Programming note: Money Stuff will be off tomorrow, back on Thursday. SPACsMy model of SPACs and IPOs goes like this: - A private company is worth some uncertain amount of money.
- A company that has been public for a while is worth some reasonably stable observable amount of money, its market price.
- The transition between those states is hard.
- To become a public company, the private company has to sell its shares to some initial public buyer or buyers.
- Those initial buyers take the risk that the price they pay for the stock when it first goes public will end up being higher than the ultimate public market price of the stock.
- To get them to buy, you have to compensate them for that risk, by selling them the stock for less than you think it will ultimately be worth.
- In good stable times this compensation can be low, since the risk is low.
- In wild volatile times the risk is high, so the compensation has to be high.
The normal way to do all of this is the IPO, the initial public offering, where you go out to investors and market the stock to them and take orders and try to find a price that enough investors can accept. Then you sell the stock to them at that price, it opens for trading, and probably it goes up; they were compensated for their risk by a 10% or 20% or 30% "IPO pop." Or 100%, this is not an exact science. Or sometimes the stock goes down and you're like "well, right, that was the risk." A less common way to do it is the SPAC, the special purpose acquisition company (or "blank-check company").[1] The SPAC is an empty shell that raises a bunch of money publicly (in an IPO) and then tries to find a target company to merge with; the merger makes the target company public. The simple way to think of this is that the SPAC will agree to buy a private company's entire IPO at a fixed price: Instead of launching a deal and marketing it to investors and seeing what price it can get, you just negotiate the price with the SPAC and announce it with a fixed price and size. The SPAC gives the cash to the company, the company gives shares back to the SPAC, the SPAC gives those shares to its investors, and now those investors are the owners of shares in a newly public company. Compared to an IPO, the SPAC is much less risky for the company: You sign a deal with one person (the SPAC sponsor) for a fixed amount of money (what's in the SPAC pool[2]) at a negotiated price, and then you sign and announce the deal and it probably gets done. With an IPO, you announce the deal before negotiating the size or price, and you don't know if anyone will go for it until after you've announced it and started marketing it. Things could go wrong in embarrassing public fashion. In volatile times, that certainty is worth a lot more, so companies are looking for it. From today's Wall Street Journal: Fallout from the coronavirus has fueled a fresh wave of interest in an unusual investment vehicle with a shaky reputation: the blank-check company. ... Buzzy startups such as electric-truck maker Nikola Corp. and sports-betting operator DraftKings Inc. used blank-check deals to go public this year. On Sunday, health-care-services provider MultiPlan Inc. said it was merging with a blank-check company in an $11 billion deal that would be one of the largest such transactions ever. Meanwhile, a growing number of prominent executives have been launching new blank-check companies in hopes of finding a hot acquisition target. … Fallout from Covid-19 has put many businesses under stress and led backers of new SPACs to bet that they can find distressed companies to acquire. And as volatility made it tougher for companies to hold IPOs, some turned to deals with SPACs, which can offer a quicker and more reliable route to going public. … Nikola was considering two ways to go public at the beginning of 2020: an IPO or a deal with VectoIQ Acquisition Corp., a blank-check company led by a former General Motors Co. executive. Then the coronavirus hit. Getting an IPO done began to look uncertain as markets tumbled, recalled Nikola Chief Financial Officer Kim Brady. With a typical IPO, a company learns how much capital it is raising only after several months of wrangling with underwriters and investors. It can also fall through at the last minute, especially if markets slide. A SPAC deal can take a similar time to complete, but the negotiations are simpler—involving the company and the SPAC—and the terms are determined earlier in the process.
The risk—the range of possible difference between the private company's uncertain valuation and its ultimate public valuation—has gone up, so private companies are more interested in avoiding that risk. But the fact that the risk has gone up also means that if you want to avoid it, you have to pay someone more to take it. The SPAC structure is less risky for the company than an IPO, which means that it's riskier for the SPAC (than just buying shares in a regular IPO would be), which means that the SPAC should be compensated by getting an even bigger discount than regular IPO investors. There are two ways to do this. One is that the price of the SPAC deal is negotiated, and—just as in an IPO—you can, and probably should, sell shares to the SPAC for less than they're worth. If a SPAC with a billion-dollar pool of money buys a 20% stake in a company that's worth $8 billion, then the SPAC's billion dollars of cash has bought $1.6 billion of stock, and you'd expect the shares to go up by 60%. In fact the track record of big SPACs recently looks a bit like that: We talked about Nikola last month, and I noted that it arguably had a 240% first-day pop, selling shares at $10 that traded up to $33.97 on its first day as a public company.[3] The stock closed at $53.95 yesterday, a bit more than a month after the SPAC deal closed. If you sold stock for $10 in an IPO, and it went up to $53.95 in a month, a lot of venture capitalists would complain that you left money on the table. The other way is structural: A SPAC offering usually consists of common shares and warrants. If you buy in the SPAC offering you get both a share of SPAC stock (which will transform into the target company's stock when the SPAC does a deal) and a (fraction of a) warrant to buy another share of SPAC stock after the deal is done. Basically if the SPAC merges with a good company at a big discount to its true value, which is its goal, you'll be able to buy more shares of that good company at a discount. In an IPO you just buy stock and hope that it goes up; in a SPAC, if your stock goes up, you get even more of it. The SPAC is getting more value on the upside to compensate it for taking more risk. This is all fine, it's good, it's what financial engineering is supposed to do. There is a problem, a risk: Companies want to go public, but they are worried about the risk of the market collapsing. There is a solution, a holder of the risk: A SPAC will take a company public in a fully sold deal with a fixed price and size, so they don't have to worry about the market collapsing. There is a price: The SPAC doesn't take this risk because it is nice, or foolish; it takes this risk because it expects to make much more money than a typical IPO investor. In normal times, the risk is low, the compensation is low, and the tool is not used that much. In volatile times, the risk is high, the compensation is high, and people talk about SPACs a lot. SPACs: Far PointWell. The idea is that a SPAC is less risky, for the company, than an IPO: You negotiate a deal with one person (the sponsor of the SPAC), you sign off on a size and price, you announce it to the market as a fait accompli and it probably gets done. But you don't get 100% certainty. For one thing, the SPAC will normally have withdrawal rights: Investors in the SPAC who vote against the deal can demand their money back, which will reduce the amount of money that you raise. You don't expect that to happen—remember, you're giving the SPAC investors a discount to encourage them to roll their SPAC shares into your company—but the point is that you are doing this in risky volatile times, and sometimes that discount won't be enough. Or, even worse: The SPAC shareholders have to vote to approve the deal, and while again you should expect that to happen (you should be giving them a good deal), it is not a certainty. If you sign up a good deal with a SPAC, and then things go horribly wrong with your company before the shareholder vote and it becomes a bad deal, the shareholders could vote down the deal and you'll get nothing. DealBook notes today that "Far Point, a SPAC backed by the hedge fund mogul Dan Loeb and Thomas Farley, a former president of the New York Stock Exchange, is urging its investors to reject the $2.6 billion takeover of Global Blue, a tax-free shopping company." That is: Far Point Acquisition Corp. went public in 2018, raising $550 million; in January, it agreed to a deal with Global Blue; and in May, it decided that the deal was no longer a good idea and asked its shareholders to reject it. From last week's proxy statement: After approval of the Merger Agreement, FPAC management was informed by Global Blue management that the ongoing COVID-19 pandemic was having a significant negative impact on Global Blue's financial condition, revenues and results of operations. … As a result, after careful consideration and consultation with its management and outside legal advisers, FPAC's board of directors has changed its recommendation for FPAC's stockholders to vote against the Business Combination Proposal and the Adjournment Proposal.
Awkward! Ordinarily, in a public-company merger, if a board of directors changes its mind like this it needs to pay the other side a big termination fee, but SPACs are just pots of money held in trust for public shareholders so its harder to do that; the Far Point merger agreement has no termination fees. Just as in an IPO, the deal isn't really done until you get the cash, and while you're more likely to get the cash in a SPAC merger than in an IPO, there's still some risk. If you buy stock in a bankrupt company because you don't know how bankruptcy works, should the rules of bankruptcy be changed to allow you to get your money back?Nope! Amateur investors who loaded up on J.C. Penney Co. shares as the retailer went bankrupt are now pleading with a judge to spare them from a complete wipeout. "I hope and pray for you to consider the shareholders," wrote 50-year-old individual investor John Hardt in a letter dated May 25, one of dozens sent to the Corpus Christi, Texas-based court overseeing the case in recent months.
Absolutely not! That is not how it works! Hardt is part of a growing number of retail traders -- many driven by lockdown boredom and free online trading -- who have piled into the stock market. Speculation by amateurs is nothing new, but for the first time experts can recall, investors are buying shares of even bankrupt companies. Hertz Global Holdings Inc., oil driller Whiting Petroleum Corp. and J.C. Penney have all seen their stock price surge in recent sessions, despite being in Chapter 11. Those gains almost always prove fleeting, leaving retail traders with little to show for their stakes other than an expensive lesson in the U.S. corporate bankruptcy process -- where shareholder value disappears almost as a rule. That's because all creditors have to be made whole before equity owners get anything. For J.C. Penney investors, there's little to suggest this time will prove any different. … Mom-and-pop investors who insist on betting on struggling companies would be well advised to stay away from those in or near bankruptcy, said Fred Ringel, a partner and co-chair of the bankruptcy department at law firm Robinson Brog Leinwand Greene Genovese & Gluck. "People who buy equity hoping that they're not going to get wiped out in a bankruptcy just don't understand the process," Ringel said.
Etc. How would you fix this? What theory of "financial literacy" would help you here? Imagine that every high school student in America was required to take a state-of-the-art full-year financial-literacy course: Would this be covered? How? Would the course spend a week on the corporate bankruptcy process, explaining the absolute priority rule and the idea of a fulcrum security? Or would there be a list of trivia at the end, a bunch of miscellanea that has tripped people up in the past and that students would just have to memorize? "Don't buy stocks that are in bankruptcy, just trust us. Don't buy stocks with five-letter tickers ending in 'Q,' just trust us." I think if you had gone to 100 investment advisers six months ago, and asked them each to write down the 100 most important things for retail investors to know, your list of 10,000 tips would include many variations on "high returns come with high risks" and "compound interest is good" and "save as much as you can," but probably zero advisers would have said "don't buy stock in bankrupt companies"? It just doesn't come up, until it does; it is so obviously wrong that you'd never think to advise people against it. But it is obviously wrong if, you know, you took bankruptcy in law school, or if you've been in the financial markets for a while and have seen what recoveries in Chapter 11 look like. It's obvious to you and me. It is not innately obvious to humans generally; it is not knowledge we were born with. You could come to a solution of the form "every time a retail investor tries to buy shares of a company in bankruptcy on their brokerage's app or website, a big red warning should pop up that explains the bankruptcy process in a brief, accurate and scary way, and then asks if they're sure they want to do this." But that is a very specific solution, addressing one particular problem that happened to occur in the last month or two; there will be others. The problem here is not really that some retail investors do not understand the intricacies of bankruptcy; it's that you can find some retail investor who doesn't understand anything, and that investor is probably making a mistake. I think the two general solutions are: - Retail investors should not be allowed to trade single stocks on their phones without, I don't know, talking to a financial adviser or passing a detailed financial-markets-knowledge test or signing a Certificate of Dumb Investment; or
- Ignore this, don't worry about John Hardt, just accept that some people are going to make financial decisions that they don't understand and that cost them a lot of money, and hope that in the long run it all somehow works out for the best. "Well, if they lose all their money, they'll learn not to do it again," super.
Chop roomWe have talked a lot about the differences between legal and practical corporate control. There is some theoretical hierarchy in which the employees answer to the chief executive officer and the CEO answers to the board and the board answers to the shareholders, but there is also the practical reality that the company is a bunch of people in some locations doing stuff, and if those people stop listening to the people above them in the hierarchy—if they lock the door to keep the shareholders out—then the legal rights may not matter that much. "The night watchman controls the company, sort of," I like to say, "if he can change the locks overnight and not let the managers and directors and shareholders in the door the next morning." We have also talked a few times about the Chinese version of this, which involves the corporate seal, or "chop." You need the chop to validate documents, and so in practice whoever has the chop controls the company. What is pleasing about the chop is that it conveys purely symbolic, theoretical control—it's not a lock on the front door, it's not an army of loyal employees, it's just a stamp—and yet it is also a physical object that you can literally put in your pocket or try to wrestle from someone else. Anyway here's a good Wall Street Journal article about chops, and about the recent controversies at Chinese companies that have (maybe?) fired their CEOs but whose CEOs have hung on to the chops. For instance: According to the company, Mr. Li left with almost 50 official ink-stained Dangdang chops stuffed into a shoebox which he vowed not to part with until he found justice. "I will have sole custody of the chops, tying them to my belt during the day and keeping them under my blanket during the night," Mr. Li announced to his 5.4 million followers the next day on the Chinese social-media service Weibo.
And: Though chop-hostage crises have long been a source of corporate drama in China, the sudden spate of high-profile cases has prompted a number of companies to seek out legal advice and custodianship over their seals, says Vivian Mao, a partner at professional services firm Dezan Shira & Associates, whose offices across China include special "chop rooms" where the prized rubber stamps are kept under lock and key.
It is the modern equivalent of a magic amulet. If you control a company, you do so as a purely social fact: A bunch of people who work there will treat you as the boss, a bunch of customers will treat you as their counterparty, the legal system will treat you as a controller. Everything that you think gives you control—share certificates and board resolutions and a big desk—is just a symbol of those intangible social facts. But if you concentrate enough symbolism in one more or less arbitrary physical object, that physical object will become almost as good as the social fact itself, and you'll end up sleeping with it under your pillow. Radical transparencyI don't know why I love Bridgewater Associates gossip so much but I am pretty sure it is their fault. Their whole self-presentation, as a firm, is that they spend all of their time talking about each other. They wouldn't call it gossip, because they talk about each other to each other's faces; they'd call it "radical transparency" and critical self-examination. Still! James Comey once investigated a Bridgewater executive for saying that she had typed an email that her assistant actually typed, and "videos of the interrogations were edited and later rolled out in a serialized fashion, a Bridgewater version of a reality TV show." I like workplace gossip as much as the next person, maybe more, but I cannot imagine that level of commitment. It is wild stuff. Speaking of wild stuff: Bridgewater Associates, the world's largest hedge fund, was found to have "manufactured false evidence" by a panel of arbitrators in its attempt to prove that former employees had stolen its trade secrets. According to court documents made public on Monday that quote findings from a panel of three arbitrators, Bridgewater was found to have "filed its claims in reckless disregard of its own internal records, and in order to support its allegations of access to trade secrets, manufactured false evidence".
You know, if it was any other hedge fund I'd be like "sure whatever it's a cutthroat business," but this is Bridgewater! And, disappointingly, in a confidential arbitration! At the very least, there needs to be a public show trial in which the entire management committee of Bridgewater is interrogated by a former FBI director about what they knew when about this allegedly manufactured evidence. If there wasn't a pandemic they should do the show trial at Carnegie Hall, but in any case it should be videotaped and made available to everyone forever. I will serialize it in Money Stuff. I don't mean that a court or the arbitrators or whoever should order this trial, by the way, I mean that Bridgewater should just volunteer to do it themselves, out of their commitment to radical transparency and embarrassing people as much as possible. Things happenSheelah Kolhatkar profiles Steven Mnuchin. Ten Thousand Day Traders an Hour Are Buying Tesla Shares. Wall Street Reaps a Bonanza on Fed's Support for Corporate Debt. McKinsey warned Wirecard a year ago to take 'immediate action' on controls. Wirecard Draws German Scrutiny Over Insider Trading Suspicion. NYC Hedge Funds Angle for Work-From-Home Windfall on Their Taxes. SoftBank ready to do deals as shares soar to 20-year high. M.B.A. Programs Debate Dropping GMAT. Tons of Redskins nickname options have been trademarked by a guy in Virginia. Squirrel tests positive for the bubonic plague in Colorado. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] A third way to do all of this is a direct listing, where you just let the stock trade on the stock exchange without selling a big chunk of it to new investors. No one really takes the risk of buying at a negotiated initial price, so you don't have to compensate them for that risk; you avoid the whole issue. (But you don't raise any money, which is often the point of doing all of this to begin with.) [2] Actually it is common for SPAC deals to be done alongside private deals with the sponsors to raise more than what's in the public SPAC, but the point is that it's a negotiated known amount of money. [3] That math is debatable and I explain my assumptions in footnote 1 here. | 
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