In late 2019, Boston, Massachusetts-based DraftKings publicly announced their intentions to become a publicly-traded company. The online gambling and gaming firm had experienced several years of growth and, following a Supreme Court ruling that lifted a previous ban on sports betting, had its eyes on capitalizing its good fortune. Rather than raising capital through an initial public offering (IPO), the company opted to enter into a deal with Diamond Eagle Acquisition Corp., a shell company that existed solely for the purpose of acquisition. This type of company, commonly known as a special-purpose acquisition company (SPAC) allows private firms to become publicly traded and listed on stock exchanges without the time, capital, and regulatory expenditures required in a traditional IPO.
DraftKings and Diamond Eagle completed their merger in early 2020 and as a single entity, was listed on the NASDAQ stock exchange under the symbol DKNG. By the end of August 2020, the company's valuation was sitting at nearly $13 billion, up from the $3 billion valuation it carried when the SPAC deal was completed. The DraftKings story represents one of the recent success stories for SPACs and similar successes have fed into a boom period where institutional and retail investors are jumping into action at a record rate. The SPAC market raised $26 billion this January alone, reaching a third of the amount raised during all of 2020. Signs are pointing towards a bubble, and when it comes to investing, bubbles are known to burst.
Boom or bust?
The current market has been bullish for several years now, even showing indifference to the effects of the COVID-19 pandemic when just about every part of civilized life experienced staggering changes. Markets closed 2020 with record highs, including the S&P 500-stock index netting 16% year-over-year growth. This in spite of staggering job losses, depleted food banks, and the COVID-related deaths of hundreds of thousands of Americans.
Traditionally, in booming markets such as this, the finance sector angles to gobble up capital from speculators who want a piece of the action. Interest rates are incredibly low and investors are eager to jump headfirst into all things tech. SPACs have become all the rage with tech companies who have been considering the IPO route and those providing the capital are all too eager to accommodate them. The influx of capital into the market continues to drive things upward, but not all parties are convinced. Last month, David Solomon, CEO at Goldman Sachs warned that the SPAC boom is “not sustainable in the medium term.”
SPAC acquisition deals are intriguing compared to IPOs for several reasons, particularly when it comes to the amount of time required for a company to enter public markets. Where the IPO process can take six months or more, SPAC deals can be wrapped up in three months (and sometimes less). SEC investigation and disclosure are much less involved as the shell company side of the transaction has no books to look over. SPACs also offer private companies a stronger long-term investment base via a private investment in public equity (also known as PIPE).
These SPAC shell company listings, also known in the industry as blank check companies, solicit capital from investors without divulging what the target acquisition may be. The SPAC works to build a fixed amount of capital in a predetermined amount of time. If the capital target is not met, the capital is returned to investors.
Critics contend that the current SPAC boom is leading to deals with companies that have no clear business plan or prospects for revenue. The hurried nature of the mergers also leaves open the door to warning signs or fraud that might have otherwise been uncovered during the IPO process. One of the most infamous cases in recent memory is that of Nikola (NKLA), a zero-emissions vehicle firm that went public on the back of a SPAC merger and had members of its leadership step down. The company was accused of misleading the public and partners about its products by Hindenburg Research. This led to Nikola's stock value being pummeled in September of 2020 and it has yet to recover from the highs it experienced prior to the accusations.
Just this week, Churchill Capital Corp IV (CCIV), a popular SPAC that had experienced staggering jumps in valuation during early 2021 on rumors that it would be merging with electric vehicle firm Lucid Motors, felt the wrath of market volatility. Yesterday, CCIV formally announced the merger with Lucid, leading to a 30% drop in its stock price. The shell company’s value had benefited from the electric vehicle hype, but some investors were clearly concerned with the merger and the $56 billion market cap implied for Lucid. Lucid has yet to produce a commercially available product and will miss the originally scheduled Spring 2021 start of production on its Air luxury car. The merger’s implied market cap puts Lucid in the same air as General Motors (GM), even though it has no revenue to speak of.
Predictably, the unprecedented success of Tesla (TSLA) has whipped investors into a frenzy, but this type of fervor has previously pushed SPAC mergers to unsustainable highs, particularly during the dot-com bubble of the early 2000s when any tech company with half a pulse could raise unfathomable amounts of investment capital. Like most bubbles, the dot-com bubble crashed and burned, leaving only those entities who produced revenue standing in its wake.
SPACs are clearly the horse that investors are hitching their wagons to in the current market. Caution seems to be thrown to the wind, even in the face of regulatory concerns. As previously mentioned, these shell companies must complete their mergers within a limited time frame or the capital must be returned. With as many as 300 SPACs set to expire in 2021, expect their founders to work towards finalizing mergers, even at the cost of shareholder value, to avoid expiration. If the market is a skyscraper and adding new floors is making money for investors, you don’t want the building foundation to be made for shaky SPACs.