blockworks.co
This is a segment from The Breakdown newsletter. To read more editions, subscribe.
“An economist says to a physicist: ‘Sure, this equation works in practice. But does it work in theory?’”
— Overheard in the faculty lounge
For those fortunate enough never to have learned the mechanics of special purpose acquisition vehicles, here’s all you really need to know: If you don’t like the company a SPAC finds to buy, you can get your money back.
There are lots of important details, of course — PIPEs, warrants, fees, the price you paid — but the differentiating factor is the redemption mechanism.
SPACs raise capital by issuing shares at $10 and then looking for a company to buy.
If you like the one they find, you stay invested. If not, they’ll give you your $10 back.
In theory, this democratizes the IPO process.
As a retail investor, you won’t be getting into the next Goldman IPO at the offer price — banks reserve IPO allocations for their top institutional customers.
With SPACs, however, retail investors can typically buy in at or near the standard $10 offering price.
You won’t know what company the SPAC will become, which isn’t ideal, but when you do find out, you’ll have the option to redeem at $10.
In theory, that lets you participate in the IPO process at something close to the same terms of institutional investors.
In practice, however, it rarely works out.
Citing data from ListingTrack, the Financial Times reported that “the median return from [SPACs] that have completed mergers with target companies is minus 83% since 2020.”
Minus 83%! Yikes.
In hindsight, though, it’s not hard to see why.
Here are some of the dubious businesses that were brought to the stock market in the last SPAC boom: electric-scooter sharing, hydroponic farms in Kentucky, cell towers in outer space, a music-streaming service with no paying users, an EV truck company that couldn’t make trucks, bitcoin ATMs, Playboy Inc. and BuzzFeed, to name just a few of the notorious ones.
(Partial disclosure: I may or may not have invested in the cell-towers-in-outer-space one.)
Even so, there was still a lot of money to be made — just not by retail.
One academic study found that SPAC sponsors — the bankers who list the SPAC and go hunting for a deal — do extremely well: “The average annualized sponsor return, over approximately 2.5 years, was 113%.”
The institutions that invest in those SPACs via private funding rounds also did fine, earning an average one-year return of 9.3%.
But the public shareholders who invested in the exact same deals made an average loss of 19.8%.
And yet, SPACs have been wildly popular at times.
In 2021, a series of SPACs sponsored by Chamath Palihapitiya traded 50% to 80% above their $10 issue price before investors even knew what company they were investing in.
Most egregiously, a SPAC sponsored by star banker Michael Klein traded up 550% in anticipation of a merger with Lucid Motors (thought, at the time, to be the next Tesla).
It’s hard to overstate how irrational those prices were.
With his $10 SPAC trading at $65, the market was implying that Michael Klein could negotiate a deal that would instantly make a 6.5x return for his investors.
There are only two ways he could have made that happen: 1) by finding a company willing to sell itself for far less than its worth, or 2) finding a business that’s worth far more on the stock exchange than it is as a private company.
Either way, it turned out to be a poor assumption to make: Lucid Group now trades at $2.60.
That is an extreme example, but it illustrates the point that paying well above $10 for a SPAC doesn’t make much sense.
A skilled banker like Klein might buy a company for 10% or 20% below what it’s worth on the stock market, which would justify paying $11 or $12 for a SPAC, but not much more.
But what if the SPAC buys crypto?
As we’ve learned from MicroStrategy, the stock market routinely values crypto at double what it’s worth on a crypto exchange. Or more.
So it makes sense that a SPAC that uses $10 of investor money to buy $10 of crypto could be worth $20 or more.
In theory.
In practice, it’s not working.
SPACs that have recently announced deals to become digital asset treasury companies (let’s call them DAT SPACs) are mostly trading around $11 per share.
This seems pointless.
An $11 SPAC price implies that the new company will be valued at 1.1x NAV — and what’s the point of a digital asset company that trades at 1.1x NAV?
The core value proposition of DATs is that they can grow their stack of crypto by selling shares above NAV: MicroStrategy, for example, has been growing its “bitcoin per share” by exchanging $10 of equity for $20 of crypto.
But exchanging $11 of equity for $10 of crypto? That hardly seems worth the trouble.
Weirdly, DATs that have gone public by merging with a shell company have been doing much better.
The shares of VAPE, SBET and TRON, for example, are all up 5-10x since announcing their conversion into digital asset companies (buying BNB, ETH and TRON, respectively).
Even the Litecoin one, MEIP, has doubled in price.
There’s no obvious reason why a digital asset company that started as a shell company should be any more valuable than one that started as a SPAC.