Have you ever written a blank check or made a purchase without knowing what you just bought? The answer is probably ‘no’, unless you’ve been to a SPAC or two. In recent years, SPACs, or special purpose acquisition companies, have been all the rage and investors can’t get enough of them.
If you are new to the term, a SPAC is a company with no operations. Instead of providing a product or service, they raise capital and use the funds to purchase an existing organization. From a startup’s perspective, SPAC is a great source of funding and offers entrepreneurs an alternative to IPOs (initial public offerings) as a route to public markets.
From an investor’s perspective, however, investing in a SPAC is a shot in the dark because you won’t know what they’ll be buying – they could be acquiring a healthcare provider, a fintech company, or a e-commerce – or something else, for that matter. You also won’t know if the target will be well funded, profitable and have good valuations, or if it will be heavily indebted, incomeless and expensive. As a result, SPACs have been labeled as “blank check corporations” and create ideal conditions for speculation.
As you might expect, not all SPACs perform well. In fact, some do it horribly. Electric Last Mile Solutions (ELMSQ) illustrates what can go wrong. In late 2020, a SPAC called Forum Merger III listed at US$10 per unit and began looking for an acquisition. The target they settled on was ELMS, which started trading in June 2021.
This company is an electric vehicle manufacturer that focuses on building “last mile” commercial delivery vehicles, the final link in the product distribution chain. In many ways, it was a classic SPAC. He was well promoted, had smooth presentations projecting strong growth, and had a great story behind it coupled with a booming industry. That said, even in its heyday as a publicly traded entity, things weren’t going so well.
In the third quarter 2021, it only generated $139,000 in revenue, posted a net loss of $17.8 million, and depleted its cash at a rapid rate – yet its valuations were exorbitant. At that time, the stock price was around US$8.50 and there were 118.8 million shares outstanding, which generated a market capitalization of around US$1 billion.
Unfortunately for shareholders, this has not improved. In 2022, late filing SEC notices began to appear; instead of quarterly earnings reports, the organization fell under NASDAQ listing rules noncompliance; and the general manager resigned. As that unfolded, shares fell, solvency issues increased, and then in mid-June the company filed for bankruptcy.
The title is currently trading for pennies, and the US Chapter 7 bankruptcy process will almost certainly eliminate existing owners. In short, ELMS is a cautionary tale for investors speculating about new companies coming to market. Many SPACs (and IPOs for that matter) come with big promises and promising prospects promoted by excellent sellers, and align with an important macro trend to give investors a “feel good” vibe. misleading.
Indeed, Electric Last Mile Solutions is far from being the only one. According to the research firm Audit analysis, 25 SPACs listed between 2020 and 2021 have issued business continuity warnings in recent months. This is equivalent to more than 10% of the 232 after-sales service listed during this period. Compared to IPOs listed in the comparable period, this is double the potential near-term failure rate. In short, it highlights the risk of this relatively new way of going public.
The final point to make here is one that Warren Buffett and Charlie Munger like to come back to. They regularly point out that breakthrough industries with great prospects (like electric vehicles) can make wonderful contributions to society, but that doesn’t automatically translate into good returns for investors. In fact, investors can end up with the bag or lose their shirt. They refer to auto stocks listed in the 1910s and 1920s to support their point. At that time, there were thousands of automakers in the United States, many of which were listed, but most of them went bankrupt early on. Those who survived battled it out to the point where capital returns were low, and eventually there were only three publicly traded U.S. automakers left. To add insult to injury, two of them subsequently went bankrupt in the 2008-2009 season. financial crisis and had to be recapitalised. Mr. Buffett and Mr. Munger go on to note how similar experiences happened to airlines in the 1950s, semiconductor makers in the 1970s and internet start-ups in the 1990s.
Taken together, investors in ELMS or other SPACs looking to cash in on breakthrough industries can be forgiven if they get caught up in the hype. At the end of the day, many will be exasperated shouting into the air, “What the SPAC?!”
Philip MacKellar is a writer for investment newsletter Contra the Heard.
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