We spend quite a bit of time discussing how to analyze businesses, and for good reason. But what about stocks that don't have any underlying business?
We're talking about the recent trend of special-purpose acquisition companies, or SPACs. These companies are set up to raise capital, with the goal of using that capital to take a company public. The problem is, how can you evaluate a SPAC as a potential investment before a merger agreement is announced?
While investing in a predeal SPAC is certainly a speculative endeavor, there are some ways to narrow down the field to those that make the most sense as investments for you. In this Jan. 21 Fool Live video clip, Fool.com contributor and SPAC investor Matt Frankel, CFP, walks investors through the important points in any SPAC's regulatory filings, along with fellow contributor Brian Withers.
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Matt Frankel: So, when a SPAC files to go public, it issues files of the form SEC called an S-1. You can pretty much every SPAC has its own investors relations page -- Chamath's SPACS have their own right here. You've seen IPO 2.0 he calls it. You can find all other SEC filings. If I go to SEC filings for IPOD [Social Capital Hedosophia Holdings IV (IPOD)], you will see a lot of filings; you're looking for S-1, specifically the most recent S-1. You can see here that he initially filed for this one to go public on Sept. the 18th. He issued two amendments to the S-1. A lot of that usually has to do with the deal got bigger or smaller. If it's resized, they'll issue at amended S-1. The point being, just make sure you are looking at the most recent version of that S-1.
Brian Withers: That will include all the original S-1 information plus the new?
Frankel: Correct. The one that I'm putting up on the screen right here, is that most recent amendment. It's Oct. the 6th, and I would hope it includes everything because it's about 170 pages long.
Frankel: So these do generally include the entire S-1 document just updated as soon as possible. Even if the SPAC has already gone public, like this one, Social Capital Hedosophia Holdings IV-- we're going to call that IPOD for the rest of the show [laughs]. Even after one of those has gotten public, the S-1, which was issued before it went public, is still full of useful information to make a call on whether you might want to invest. There are a few parts of this. You don't have to read all 170 pages. Please don't read all 170 pages; you will drive yourself crazy with all the mumbo jumbo in here. I want to highlight a few different parts of this that are really important to investors. Scroll down past this initial part to the table of contents.
The first stop I want you to make is where it says the offering. If you click on the offering, this tells you a lot of valuable information that you need to know. One, it's telling you how much they're offering. As I mentioned, pretty much every SPAC starts at a unit price of $10 a share. If this one's selling 35 million units, 35 million times 10 would imply that they're aiming to raise $350 million to use for their acquisition. In parentheses, it'll be if the underwriters exercise their full overallotments, which is standard IPO practice. In the case of all of Chamath's IPOs, it did. They ended up selling a little over 40 million units, they raised about $400 million.
Going down just a little bit, you will see how to actually buy these. The NYSE symbols are very important. You have to know how to actually buy one of these. Once SPACs go public, they will initially go public as a unit which consists of a combination of one Class A share of stock plus some fraction of a redeemable warrant to buy another share at some point in the future, which I'll get to in a minute.
The key thing to know is that at first, these will trade as units. The actual way you type that in, maybe there's a dot there -- maybe there's not -- will depend on your brokerage. But if you want to buy a SPAC right after it goes public, you're going to be buying these units that have a combination of a share and some warrant. After a certain period of time, which is highlighted right here, the Class A ordinary shares and warrants will begin separate trading on the 52nd day following the prospectus. That's a very often misunderstood point.
Withers: Yeah. IPOD.U -- and this was a question I got about my spreadsheet stuff -- that actually only trades for a short period of time and then it splits into those two things below it.
Frankel: What happens on that 52nd day depends on the actual SPAC and what the management decides to do. As I'm talking, you can either buy the units, the shares, or the warrants of IPOD. For the first 52 days, all you can buy are the units. After 52 days, you can choose to invest in the units, which are the combination of shares and warrants, which is usually the way I invest. I see the warrant as like a part of an option, it's like a cherry on top if the deal goes well. Or you can buy the shares or the warrants after those 52 days have passed.
Right now, it's been more than 52 days. IPOD went public in October. You could choose to buy the units, you could buy the shares, you could buy the warrants. Those are symbols; the exact symbols will depend on your broker. That's the first part I want you to pay attention to.
On the very next page, you can see the number of shares outstanding in the SPAC and how many warrants there are. The big thing to pay attention to here is the private-placement warrants, because this is management skin in the game. We like to emphasize when management has a lot to gain by making shareholders money. In pretty much every SPAC deal, you'll will see the management invest in warrants.
Management make money off SPAC deals in two ways. They generally get 20% of the common shares of the SPAC for which they essentially get for free, they paid something like $25,000 for several million shares, in this case. That gives management a lot of skin in the game, and they have to buy warrants just like everyone else would.
In this case, I know that Chamath and his management team bought 4.5 million warrants in IPOD for $2 apiece when it went public, which is contained elsewhere in the 170 [laughs] pages of this prospectus. Management has an equity stake of 20%, and they also buy a certain number of warrants.
If a SPAC does not find a deal -- this is a very important point -- warrants expire worthless. It's an option in a business that doesn't have a business if the SPAC doesn't find a target. Having that many warrants gives the SPAC sponsor a big incentive to actually find a deal. That's something to look for. You want to see they have a lot of skin in the game.
Finally, on this page, the exercise price. A warrant gives you the right to purchase another share of stock. The exercise price is the price that that warrant allows you to pay. Obviously, while the shares are trading for $10, it doesn't make sense to exercise the right to buy another share for $11.50. The idea is that someday down the road, if the SPAC makes a successful merger agreement...
If you look at some of Chamath's earlier ones, like Opendoor (OPEN 10.30%), ticker symbol OPEN -- I can't spell today -- is trading for significantly more than $11.50 a share. In those cases, it would be really worth exercising your warrant. So knowing the exercise price is important.
Scrolling down a little bit... Most of the important information, by the way, is on these first seven or eight pages of the offering price.
Scrolling down... The exercise period is the next important part. Generally speaking, warrants become exercisable after a year or 30 days after the completion of the business combination, whichever comes last. In Chamath's other example, Opendoor, even though they've completed their business combination, the warrants won't be exercisable until 12 months after the closing of the IPO for that SPAC if that hasn't happened yet, which it hasn't.
That's important to know: You can't exercise the warrants right away. A lot of people sometimes ask, why warrants aren't trading for what they should be worth. Usually, the answer is because they're not yet exercisable. A warrant that you can't exercise doesn't really have that much intrinsic value; it's based on what the share price will be at some point in the future.
Brian, stop me if I'm going through any of this a little too quick.
Withers: No. This is really good. I guess I was also wondering whether, in this registration document, it talks about what kind of company they are looking at, specifically this SPAC. Like, I want to be in fintech, or does it talk about that?
Frankel: It does, I'm getting there. [laughs]
Frankel: I'm saving the management discussion for last because I think that's the most important part of it.
Withers: We're at 11:15, just want to give you a time.
Frankel: Got you. Let me go through the rest of this page pretty quickly. The other thing that you need to know about warrants is when the company can force them to be redeemed at certain points in time. The two most common provisions you'll see in these SPAC documents, the good thing is this 170-page document, for pretty much every SPAC, it's the exact same format. If you've learned how to do this once, you can get through the other ones in a breeze.
Usually, $18 is the trigger to where companies can force warrants to be redeemed, meaning that they can call in the warrants. They will announce this with at least 30 days' notice. Basically, when you get that notice, you sell your warrants. It's the key. But it's really important to pay attention and watch press releases. If you're going to invest in SPAC warrants, you have to pay attention and see if the company is going to call them in, especially if the shares are trading for more than $18. That's the key price for pretty much every SPAC I know of.
The other threshold is when the shares are between $10 and $18. In that, they can force the warrants to be redeemed, and shareholders can convert them to stock on a cashless basis. There's a table later on in the prospectus, which I'm not going to cover for time purposes, but between $10 and $18, the company can let people exercise them for a cashless basis, meaning that you can convert a certain number of warrants to a certain number of shares of stock at that point.
If you're thinking of investing in a SPAC, read through those things on your own time. It's really worth knowing, but for time purposes, I can't read through the entire thing there. That does... the rest as risk factors, management structure, legal mumbo jumbo, don't worry too much about any of that.
The next thing I wanted to get to is..bear with me while I scroll through this; it's a long document...capitalization. I just wanted to quickly touch on. This breaks down into one table how much the SPAC is raising and who's paying it. Class A shares, this is pretty much the money they're collecting from shareholders. The other big line, usually on the bottom, is paid in capital. That's usually the warrants the sponsor is buying. I mentioned they bought a bunch of warrants for this one, so that's where a lot of that comes from.
The last thing I wanted to talk about, and this is what I wanted to spend some time on, and this will answer Brian's question from a minute ago, is the management section, which on any of these pages, you can just click on table of contents and easily get to things like management and capitalization and things like that. I don't think you have to scroll through the way I just did. If I go to management, this tells you who is running the show, which I mentioned, a SPAC doesn't have a deal yet is a bet on management. Chamath is obviously the SPAC celebrity. Brian told me he's not nearly as familiar about SPACs, and I'm sure he knows who Chamath is.
Frankel: [laughs] His reputation precedes him. We'll give this bio on him. He's taken Virgin Galactic (NYSE: SPCE) public. Since this was published, he's taken Opendoor public, Clover Health (CLOV 3.15%). They just announced SoFi (IPOE), that's that IPOE right there. IPOF [Social Capital Hedosophia Holdings VI (IPOF)] is the other SPAC that hasn't figured out a deal yet.