timeframe the SPAC has to find a deal. Two years is typical, but I've seen time periods of as little as 15 months. And can the timeframe to find a deal be extended?
What to expect when a new SPAC launches
Here's the general process. A sponsor will create a corporate entity. (Hint: The giveaway you're looking at a SPAC is the presence of "acquisition company" in the name.) They'll register the name with the SEC and file registration paperwork (known as an S-1). Then, some time later (a few days to a few weeks), the SPAC will complete its IPO and sell units to investors, which will then trade on the public markets.
Units, shares, and warrants
Notice that in the last section, I used the term "units" as opposed to "shares." When a SPAC first goes public, it generally does so in the form of units. One unit of a SPAC consists of a common share of stock as well as some fraction of a warrant redeemable to buy another share at a predetermined price later on. For example, you might see in a SPAC's registration statement that "a unit consists of one Class A common share plus one-third of a redeemable warrant."
At first, if you want to invest in a SPAC, you'll need to buy a unit. Some time later (52 days after the IPO is typical), the common shares and the warrants will begin to trade separately. You can invest in whichever you want, but keep in mind that if the SPAC can't find an acquisition target, the warrants will expire worthless.
What happens if a SPAC can't find a target?
As I mentioned, SPACs have a finite amount of time in which to identify an acquisition target and complete its business combination. This typically ranges from 15 months to 2 years, depending on the company. And there's always a possibility that the SPAC won't find a suitable acquisition candidate. In fact, it happens quite often.
When a SPAC can't find a target, one of two things happen. First, the SPAC can ask shareholders to approve an extension of its allotted time. Second, the SPAC can dissolve and return the money in its escrow account, along with any interest it has accumulated, to shareholders.
Why is the SPAC boom such a big real estate trend?
The short answer is that there are some big growth trends and innovations happening in the real estate industry, and there are some companies that are doing a great job of leading the charge. SPAC IPOs give them the capital they need to take their growth to the next level.
Just to name a few recent examples of real estate-related SPACs, Opendoor Technologies (NASDAQ: OPEN) recently completed its SPAC merger with Chamath Palihapitiya-led SPAC Social Capital Hedosophia Holdings II. Property technology, or proptech, company Latch is set to go public through a merger with a SPAC sponsored by real estate firm Tishman Speyer.
There are also some on the market that plan to target real estate companies. Boston Omaha's SPAC Yellowstone Acquisition Corp., which I mentioned earlier, has real estate companies listed among its target business types. Real estate firm CBRE Group (NYSE: CBRE) has a SPAC that's still looking for a deal, and Tishman Speyer has launched a second SPAC.
The Millionacres bottom line
The SPAC trend isn't showing any signs of slowing down, so it's important for real estate investors to be aware of what they are. The fact is that the IPO-alternative investment vehicles are almost certain to take several exciting, innovative property technology and other real estate-focused companies public over the next year or two at a minimum.