Wilmington Trust’s Capital Considerations with Tony Roth
IPOs out, SPACs in—but for how long?
Tony Roth, Chief Investment Officer, Wilmington Trust Investment Advisors, Inc.
Amy Butte, Director for Bain Capital Specialty Finance, BNP Paribas USA, DigitalOcean Holdings, and Tuscan Holdings Corp.
AMY BUTTE: In 2019, there were 59 SPACs that went public. In 2020, there were 248. And year-to-date in 2021, we’ve already had 207 SPACs go public
TONY ROTH: That's Amy Butte, director of Bain Capital Specialty Finance and a member of a number of boards, including Tuscan Holdings Corporation, a SPAC launched in 2019, and DigitalOcean. In today’s episode, Amy walks us through the ABCs of SPACs.
Welcome to Capital Considerations, the podcast that takes complex ideas from the investment world and makes them accessible to everyone. I'm your host, Tony Roth, chief investment officer of Wilmington Trust.
TONY ROTH: The market has been a whirlwind since the onset of COVID-19. But one area has been shockingly steady, even growing in size. That's the IPO space. It has charged ahead full steam after a near complete shutdown early in 2020 when the pandemic first hit. Over the balance of the year, $300 billion was raised through IPOs globally, including record-breaking issuance in the U.S. Over 50% of this IPO mania was through special purpose acquisition companies, or SPACs. Previously a mostly overlooked area, SPACs have come to dominate financial news given their quick and widespread adoption and the availability to all types of investors.
Here to walk us through is Amy Butte. Amy was the CFO of both the New York Stock Exchange and Mann Financial and got her start as an equity research analyst. And, in fact, Amy and I have a shared heritage. We both worked at Bear Stearns at the same time.
So, Amy, thank you so much for being here today.
AMY BUTTE: It’s a pleasure. Thank you so much for having me.
TONY ROTH: I also want to remind our listeners that Capital Considerations is nonpartisan and takes no political position one way or the other. With that in mind, let’s get started.
Amy, let’s start at the ground level. What is a SPAC and how does it work? Most of our listeners are aware of them, but they’re actually pretty complicated vehicles, aren’t they?
AMY BUTTE: They are complicated. And you know financial services well, Tony. Sometimes things are more complicated than they need be. So, let’s try to make it simple.
So, a SPAC is a blank check investment vehicle. It’s created to merge with a private company and bring it public, usually within an 18- to 24-month period. So, when you first raise money into the SPAC, you’re basically saying, hi, we’re a management team. We want to raise X tens or hundreds of millions or sometimes billions of dollars and we’re going to use those funds in order to identify a merger candidate. We’re going to find a company that is currently private or a combination of companies that are currently private and take them public.
Now when they do this, they make an offering to the public markets. And when they go out and they sell shares, it’s actually a little bit more complicated. So, first, they sell units and warrants. So, when you invest in the IPO of a SPAC, you buy shares at $10 a share and you also get a warrant, sometimes a quarter, sometimes a half point, so that you’re really buying both the basis plus the opportunity for upside.
AMY BUTTE: So, a warrant is a right to buy the shares at a specified price. Many SPACs specify that price at $11.50.
TONY ROTH: It’s sort of an option in a sense, like a call option.
AMY BUTTE: Right, it’s a call option at just a slightly higher price. So, the capital that they collect it sits in a trust account while they go out and look for an acquisition candidate. So, you, as the investor, you get to sit there with knowing your money is in trust and it’s safe. And, two, you have potential upside because of the warrant.
TONY ROTH: So, let me ask you about it being safe. You mentioned that they’re going to use the money to find an acquisition target. How much of the money is used to do the research, to pay themselves, if you will, to do that work versus actually spending the money for the merger? Is it possible that you could put money into this and it could go below $10?
AMY BUTTE: Well, it’s always possible the stock can go below par, right, or a bond can trade below par. So, yes, it is possible that it can trade below $10. What the interesting thing is, about the SPAC, is at the point that a merger is announced, the shareholders who hold the shares in the SPAC get to vote on it and they really vote with their money. If they’ll like the deal that the SPAC managers have put together, they keep their money in, and that money goes towards the combination. If they don’t like it, they get to exchange it for par or that $10. So, at any given time, you’re right, it can trade below par. But as long as you’re patient at that time of the vote, or at the expiration of the SPAC if they don’t find a deal, you would get your $10 back.
TONY ROTH: So, if you believe in the management team, essentially what you’re doing is you’re investing in the management team’s ability to do well, even though you don’t know what the target will be. So, if you believe in the management team, you really don’t have any downside until after they announce the merger. Is that fair?
AMY BUTTE: Well, bingo on the fact that most investors invest in the management team. That's really the key thing. Who are they? What have they done before? What are their networks like? Do they have the opportunity, particularly in this world with so many SPACs, to actually identify a candidate? So, that’s bingo number one.
Number two, you’re also saying to the management team, you asked a question of how do they fund themselves? You really want to make sure that this is a management team that’s going to be thoughtful about the approach that they take. Usually, most SPACs take expenses of about $10,000 per month or expenses that come out of doing this deal and they also fund it with some of their own risk capital. So, you want to know that it’s a good, connected management team that knows how to find a deal and do a deal, but you also want to know that the management team has skin in the game through the economics of the risk capital. And that way, incentives are aligned.
TONY ROTH: So, before we go deeper into the SPACs, let’s just compare and contrast for a moment if we could to the regular IPO. One of the things that I'm not hearing here or I'm not seeing is the role of the investment banks that, of course, love IPOs because they make so much money. And I would just also note observationally that many of these companies that have benefited from SPACs as a means to become public are earlier life stage companies than the typical IPO it seems like, that are going public and that are applying valuations of $50-$100 billion. The Airbnbs, the Pelotons, the DoorDashes, etcetera, a lot of these are companies that may be a few billion dollars in value or so.
AMY BUTTE: So, two really good questions. One is what is—what type of company is the SPAC right for or what’s the difference between a traditional IPO and a SPAC? And the second question is how do the banks, how are they involved and how are they incented to participate in this approach?
So, in a traditional IPO, a company produces what’s called an S1 or a registration statement. And what you see in that S1 is information about their past performance. You don’t really see any information about anticipated growth or what they’re going to do with proceeds. It’s basically up to the investor or maybe the analyst or, Tony, maybe the CIO to help extrapolate and decide what’s the potential value for this company, whether it’s two, three, five, or ten years out depending on the time horizon.
What’s different about a SPAC is it isn’t really an IPO. It’s a merger. It’s a merger between a public entity that’s a SPAC and the target that is private. And when you do a merger and you issue your proxy statement, which tells you all the information investors want to know about the deal, you’re allowed to talk about it as a merger. So, you’re allowed to say, hey, with these proceeds we’re going to grow revenue by X or we’re going to make acquisitions of Y. So, you really are allowed to use more forward-looking statements and I think that’s part of the reason why we’re seeing more growth-oriented or earlier stage companies go out through SPACs.
TONY ROTH: Isn’t it also less expensive because you’re not–and less onerous and complicated because you’re not dealing with this very intricate offering process and the investment banks and road shows and all those types of things?
AMY BUTTE: So, expense can be—in my view, expense can be defined in multiple different ways. And you asked the question of how do banks get paid? And fortunately, or unfortunately, investment banks are a large percentage of the expenses of going public.
So, in a traditional IPO, the investment bank is making upwards of 7% on the issuance of the shares. In a SPAC, the investment bank is being paid in a multiple of different ways, which may or may not equal 7%. And also, there are other people taking a little piece of the pie.
So, the investment bank gets paid when they take the SPAC public. They get paid two ways, both on the underwriting fee of taking the SPAC public, but very often some of the investment banks are taking some of the warrants associated with the deal.
Second, the investment bank is getting paid when there’s a merger. So, they act as the advisor, right? And so, they’re part of that process of, if you will, taking the merged company public through the SPAC.
The other way people take money out of a SPAC investment or a SPAC process is when the risk capital is defined there are also founder shares and founder shares can be upwards of 20% of the value of the SPAC. At 20% of the value of the SPAC, that’s money, if you will, that’s going to the people that were responsible for putting the deal together rather than simply the investors who were early investors or ongoing investors. So, there still are a lot of nibbles at this process.
TONY ROTH: Either way, the bankers and the sponsors find a way to put their hand in the till.
AMY BUTTE: One of the things that people have been talking about is that this is actually a nice way for earlier stage companies to come to market for retail investors to participate in that upside. So, for example, just in the last ten years companies that you mentioned, right, Airbnb or Peloton, they took longer to come to the public markets because there was a lot of private equity or venture money that sustained them. They didn’t need to go as fast to access the capital markets and that meant individual investors or high net worth investors weren’t able to participate in that period of growth that they saw let’s say between year five and ten or three and seven. So, this is in some ways it might be worth the cost to make sure that you have a more diversified investor base and give more people a chance to participate in the upside.
TONY ROTH: So, let’s talk about how to participate. Talk to us about the different ways, different stages that investors can potentially get exposure to SPACs. And I know that there’s also another stage, which is really important to talk about, which is the so-called pipe, which is another way that people or investors come in at a fairly early stage. And how does that work?
AMY BUTTE: So, in full disclosure, when I joined the Tuscan board in 2019, you know, I really joined it because I thought, wow, it’ll be interesting to learn another way to take a company public.
TONY ROTH: The Tuscan board is what, just to level set for everybody, just to remind everybody.
AMY BUTTE: Tuscan Holdings is a SPAC that was formed in 2019 and has announced its acquisition target of Microvast, which is a electric vehicle battery company. When I started to become involved in SPACs, my interest was learning about another approach to taking a company public. What I subsequently learned is that there’s a lot of things to learn about SPACs and one of them is all the different ways to invest to your question.
So, first, you can be part of that risk capital or sponsor group. So, you could say to your next-door neighbor, he comes to you and he says, hey, I'm going to form a SPAC. And you can say, look, I'd like to be a part of that risk capital and have some of those founder’s shares. And usually when you put in the risk capital, which is the amount of money to fund the initial business of a SPAC, you can get a percentage of the promote.
So, about 20% of the shares of a SPAC, so if it’s a $200 million SPAC, $40 million would go to the promote and you usually receive that when you put in the risk capital.
TONY ROTH: Clearly, this is for a very rarified group of folks like yourself that are on the inside and know what they’re doing. It’s not going to be for the typical high net worth investor. So, what’s the next stage of investing if you're not fortunate enough to be in that stage?
AMY BUTTE: Or you’re more risk averse than to be in that stage.
TONY ROTH: Right. Okay. Fair enough. Fair enough ...
AMY BUTTE: ... The second is through the initial SPAC listing or IPO. And at that time, you would receive your shares in the SPAC for $10 plus the warrant at whatever ratio is decided for that issue. And to start those two things, the warrant and the shares trade together. Eventually, they split. So, you can choose to hold onto the shares and sell the warrants. You can choose to sell the shares and hold onto the warrant. You have that choice. So, that’s the second place that you can invest, at the IPO of the SPAC where you get both the shares and the warrants associated with them.
You can then also invest in just the aftermarket after the IPO and you can trade just those shares because maybe you think that management company’s going to find a really great company. And when the deal’s announced, the shares aren’t going to be $10 a share, they’re going to be $15 a share. So that’s a third place that you can invest.
TONY ROTH: I see that a new SPAC has come to market. Amy Butte is one of the principals and she’s only done SPACs that have hit homeruns. So, I'm going to just buy this one right up at $10 or slightly higher than that but perhaps in order to get in early.
AMY BUTTE: Well, I would definitely buy that if it had your name on it, Tony.
TONY ROTH: I don’t think so.
AMY BUTTE: The next way to invest in a SPAC is at the pipe and what the pipe is is an additional fundraising that takes place at $10 a share. So, let’s say you’re a SPAC and you have $200 million. That tends to be kind of an average amount of money to go out and find your acquisition target. But hypothetically, let’s say you find such a good acquisition target that they need more money than $200 million or they want to grow further, they need more capital or they have a higher valuation, whatever it might be.
Banks, kind of behind the scenes, will go out and raise what's called a pipe. So, it's a way of adding on to the number of shares. And pipe investors tend to be institutional investors or high-net-worth investors who are willing to kind of go along with the deal at the terms that the deal is coming to market at. So, you get a little bit more information at the pipe than you do at the IPO. But you get the same terms as those holding the original shares.
TONY ROTH: So, these are, interestingly, have become pretty sort of hot onramps to SPACs as I understand it because a lot of folks don’t have the wherewithal to necessarily or the savvy to say, oh, the SPAC just came public and its management team is going to be terrific and I want to get in $10 right away. Instead, it becomes evident at some point that the management team is going after a certain target or they’re in a certain industry specifically that they’re likely to be successful and they want to raise some extra money. So, there’s visibility into potential success of the merger and a lot of institutions can jump in at that point but still do it at $10 a share.
AMY BUTTE: Why don’t I use Tuscan as an example? It was trading above $10 a share. Tuscan issued a press release saying that there was discussions taking place with Microvast and between that time and the formal announcement of the merger between Microvast and Tuscan there was a pipe that was being raised. So, the pipe investors knew who the target was, and most pipe investors do know who the target is. But they also knew that there was a difference between the $10 a share that they were going to be buying in at and where the public shares were trading.
TONY ROTH: So, where does this leave us going forward? There are increasing numbers of these SPACs being raised. Is it gotten out of hand? Are there enough targets out there for all these SPACs to be successful? There’s only so many upstarts out there that can come to market how do you think it’ll play out?
AMY BUTTE: I think that’s the most important question. In 2019, there were 59 SPACs that went public. In 2020, there were 248. And year-to-date in 2021, we’ve already had 207 SPACs go public, which means we’re on pace to 800 to 1,000 SPACs in this year alone.
If you think about an average IPO market that brings 200–250 companies to market each year, you can quickly see that there’s an imbalance. There are too many SPACs chasing too few companies. And even if you were to add on what number of companies that would normally go public through a traditional process plus number of Series B or Series C companies that are out raising money, we still have too many SPACs.
So, the general consensus is that it’s easy to raise a SPAC and take a SPAC public. When you’re an investor, you can buy the shares and get a warrant. So, it’s par plus, which is very different than just leaving it in the bank. And so, people are interested in finding a way to get a little plus. So, it’s not hard to raise the SPAC. What is going to be hard is for SPACs to really differentiate themselves and there are going to be SPACs that don’t find their acquisition target in their 24-month timeframe that they have. It’s kind of like a game of musical chairs. And so, how you choose which managers you invest in is going to be really, really important.
When the SPAC dissolves if it doesn’t find its target and it doesn’t de-SPAC, let’s just understand what that means. What that means is the money that you put in, your $10 a share, you get that back. The people that lose money are not the IPO investors in the SPAC. The people that lose the money are the people that put in the risk capital and I think as we see some failures and, remember, we’re probably 12-to-18 months before we start to see those dissolve, you know, that’s when you’re really going to differentiate in this market.
TONY ROTH: And just to be clear, is it your expectation when these dissolve, because they are unable to find a target that the non-risk investors, in other words those folks that have either bought out the IPO or bought maybe in the public market, will get back their $10 a share?
AMY BUTTE: Correct. I think that there are two things that are going to happen at the end of this. One, some people who put in risk capital are going to lose their money and that’s one fallout. The second fallout is it’s very possible some SPACs will acquire companies that really aren’t public company ready and we’re going to have, you know, some failures out there.
As it relates to the investors that buy shares in the SPAC IPO, if that SPAC dissolves without finding a target, they get their $10 back. Their warrant’s worth nothing. But they don’t lose anything if a SPAC doesn’t find a target. The people that will get hurt is if a SPAC manager finds a target, takes it through a de-SPACing process and that target really wasn’t ready to be public and you’re holding those shares. That's when individual investors will get hurt.
TONY ROTH: Right. Assuming that they stay, they don’t bail out, because they have an opportunity to bail out at that time that they merge. If they stay in and it’s not a suitable company, doesn’t do well, then they’re going to lose money. Now, what’s interesting about that is when we look at the numbers, Amy, we see that generally speaking SPACs as a group haven’t performed that well post merger. Even though there are some big shoot the moon SPACs out there, I think it’s Churchill IV, which is the one for Lucid Air, right. There’s ones that have really done incredibly well, and yours of course. But when you look at them as a group, the post-merger performance has been fairly mediocre.
AMY BUTTE: Well, it doesn’t surprise me that that’s happening because if you think about it, a lot of the value and the growth assumptions are already in it at the time of the de-SPACing and expectations are so high. So, I do think it’s going to take some time. I don’t think it’s fair to compare the pop of an IPO on an Airbnb or a Snowflake to the trading, the aftermarket of a de-SPACed company, right?
The pop kind of already happens at the time of the merger announcement. Whereas with an IPO the pop tends to happen after it gets to the public market.
TONY ROTH: So, for the wealthy investor looking at this having that phenomenon that we all call now FOMO, fear of missing out. I know that you don’t have it right now, but the rest of us do. What should we be thinking in terms of our access to this space and our–should we try and play in this space? Should we be cautious? How should we play in this space, assuming that we don’t have the opportunity to be risk capital people? What should we do?
AMY BUTTE: Look. I'm not an investment advisor like you. So, you probably have the best advice. But I would say it comes down to risk tolerance and it comes down to just a general approach to playing in the public markets or investing in the public markets. If you are an investor and think it’s important to invest in earlier stages of capital formation, so you traditionally invest in IPOs and you want to invest in companies that are earlier on their path to public markets, I think it’s something that’s worth looking at because it’s becoming a larger part of that earlier continuum of investing opportunities.
The way to think about it is instead of investing in a Series C or a Series D, are you–which is private. You don’t have any access to it. Are you interested in investing in companies that now are kind of coming to market through a SPAC? So, you’re kind of investing it like a Series D for some of them.
I also think it’s interesting, because if you’re looking for ways to make a little bit more money on your cash and as long as you have good diligence on the managers that you're investing in or at least a time horizon of approximately 24 months, why not invest in an IPO of a SPAC? You get the shares. You know you can get your $10 back at the time of either the announcement of a deal or at the dilution of the SPAC and you have a warrant, which is like a little bit of extra upside, which is kind of interesting. And the pipe, if you have access to it and you have interest in the company and you think it’s a good value or you can really do the analysis and know what you’re buying, that’s another interesting entry point once again for something–for a company that’s earlier in its capital formation kind of history.
TONY ROTH: Well, it’s certainly a very cool space that is going to evolve and we’re going to follow it very carefully. So, let me just summarize what I think three key takeaways are for us today, Amy.
First, I would say that the SPAC space is—it’s certainly an exciting space. I like to call it a new space. It’s actually been around for decades. But it feels quite new because it is newly exploded on the scene for us. And relative to traditional IPOs, it can provide for a very well-informed and savvy investor, even one that’s not a risk capital investor, the opportunity to get exposure to an enterprise possibly at an earlier stage of its lifecycle. Earlier is always better when a company turns out to be successful. And so, it could provide opportunity for the retail investor or the wealthy investor if they can identify the right management teams that are coming to market with SPAC IPOs to get in really early and to even have the optionality that you’ve described and decide if they want to bail out or they want to continue once the target is identified. So, that is I think a really cool aspect of SPACs.
Second takeaway I would say is that the space is becoming increasingly saturated and that means just from the math, the law of numbers, there are going to be a lot of SPACs that are not successful, either because, which is more innocuous, they don’t find a target and they basically just return the $10 or, more problematic for the investor, the investor that decides to stick with the management team, they find a company but it’s really not ready to be public and it doesn’t actually work out. And, in fact, when we look at the returns for SPACs post-merger, they’re a little over 5% as a group and that includes some big homeruns in there. So, a lot of them are failing and given the increasingly large numbers of SPACs coming to market, there’ll be a lot more failures going forward.
So, that leads us to the last takeaway, which is like so many things in the investment world it’s all about selectivity and curation. It’s about being able to work with somebody that has the capability, an outfit that can discern which sponsors are likely to be successful given their bona fides, their experience, their track record, their history, etcetera. And then, in particular in the case of the SPAC, to get you into the deal at the right time and the right place because there are so many on ramps to these SPAC transactions. You have to make sure you’re doing it at the right place and you’re early enough, frankly. Late enough to have visibility into what it is you’re buying into, but early enough to get in before the big value explosion happens.
We at Wilmington Trust are working hard to try to find those kinds of opportunities. We have a few things that we’re looking at and we’ll report to our client base as we develop those opportunities for them.
Amy, any last words? Anything else that comes to mind that you want to share with us before we sign off today?
AMY BUTTE: I think it’s well said. I think your approach to thinking about the right place and the right time for your clients is thoughtful. Our markets run in cycles. We might be at a very high point for SPACs right now. But that doesn’t mean there aren’t going to mean there aren’t going to be bumps in the road. I think people are realizing that this is a useful vehicle, and it could be an important vehicle into the future. But that doesn’t mean it’s not going to be bump-free and I think we all have to be very cautious, even those like me who are looking at the risk capital as we approach it.
TONY ROTH: Yeah. And it’s also an exciting time in the economy as we keep our fingers crossed, we come off of this COVID scenario into hopefully a really accelerating economy.
Well, thank you so much, Amy, for joining us today and for sharing your insights. It’s been a real privilege for us.
AMY BUTTE: Thank you for having me.
TONY ROTH: And thank you to our listeners for joining. I encourage everyone to visit wilmingtontrust.com for a roundup of our investment and planning content. You can subscribe to Capital Considerations on Apple Podcasts, Spotify, Stitcher, or your favorite podcast channel to ensure you get updates on future episodes. Thank you all for listening.
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