IN-DEPTH: SPAC attack

Special purpose acquisition vehicles are offering opportunities for both activist investors on the long side and activist short sellers.

Activists like Pershing Square Capital Management, Engaged Capital, and Starboard Value, have used their reputation as activists to raise money for their own SPACs and take private companies public, gaining handsome returns in the process via charged fees and being an early investor. At the same time, looser regulations related to SPACs has given rise to fraudulent companies becoming public, making the space a good hunting ground for short sellers.

“Frauds, fads and promotes taken public in 2020-2021 will be a key source of short ideas for the next decade,” Hindenburg Research founder Nathan Anderson recently noted on Twitter. He explained that the average of five SPAC IPOs on average per day in 2021 has set the pace for 1,250 SPAC IPOs to be launched by the end of the year.

Here to stay?

Despite the criticism, some activists are seeing investment opportunities in SPACs. While Bulldog Investors’ Rajeev Das conceded that there are risks involved in regulatory arbitrage when talking to Activist Insight Shorts, the investor claimed that “if played correctly, SPACs are a low-risk vehicle, with limited downside, but solid potential upside.” Bulldog manages The Special Opportunities Fund which allocates around 36% of its $137.1 million worth of assets to SPACs.

Das noted that a virtuous cycle has been created from sponsors recognizing the new willingness of companies to look at the SPAC route and rushing to bring more of them to market. “I think SPACs as an alternate route to IPO has now been accepted,” Das said. “Therefore, they are here to stay.”

Bill Ackman is certainly betting on the durability of the trend. After raising a record-breaking $4 billion in its initial public offering for his first solo SPAC last year, Ackman has already filed for a new SPAC, despite not yet announcing an acquisition for the first one. (Like most SPACs, Pershing Square’s has two years to announce a deal or return capital to investors).

Yet the market is certainly optimistic about Ackman’s stock-picking abilities. Pershing Square Tontine Holdings is trading 50% higher than its initial public offering last July. Rumored deals spiked the stock price in November, December, and January. “We believe we can make an advantageous deal for our shareholders while creating a great opportunity for a company to accelerate its growth, de-leverage its balance sheet and provide capital to investors seeking to exit,” Ackman told CNBC in July.

However, there are mixed opinions on whether SPACs will continue to be the preferred route for companies going public or if they will explode into oblivion. Quintessential Capital Management’s Gabriel Grego told Activist Insight Shorts that he believes there are good companies among the rotten and sees no reason why they would not continue to be strong the next time the market is shaken. “When the tide goes up you can see who’s swimming naked,” the short seller said, quoting Warren Buffett. “But there’s no reason to think that the good companies will also do bad in the future.”

Not everyone shares this sentiment, though. Muddy Waters Research founder Carson Block told Activist Insight Shorts that SPACs are a symptom of a bullish market that has even greater illnesses at the heart of it. Although he doesn’t know when, Block claimed that “there will eventually be a point when all of this gets washed out and SPACs will be radioactive. No one credible will want to go public via a SPAC and eventually we’ll be back to IPOs.”

Imaginative projections

Block believes there are only so many quality companies that are ready to go public in a year compared to the sheer number brought forth by SPACs. The short seller has targeted two such companies itself, going after MultiPlan in November and XL Fleet more recently. Muddy Waters called the latter “middle of the fairway SPAC garbage,” alleging that the company has hyped its sales pipeline which may be a lot smaller than it claims. “There is company after company with laughable projections for the future,” Block said in an interview with Activist Insight Shorts.

Quintessential has also found targets in the space, with Akazoo delisted from the Nasdaq in June after the short seller said it had overstated revenue, profits, subscribers, and services. Its sponsor, Modern Media Acquisition, later said it had been defrauded by Akazoo’s former management. Clover Health also recently found itself the subject of a shareholder lawsuit alleging securities fraud after Hindenburg Research said the company had failed to disclose a U.S. Department of Justice investigation. Clover Health was taken public by Chamath Palihapitiya, who has been labeled the “king of SPACs” for taking more than a dozen companies public via this route.

While Quintessential’s Gabriel Grego admitted not all SPACs are bad, the short seller told Activist Insight Shorts that the space provides a source of ideas for new short bets. Grego explained that although SPACs allow companies to go public quickly, easily and cheaply, these same reasons also attract those who want to game the system.

The short seller noted that while SPACs attract fraudulent companies, that is not the biggest problem. In the frothy market we are currently experiencing, investors are not being as careful as they should about fundamentals, Grego added, warning that they will get burned if they do not carry out due diligence. “The market is very meritocratic,” he said. “If investors do their homework, they usually get rewarded with nice profits but those who don’t and buy on a whim or just follow the herd eventually get punished.”