IPO 2.0 — SPACs
Why the world needs a new IPO process and what are the benefits to it.
In the 90ies, we had over 8,000 domestic companies listed on U.S. stock exchanges. About 3,600 firms were listed on U.S. stock exchanges at the end of 2017, down more than half from 1997.
First of all, you have to ask yourself if this is a problem and if yes, what could be a solution to that?
So, what has happened?
Some blame regulation — notably, the 2002 Sarbanes-Oxley legislation, designed to counteract the accounting frauds of the 1990s. In the decade of irrational exuberance leading to the crash in 2000, many “concept-companies” with no revenues and no proof-of-concept entered the public stage just to be delisted a few years later. Remember: Pets.com?
But that cannot be all.
Although the number of public companies has decreased, the overall company valuations have grown in unprecedented size, most notably the so-called FAANG-stock: Facebook, Apple, Amazon, Netflix, and Google. Their valuations helped to increase the total market value of the fewer public companies. When you compare the total market value as a percent of gross domestic product, we have reached already in 2016 the peak levels of 1999:
Granted, size might be an issue in itself. Fewer, bigger companies could reflect an unhealthy degree of concentration and dominance. Again, though, it’s dangerous to generalize: In many cases, you need a pioneer to create a new market and capitalize fully on it. Those companies have proven, that they are extremely most productive and profitable. But in recent years, we are facing an issue if these companies are innovating enough and bringing enough value to society.
So, what happened with all the other high-profile private companies?
Once upon a time, selling shares to the public was an important way for companies to raise money — and for early investors to cash out. That’s was not the case in the last decade.
Private Equity and Venture Capital was abundant and helped companies to stay longer private. Venture Capitalists could also count on follow-on financing series (B, C, D…) or exist via M&A. Large public enterprises focused on their M&A strategies to build out their platforms e.g. Microsoft (acquired LinkedIn), Facebook (acquired WhatsApp), or Salesforce (acquired Tableau).
In 2017, just 15 percent of venture-capital exits involved initial public offerings:
According to venture capitalist Chamath Palihapitiya, the flow and distribution of private money let to an “enormous multivariate kind of Ponzi scheme” (Chamath Palihapitiya)
“We are, make no mistake… we are in the middle of an enormous multivariate kind of Ponzi scheme” — Chamath Palihapityia, 2018.
This scheme can be described as venture capitalists pushing the valuations of private companies via follow-up round to increase their IRR to raise further money from Limited Partners for the next fund. On paper, the investors and Limited Partners experienced massive gains. Unfortunately, when some companies became too large and tried to IPO. The whole house of cards failed e.g. WeWork.
Tim O’Reilly also criticizes the current Silicon Valley investing approach and calls it a delusion that reminded him of the Financial Crisis of 2008.
It reminds me of Wall Street going up to 2008. The idea was, ‘As long as someone wants to buy this [collateralized debt obligation], we’re good.’ Nobody is thinking about: Is this a good product? — Tim O’Reilly, 2020
VCs have created more financial instruments similar to CDOs than profitable companies. They stopped thinking about whether this company could survive on revenue from its customers. Deals are designed entirely around an exit.
This short-term thinking has let even to a general underperformance of venture capital in comparison to the public market. Venture capitalists only returned on huge wins, but they are only happening sparsely. Unfortunately, those rare opportunities are not predictable but rather a systematic gamble.
“A huge amount of the VC capital doesn’t return. Everybody just sees the really big wins. And I know when they happen, it’s really wonderful. But I think [those rare wins] have gotten an outsize place, and they’ve displaced other kinds of investment. It’s part of the structural inequality in our society, where we’re building businesses that are optimized for their financial return rather than their return to society.” — Tim O’Reilly, 202)
A new type of businesses
Building businesses should be more optimized for their return to society rather than their financial return.
On the other hand, Wall Street (public market) is obsessed with free cash-flows. Hedge funds and activists do not push S&P500 companies to spend more on R&D. In fact, only a third of the S&P500 companies have R&D budgets, which means that they don’t invest in the future. Their thinking can be described as the following:
Short-term capitalism: Let’s borrow money to buy back shares to boost stock prices for short-term gains.
In contrast:
Long-term capitalism: Let’s invest in innovation and disruptive technology paradigm shifts for long-term gains.
We as a society should invest further into innovation and breakthroughs that move society forward. Those projects are consuming a lot of time and resources but are enormously rewarding in the end. Think of clean and abundant energy or interplanetary travel. As Sam Altman has stated in a world where everyone worries about instead gratification, these people will be hugely rewarded that are patient.
“One of the notable aspects of compound growth is that the furthest out years are the most important. In a world where almost no one takes a truly long-term view, the market richly rewards those who do.” — Sam Altman
So, what kind of method exists to change this paradigm?
Over the last decade, investors’ appetite for private tech companies has increased while IPOs for tech companies have declined. This let to increasing private technology company valuations as more and more investors wanted to get exposure to the fundamental economic shifts.
At a certain stage, a company would normally experience material benefits from being publicly-traded. It increases brand awareness, enables a liquid acquisition currency, and enables access to additional capital.
Is there any effective way to get this for a tech company done?
Let’s talk about SPACs, baby!
Special-purpose acquisition companies, also known as SPACs, once a last resort for owners looking to exit an investment, have become a popular choice for private companies spooked by the swings in the regular IPO market. The volume of SPAC deals hit an all-time high in 2019 and the trend is getting more accelerated in 2020.
SPACs are blank-check companies that raise money through a traditional IPO to buy other companies. In 2020, SPACs have accounted for 38% of US IPO filings and raised $6.5 billion as of May 20th — more than the total capital raised by institutionally-backed IPOs during the period, according to an analysis of company disclosures and PitchBook data.
The COVID-19 pandemic may explain why there’s been an uptick in SPAC activity this year. As private companies’ valuations fall and they look for liquidity, SPACs could fill a void left by traditional IPOs.
SPACs have no principal risk because the money is held in a U.S.-based trust account with Continental Stock Transfer & Trust Company acting as trustee. It’s important to remember that SPACs are ultimately an extremely safe asset, which may appeal to investors with worries about the full impact of the pandemic. Each SPAC will hold cash in trust, meaning investors with enough patience to wait for a chance to redeem have virtually no downside. If the deal will not happen or you dislike the proposed deal, everyone will be receiving his or her principal investment of $10,00 per unit and maybe more depending on the interest-earning.
For investors, SPACs offer a ground floor seat on a future deal with low up-front risk. The SPAC’s founders usually have two years to find a deal after an IPO. Once they do, it’s a matter of convincing investors to back the acquisition they’ve identified.
With the recent success of Virgin Galactic (SPCE), DraftKings (DKNG), and Nikola (NKLA) have attracted many more investors into SPACs. Also, more renowned private equity giants TPG Capital and The Carlyle Group as well as investment banks such as Goldman Sachs have sponsored SPACs giving them more credibility.
Recently, Bill Ackman has filed his expected SPAC IPO, Pershing Square Tontine Holdings, Ltd., (PSTH.U). It presents the largest SPAC ever with 3 billion dollars in trust and a committed $1 billion Forward Purchase Agreement with additional potential capital.
Currently, we are a virtuous cycle where better sponsors, better investors, and more mature companies have created a tremendous opportunity for SPACs. Theoretically, SPACS offer sponsors to get very good targets at much lower valuations.
IPO 2.0
One of the leading investors that have labeled SPACs as “IPO 2.0” is Chamath Palihapitiya. He has brought with his company Social Capital Hedosophia I. ()Virgin Galactic (SPCE) to market. Their mission is the following:
“Our mission is to create an alternative path to a traditional IPO for disruptive and agile technology companies to achieve their long-term objectives and overcome key deterrents to becoming public” (Social Capital Hedosophia)
Social Capital Hedosophia is offering in the process: operational excellence, broad, global reach, efficiency.
“We believe that a more streamlined and transparent path to the public market will encourage private companies, in the technology industry in particular, to go public while allowing them to remain operationally focused on long-term value creation. As a result, public market investors can gain more near-term, direct investment exposure to long-term technology themes.” (Social Capital Hedosophia, 2017)
In the recent downturn around February/March, Social Capital Hedosophia filled for IPOB, raising $414 million, and IPOC, raising $828 million. Here are a few reasons why these two vehicles offer a great investment opportunity:
- The public market is flooded with new investors and currently, it seems that it is decoupled from the common economic reality. There aren’t that many obvious opportunities for a 10x return on investment. While public companies have access to secondary offerings and bond issuance, private companies are facing unprecedented challenges and need cash right now. Startup funding has dried up. It would be worthwhile to go public with the right support.
- Chamath Palihapitiya is able to close a valuable deal for its shareholders and taking a private tech company public. He has vast experience building successful tech products for AOL and Facebook and showed his ability in identifying amazing investment opportunities at Social Capital. During the first 8 years, the fund's performance from 2011 to 2018 was 32.9% (IRR) in comparison to the 15% of the S&P500 (including dividends). During this time, he also managed to identify great investments like Slack (Work), Telsa (TSLA), Amazon (AMZN), Bitcoin, and Golden State Warriors. His investment decisions are unconventional and thoughtful. He as a sponsor has significant capital at risk if he doesn’t close a deal and makes the company long-term successful.
- We are at the beginning of a technological revolution not at the end. We need to focus on frontier technologies. Focus on healthcare, climate change, and education (while we are moving to become a more resilient society). You want to support the process of IPO 2.0, where long-term investors are being rewarded and not short-term thinking investment banks. Companies receive permanent capital to move forward with further R&D.
- You are rewarded with a one-third of a warrant for each unit of IPOB.U or IPOC.U. This enables you for further upside and rewards your patience. The additional return of investment in the case of Virgin Galactic (SPCE) reached 40% via holding the warrant until redemption.
- Investing in IPOB.U or IPOC.U has no principal risk because the money is held in a U.S.-based trust account at J.P. Morgan Chase Bank, N.A., with Continental Stock Transfer & Trust Company acting as trustee.
- There is a huge appetite for real venture capital investments. Retail investors and family offices are looking for anticorrelation and exposition to real alpha during the current pandemic and economic crisis.
*** I’m currently long IPOB & IPOC ***
