SPACs – Ingenious Investment Tool Or Potential Pandora’s Box? [TFC 103]

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Today, I’m going to spend some time to share with you why I hate SPACs in general? Long story, but yeah, tune in. Tune in, okay?

First, I got to put it out there that I am the kind of investor that is a little bit boring. I am looking for companies that are fundamentally strong. They have a good business model. They have moats. They have strong cash flow generation and I can own them for an extended period of time. At least I will want to own them for 10, 20 years.

Of course, it does not mean that I just buy and dump it there and don’t care about it. I generally care about them less these days. When I first started investing, I cared about it a lot. I would read quarterly reports and what have you. Nowadays, it’s just annual report, investor day and that’s about it. In the past, I would have a lot more companies. These days I’m cutting my portfolio to focus on a few companies that I like, I understand, and I can own for the longer term.

Of course, my growth targets, my investment targets are about 15% year on year. That’s my personal target that I set for myself. And yes, with that premise, you will understand that I’m not the kind of person that try to go for that next big thing and price in a lot of risk and uncertainty for it. 

It’s not that I don’t want growth companies or I don’t want companies that can give me 10X, 20X. Of course, in my portfolio some of them are like that and I believe when I buy some of these companies, I have superior information compared to the market. That means I have been in a particular sector before and I know what’s going on, I think the market is not pricing it well. Like maybe recently with China and what have you, I think the market broadly speaking, it’s not pricing it very fairly.

So, I would want to load up on some of these companies given certain time period and situations. But understanding that I’m the boring investor that is just trying to pick good stocks that can give me 15%. That’s my target returns year on year. I am not the sexy person that wants to 10X everything.

With that in mind, you should be able to follow my train of thoughts when understanding SPACs. SPACs recently has come on the rise. A lot of people have SPACs these days. Tennis player also can have their own SPAC, okay? My god. Tennis player have their own SPACs… does not mean nobody cares. Even the Cathie Wood put money with the tennis player in her SPACs. 

You see a lot of big names going around. Whether or not it’s going to be profitable, that’s a big question mark going into the future, right? That’s the whole idea of profits. You buy now, hopefully in the future, it goes higher. Then you sell it for a profit. Nobody can fundamentally predict… “wah, definitely will have profit” and what have you. 

So I would say the recent hype around SPACs is a lot more about big names and big money, not so much about fundamentally SPACS being the next big thing or the best way to list a company and what have you. It’s a lot about having big fund managers like Bill Ackman and Cathie Wood putting money and all these celebrities coming in and a lot of big name exits like Grab, PropertyGuru and all that jazz. 

Of course, the people that are very supportive of SPACs will paint you this beautiful picture around restaurant brands, which has Burger King, Wendy’s and all the brands. It’s done by Bill Ackman, one of the most successful SPACs since history. 

But there’s also the other side, right? We have Nikola which some people say should be renamed Newton because this is an electric truck company that the truck cannot move yet. They actually filmed promotion videos along a slope. That’s why the truck could move and they could film it. So some people say “yeah, maybe you should call it Newton.” Because gravity mah, gravity pull the truck… 

Anyway, the idea is different people will take out different examples to try to paint you a picture depending on where they stand. I’m not going to give you very specific examples but I’m going to just try to walk you through this process of what is a SPAC? What is it trying to do? What are some of the main characteristics and why do I hate it because of that? 

For everyone that has not done any research on SPACs at all, SPACs essentially are listed companies. They are listed companies and they don’t have anything when they list on the exchange. So it’s essentially a shell or some people will call it a blank check company. They will list the company. They will pay all the fees that needs to be paid to list this company on the particular exchange. 

Why this process? Probably it’s because it’s much easier. There’s not a lot of things inside. Essentially, they’ve got nothing inside. When they got nothing inside, it’s very easy to list the company. There’s no complicated auditing fees and all the things in between. Essentially, that is the idea. You list a shell and with this shell, you sell shares of it to raise capital. You are essentially buying nothing. 

So someone raise a flag and say “okay, we gonna do this SPAC” and then you buy into the SPAC and the SPAC got nothing inside. You are just putting money to the person or what we call sponsor. The person or the company that starts this SPAC is called the sponsor and you’re putting money with the sponsor. There’s nothing in this company. You are just putting capital with them. They will take that capital and go on a purchasing process. So they will go and buy the different companies that they want to buy and that’s called a merger process. 

Essentially, there are a few parties here. Number one is the sponsor, the person that started the SPAC. Number two are investors like you that put money with the sponsor without knowing what’s going on, without knowing what’s inside. I will share it with you more later. The third party is the merger company. The companies that… like Grab, PropertyGuru that wants to merge with this SPAC, they will sell their companies to the SPACs on a merger structure. These companies would then be put into the SPAC and be rebranded as the new company.

There’s a lot of things online that tells you that maybe this is a more efficient method. It’s cheaper, easier, faster to list. It’s a more efficient process. Of course, the other side will tell you it’s not being checked. There’s a lot of… it’s essentially a back door process, less stringent, what have you.

Once again, it’s two sides saying their viewpoint. But what are some of the features in SPACs? We’ve established the parties in the SPAC. What are some of the features? In this SPAC arrangement, you put money with the sponsor and there’s actually a time period. On average… about 24 months. Within this 24 months arrangement, your money is put with the sponsor through owning this SPAC. So you buy the SPAC shares and the capital will be put with the sponsor. The sponsor will take the money to go and buy whatever company they want to merge. 

So you put your money there. In 24 months, they have to merge. If they don’t merge, they will pay you back your capital in full. That’s the understanding. They’ll pay you capital in full and supposedly you have not lost anything, but actually you’ve lost opportunity cost… two years. 24 months on average, you can garner a 8%, 10% post fees, what have you. If you buy certain companies that are good and strong, maybe 10, 15% year on year. Opportunity costs, you already lost some money. 

But that’s not my point, that’s a random blurt. 24 months is the process. The next point bothers me a little bit more. 20% of the final asset valuation goes to the sponsor. So if in the PropertyGuru deal, the whole company at the end from the SPAC is going to be worth $1.87 billion, the sponsor… that means the person that made this whole thing happened takes 20% of that. They’re going to take 20%… a few hundred million for completing this deal. 

Some people will say this is a more expensive process. Some people say this is a cheaper process, but it really depends on how big is the deal and what is the kind of complexity if they went through an IPO process. So either way, the idea is the sponsor gets 20% if they successfully list and merge the company. That’s that. 

Of course, there’s another feature called warrant, which means as an investor, as early investors, If the SPAC ultimately performs very well after the merger and this listing, you have some sort of a warrant. It’s a structure… it’s a derivative where you have the rights to purchase future equity at today’s price or at the price that’s agreed within the contract. 

These are the few features. 24 months holding period, they assure you that it will be merged if not, they will pay back the money. 20% percent of the final asset goes to the sponsor and you as an early investor, you get a warrant to buy more shares at today’s price or at a little bit above today’s price, assuming that the SPAC does very well into the future. So these are some of the features and now that you know the features, there are a lot of big name articles. I will not name drop and you also know my investment strategy or my investment style.

I’m going to give you my first point why I hate SPAC. I hate it, hate it! Number one is… this is like a Pandora box with extremely vague criterias. All the SPACs actually have S-1s. They have to list on the exchange so they need to release this report called an S-1. If you want to go and find out about SPAC, type the name of the SPAC in Google, you put S-1 behind, it will pop up.

In the S-1, there’s always the things like why we do this, the marketing, our history, our management, blah, blah, blah. All these thing are marketing. Just go to look at acquisition criteria. Let me read out a few for you. Pershing Square Tontine Holdings, which is done by Bill Ackman, supposedly one of the most successful SPAC per sponsor… he has listed a pretty successful SPAC as we have said before. So he’s not shy to flaunt that and he has currently one of the biggest SPAC in the market, if not the biggest. 

But let me read to you our acquisition criteria. “We will seek to acquire companies that have the following characteristics: simple, predictable and free cashflow generative, formidable barriers to entry, limited exposure to extrinsic factors that cannot control, strong balance sheet, minimal capital market dependencies, large capitalization, attractive valuations, exceptional management and governance.” 

This sounds like every single company that I buy. It sounds like every single company that I want to own. I will want it to meet such a criteria. But anyway, it’s fine. Vague… Very vague, but let me read you another one, okay? Another one, buay tahan. Tor huay (cannot tolerate, vomit blood). 

Let me read you another one. This is Altimeter Growth Corp, another very big SPAC. What is their investment criteria? “Large and growing total addressable market, differentiated architecture, multi year compounders, formidable, unique economics, strong management team, sensible valuations.” You know what they just buy? They bought Grab. This is the guys behind Grab. Same for many other SPACs out there. 

Let me read you another one. Just one more, bear with me. This other SPAC… “companies with operations or prospectus in the South East Asian, South Asian new economy sector, strong target management teams, fundamentally sound companies that have potential to further improve their performance under our ownership, market leader, appropriate valuations.” 

You know what is this SPAC? This SPAC is Bridgetown 2 Holdings, which is the SPAC by Richard Lee which just announced that they’re going to merge with PropertyGuru. I went through these two minutes or so to read all these different SPACs’ acquisition criteria. They all sound the same, right? .

That’s the idea. They all sound the same. That is a very big problem in my view because when you read the prospectus, it does not tell you much. I can understand why they don’t tell you much because the reality is capital is capital. It needs to look for deals. It needs to merge and if I tell you too specifically what am I merging, you may want to beat me out. 

So it tends to be that a lot of these companies, or a lot of these kind of private wealth, they don’t actually tell you who they are going to buy. This is quite a private structure although it’s a listed entity. Okay. You are essentially putting your money with the sponsor, you don’t know what they’re going to do. You read the criteria, you don’t know what it was. 

To me, that is very problematic. Why am I putting my money in a Pandora’s box? I’m not even sure what’s going to come out of it. As an investor that’s trying to seek for that 10, 15% year on year growth, I want to be investing in companies that I understand. I want to know what I’m buying. I am an investor that avoid even IPO (Initial Public Offering) because IPOs go through a process of bidding. They go through a hype process of trying to sell it at as high a price as possible and then exit into the public market. 

So within the first year, I will avoid buying the companies to just see what management is doing, how they’re managing their investors and all that jazz. Because it’s not exactly easy to list from a private company to go to a public company and continue to operate well in the public environment because more investors are here to scrutinize you. There’s a lot of pressure in management and all that jazz. 

As a person that avoids IPO for their uncertainty, I totally cannot handle this because I don’t know what I’m buying into and to me, that is very problematic. I think for most of us, we can really avoid SPACs for this. Just based on this one thing, I will avoid SPACs altogether because I don’t know what I’m owning. I’m essentially putting my money under the name of someone that is famous and did some good things before, hoping that he will continue… he or she will continue to do good things, buy good companies. That is a number one big no-no for me. 

Point number two… enough but thanks for handling my rant. Point number two is that the SPAC listing process has no scrutiny from the public markets. It’s unlike IPOs where they go through a process of pre IPOs and going around doing road shows and putting out their prospectus and letting everybody read it, everybody to study it and understand it before people decide whether they want to buy or not, or how they want to price it. Without that, it is actually fundamentally very weak and I’ll talk to you a little bit more about this after a word from our sponsors. 

For a lot of us that have not done private investments before… I have not done it before, but I do have friends in this space. You need to understand that private investments are not exactly that simple because it is not regulated. There’s no SEC (Securities Exchange Commission) to track the data, to know whether is it accurate, whether the company is frauding you. There’s no MAS (Monetary Authority of Singapore) to try to regulate this process. There isn’t even a need for them to publish all their numbers and criterias and what have you.

So in a private investment structure, there’s a lot of due diligence that needs to be done. That means as an investor, you need to go and study the ins and outs of the company, what are their current practices, what is going on all in all before you make a decision. The beauty about the public markets is that because of market mechanism, there will be people that like this company, there will be people that don’t like this company and they will all price it accordingly. 

A lot of people will be studying this company. They’ll give you their thesis, they give you that study, they give you their information, and there is a governance body to make sure that all these companies abide by a certain accounting practice and also to publicize their data in a fashion that is universally accepted. So to me, that is one of the best things in the public market. 

As an investor in the public market, although you don’t get that amazing premium that you can 10X, 100X your money from the private process, hey, you get this whole governance structure and all of these different entities and all these different interests parties from big financials to retail investors to family offices looking at all these companies and putting out their thesis to try to understand them and evaluate all the companies.

This process of checking the companies through this listing process and through the market mechanism where everybody can participate and put their ideas, put their price on the companies actually makes it a lot more rigorous as a space. For public investors, for retail investors like ourselves, it can be very beautiful for us because we don’t need to do the super, super deep work of digging everything below. 

We can actually look at investment thesis, analyse with some basic ideas that we have, whether it’s understanding management, moats, do some DCF (Discounted Cash Flow), simple models, and we don’t need to question the numbers of the accounts. We don’t need to dig deep to know their relationship with other vendors and what have you. Some simple work will already allow us to come up with a decent thesis because of this whole market mechanism and the broader governance structure. 

But when a company goes through a SPAC listing, they essentially route away from this whole market process. They don’t need to woo investors, they don’t need to present investors. They don’t need to tell a lot of people a lot of things. They are essentially just selling to a next bigger buyer, which is the SPAC. So in some ways, it is a private exit into the public market and I hate it.

WeWork… I’m sure high-profile, right? WeWork, all the interesting things that came out of WeWork, from Andrew Neumann (correction: Adam Neumann) setting up a company to do the We company and then sell it back or lease it to the parent company to make some money off this whole thing. All these things are private arrangement and it would not have surfaced without this whole process of public scrutiny. 

So on top of putting money with a sponsor to potentially invest in a company that I don’t know what’s going on or I don’t know what is the company going to be like, I’m also subjecting myself to this uncertainty of information or this lack of clarity of information, because it is essentially a private exit and I hate it. it is not even that as a retail investor, when you use a SPAC structure, you will get a good deal. I’m not saying definite, but I’m saying whether will you get a good deal, that’s even a question mark. 

This brings me to point number three. The incentive structure in a SPAC is not very advantageous to retail investors. The person that benefits the most is the SPAC sponsor, if you cannot yet tell. If the company goes at $1.87 billion, which is what Property Guru is trying to list at, $1.87 billion, what happens is the SPAC buys PropertyGuru at $1.87 billion valuation. 

This is quite a classic thing that SPACs are trying to do. They are trying to suck in all the premium of the IPO process. Because when you IPO a company, let’s say IPO is at $10. It sells to the market at $10, but immediately on the first day of IPO, it goes to $15, or it goes to $18. So there’s a 50% increase in the IPO, or 80% increase from the IPO price. 

Actually, the company does not take that $5 extra or the $8 extra. They only take that $10. That’s the process of IPO. The market then price it higher because they probably think that the company is good. Of course, the market can price it lower. 

But what a lot of SPACs is trying to do is they also want to make the $5, $8 on top of the $10 at IPO price. If you think about it, the IPO process is you have this one company that is doing decently well. It wants to raise money as a trust, so it package itself… works with underwriter, works with the bank, talk to all these investors and all the investors come in on a pre IPO structure. They buy a little bit cheaper, so they would negotiate a price with all these listed companies. 

The first day it goes for listing, it goes at $10. That means all these investors that come in, they buy at $10 from these companies. It goes into the market, the listed market… goes up $10. All these investors that buy in at $10, they can make their $5, $8, but the company does not make. 

But in a SPAC structure, the company wants to make this whole thing. So in that sense, you as an investor of the SPAC, you are buying this whole company at an even higher price that you would have probably in an IPO process. You could have bought it at $10 if we went through an IPO process with all these market mechanism, trying to evaluate the company. Instead, the SPAC tries to capture this whole thing and offers to buy at $18.

So they buy at a premium or they tend to buy at a premium in my view. It does not help that there’s a lot of market and a lot of SPACs out there. It will beat up all these private investments. There are only so many big companies that can go to a SPAC process. With that, you are potentially being sold at a higher premium because the SPAC wants to capture this whole value and they will pay a higher price for this whole merger.

Why is that so? Why is SPAC okay to do that? Because the SPAC’s incentive structure is 20% of the final merged asset. If you think about it, they have incentive to acquire at a premium and acquire well. I’m not saying that they are definitely out there to make their money and mess up with the investors and what have you. It’s not good for them, but it does put into question whether or not do they actually have the investor’s best interests, especially if you’re invested as trying to buy a company for the long term and not trying to ride this wave with all these guys. 

Some of you will say “oh, but at least there’s the 24 month return process.” If you think about it, the last thing the SPAC wants to do is to return you the money because they would have spent all the marketing money, they would have spent all the deal searching dollars and they make no money out of it. 

If you think about it, the incentive structure does run the risk of having these guys just randomly buy something. Instead of not buying anything, they will just buy something or they will put together a complicated deal with multiple parties and what have you. So all the incentive structures do not line up from your retail investor angle. 

I don’t like it because I don’t want to be able to pay the sponsor 20% and give them this whole time of 24 months to try to buy it something with very vague criteria and I don’t have a lot of upside in my view. Of course, different listings are very subjective. You may end up with very good listings. Somehow, the SPAC sponsor managed to buy some very good companies because of their good connections and maybe they found a company that is under appreciated that what have you, but just on these few factors alone, I generally will avoid SPACs. That’s my base case. I hate it in other words, if you cannot yet tell. 

So I’m going to sum up the three pointers on why I hate SPACs. Number one, it’s a Pandora box with the very, very vague acquisition criteria. You go and read all the SPACs, they all sound same. All big jargons, they cannot say exactly what they’re going to buy. You don’t know. You are essentially putting money with a sponsor, hoping that they buy something good. 

Point number two is that there is no public scrutiny of this listing process. It is unlike an IPO, and the beauty of being in the public market is that there’s proper governance and there’s all these market participants evaluating the company and deciding what is a good price for it. So without that, essentially a SPAC is quite like a private listing and because it is a private business process, a private investor process, I don’t really like it. For… I think most public investors, most retail investors will struggle with this. 

Point number three is the incentive structure for the SPAC is leaning towards the sponsor, not so much towards the investor with 24 months time period at 20% of the final asset price goes to the sponsor, I think the incentive structure is wonky. So as a retail investor, I will avoid SPACs. Maybe you will find a few good SPACs, I don’t know. But generally, because of my investment palate, I’m not going to do it and I presented you my points. So I hope you learnt something useful today. See you! 

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Okay… so yeah, that’s for SPACs. Why I decided not to go down the whole data path… because everybody will throw you different set of data, essentially. They will tell you historically, certain SPACs do better. They will also tell you historically, most SPACs don’t do so well. It’s not that difficult to find the data.

But I really want to study it from a company structure viewpoint. From a structure process standpoint, I don’t like it. I’m buying a mystery Pandora box. There’s no market process. The incentive structure is kind of weird. Just based on all these things. I think it’s not something that I want to purchase. 

Sorry if I did not give you a very specific numerical value as to how to evaluate SPACs and what have you, because a SPAC is just a shell. There’s nothing really in it to evaluate from a business standpoint. But yes, that is it for today. I hope you learnt something useful. 

If you have any specific listings that you want us to look at, even though I’m not a big fan of IPOs, I am looking at some IPOs. I always look at some of them. I do not buy them straight away, but they will be in my observation list and I’ll share with you three of them down the road. If you have any specific companies that are getting listed that you think will be interesting for us to discuss, definitely come to our Telegram group. Talk to us about it and let us know so we can continue to learn together. 

Next week, I’m going to talk a little bit about CPF (Central Provident Fund). I think CPF is a topic that a lot of people have been asking for and I want to share you my thoughts about CPF. We are doing two topics. Next week will be about optimizing your CPF. I’m not the most fashionable content creator in this space. There are already a lot of people that wrote a lot of blogs and I read a lot of them, so I’m going to share with you what I think are the best and a little bit of add on from my perspective, which I think is under discussed and under development. I’ll see you next week. Take care.