As the numbers have gone from a trickle to a stream to a flood, I’ve been watching the announcements of new SPAC formations the past year with a mixture of amusement and bewilderment. On the one hand the rationale behind why someone would want to give their money to someone else to invest blindly is baffling. On the other hand I fully comprehend why every sponsor of a SPAC is coming to market as soon as possible – it’s free money for them. 

Because of the utter logic of the latter point – free money – I held off on writing about the reinvigoration of what I would characterize as a charade. But now that we seem to be reaching a crescendo, whereby every financier and celebrity is lending their name getting involved with creating a SPAC, I can no longer hold back.  It would be easy to pick on Shaq as the catalyst for this writing, or Billy Beane or Paul Ryan, heck even Masayoshi Son’s SPAC announcement coming so quickly on the heels of his WeWork debacle. Yet what finally spurred me to put pen to paper was not the flood of new SPACs, but what I see as the beginning of the end for these noxious vehicles. Or maybe end-game is a better characterization.  Because it’s not the upsurge of newly announced SPAC’s that’s so alarming as much as the cashing out, and the early signs of this are sprinkled sotto voce in the SPAC-mania headlines.

A pair of announcements in early October, seemingly incongruous other than both related to SPAC’s, are the harbinger of what’s to come. The first was the secondary stock offering of Draftkings, whereby insiders at the company would be cashing out of $800-900 million worth of stock. Then came news that Redball Acquisition Corp would be taking a stake in Fenway Sports Group. What’s the connection?  Boston, or in this case more like a Boston Sandwich. While Fenway SG is known to most primarily as the owners of the Red Sox, one of the major insiders cashing out of Draftkings was Robert Kraft, the owner of the Patriots.  

Oh, and obviously there is one more connection, both Kraft and John Henry, the largest holder of Fenway SG, are billionaires. Nothing wrong with that, short of being an actual professional athlete there’s probably no dream greater for American males than being a billionaire sports team owner, and you can count me in that group. I don’t even have an issue with Henry and Kraft being on the right side of a SPAC, it’s perfectly legal and about as opportunistic a tool as there is in the capitalist playbook. Why is it so opportunistic?  Because the mechanics of a SPAC require minimal investment by the sponsor, and will generate enormous returns for the sponsor even if the stock goes nowhere. In fact it will generate enormous returns even if the post-acquisition stock were to lose half its initial value in many cases. That’s because sponsors are given 20% of the company upon the consummation of an acquisition.  Which means ordinary investors need to see the value of their SPAC investment go up 25% for them to breakeven. That’s an extraordinary hurdle in a world of ultra-low interest rates and its corollary: expected low-returns.

So who are these “ordinary” investors?  Right now I have no idea, but in due time I expect the bulk of the shares in SPAC’s to end up in the accounts of middle class investors everywhere, both directly and indirectly.  Direct ownership would occur through an individual’s purchase of a specific SPAC.  Probably not a great bet given the 20% dilution, but I’m fine with that.  More worrisome would be those who unknowingly acquire a stake in these companies through a mutual fund or ETF.  Either way, there’s one undeniable outcome:

SPAC’s are a direct transfer of wealth from the middle-classes to the ultra-wealthy.

As if the latter needed any more help!  Yet Wall Street is more than willing to facilitate this transfer, because they get an additional (but much smaller) cut of the pie.

Nevertheless don’t let anyone fool you by calling SPAC’s a “new financing tool” or attribute any other magical qualities to it. In aggregate these things should be avoided at all costs, and if you think you can pick the winners from the losers just remember that you’re starting 20% in the hole.

More on the mechanics of SPAC’s and a thought on how to play the downside in a future post. Until then here is some excellent context:

Blank Check Companies, a Hot IPO Fad, Contain Pitfalls For Investors – from way back in Feb of 2019
Investors Should Be Wary of SPACS. So Should Red Sox Fans – the current insightful muckraking

SPAC’s Are A 2007 Fad We Didn’t Need Revived – SPAC’s are wack