SPAC Investing: A bubble in the making

What’s common between Nikola, Fisker Inc, Canoo Holdings, Lordstown and Hyliion? 

They all have a multi-billion valuation despite having never generated a dime in revenues. The fact that they don’t have revenues is not very surprising because they have NOT made any products yet and don’t have any commercial services. As for the multi-billion valuation, it would have come as no surprise had they been early stage private start-ups. The remarkable thing is that they are public companies or will debut on the public markets within the next few months. These businesses are selling a vision rather than a proven track record of turning that dream into reality. This is stuff for the private markets only. 

Turning a profit was never required to go public - Palantir, SnowFlake and Slack are a few companies that went public despite having negative profits. However, no product, no commercial services and no sales growth track record are a new fad. 

So how did these companies rocket to multi-billion valuations on the public markets? 

They got to the public markets by merging with SPACs, which are basically shell companies - for more information about SPACs check out this post. While none of these shell companies have made it to the Panama Papers yet, they will probably form the next investing bubble. If you recall the dotcom bubble, you’ll know that things don’t always work out too well when companies go public with little more than a prototype and a business plan. 

As mentioned in a previous post, SPACs have emerged as an alternative to the traditional IPOs going public because they are more efficient, faster and less costly. However, this is now coming at the expense of proper due diligence. 

“Bet on me” is the pitch that backers of SPACs make to investors. This works if the backers are proven investors who have taken multiple successful companies and not simply riding a trend. Unfortunately, the recent frenzy indicates that SPACs are now riding the electrification (EV) trend and the hype that pushed Tesla to over $380 billion in market cap even though it remains only modestly profitable. While Tesla’s valuation could potentially be argued considering it was able to deliver on its vision, the SPACs and the aforementioned companies have nothing to show for it and they simply want a piece of the action. Let’s look closer:

• Nikola, the poster child of SPACs as a popular way to go public, is facing very serious allegations about its operations and technology - namely, their lack of both. Nikola’s CEO had to resign and the company is yet to show a working truck.

• Fisker forecasts $10.6 billion in yearly sales and $1 billion of free cash flow by 2024, even though it won’t begin production of its Ocean electric SUV until the end of 2022. Such forecasts are unreliable guides for investors, especially when knowing that Fisker’s first venture, Fisker Automotive Inc., filed for bankruptcy in 2013 after safety recalls and battery supply issues. The forecasts are all about helping investors get comfortable investing in a company with no current revenue.

• Hyliion - a heavy truck electrification company-  won’t have a product to sell and hence no revenues until late 2022. By its own estimates, Hyliion will at best generate $2 Billion in revenue by the end of 2024. Still, it now has a market cap over $7 billion after Tortoise Acquisition Corp., a SPAC, merged with Hyliion to take it public. Let’s not debate the valuation and focus on what reported by Bloomberg about the exorbitant gains the sponsors of the SPAC pocketed. The sponsors for the SPAC put in $7 million and will receive promotion fees that amount to $450 millions in equity value; that’s 80% of the $560 million Hyliion will receive. In an IPO, bank underwriting fees usually don't exceed 7% of the gross proceeds. This outcome may fuel the debate about whether SPACs are less costly to go public than IPO and should raise questions whether the  high fees (known as the “promote”) are justified. There’s a bigger question because these fees are not disclosed in a way retail investors can easily understand.

I have seen enough to know that hype alone doesn’t equal sales even when you have a product. When all that a public company has is a vision, with no product, no prototype, no revenues, and a multi-billion valuation, it’s best to stay away.

The SPAC hype, especially in EV, has too many similarities to the dot com bubble. While I hope it doesn’t turn into a new bubble, it definitely has all the signs of one. I’ll stay away and I recommend that investors look before they leap into investing in SPACs.  Due diligence is always important, more so in the case of investing in SPACs because it seems like  the dream of making huge returns is what’s driving the mania for launching them.

Disclaimer: This post is merely my own assessment and is not an investment recommendation. For professional advice, seek input from a licensed investment advisor.