What You Need to Know about SPACs – Wall Street’s Hottest Trend

Recently, U.S cryptocurrency exchange “Bullish” announced it is aiming for a $9 billion listing on the New York Stock Exchange via a merger with Far Peak Acquisition Corporation, a special purpose acquisition company (SPAC).

While many were focusing on what this transaction will mean to the crypto industry, others were asking, what is a SPAC and why should I learn about it? Still, others want to know if it’s an investment strategy that’s here to stay or another Wall Street fad.

What is a Special Purpose Acquisition Company (SPAC)?

According to most legal sources, a special purpose acquisition company (SPAC) is a company with no commercial operations that is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing company.

SPACs aren’t new. They have been around for decades, but have recently become more popular because low yields have driven investors to seek alternative ways to increase their capital. Not only have they become popular with sophisticated, high-wealth individuals, but they have also drawn the attention of underwriters who envision a big payday in the form of commissions and fees.

SPAC IPOs have seen a resurgent interest since 2014, with increasing amounts of capital flowing to them.

  • 2014:  $1.8 billion across 12 SPAC IPOs
  • 2015:  $3.9 billion across 20 SPAC IPOs
  • 2016:  $3.5 billion across 13 SPAC IPOs
  • 2017:  $10.1 billion across 34 SPAC IPOs
  • 2018:  $10.7 billion across 46 SPAC IPOs
  • 2019:  $13.6 billion across 59 SPAC IPOs
  • 2020:  $83.3 billion across 248 SPAC IPO

How is a SPAC Formed?

A SPAC is created, or sponsored, by a team of institutional investors, Wall Street professionals from the world of private equity or hedge funds. They create this entity that has no commercial operations. It makes no products and does not sell anything. In fact, the SPAC’s only assets are typically the money raised in its own IPO, according to the Security and Exchange Commission (SEC).

What’s interesting about a SPAC is that when it raises money, the investors buying into its IPO do not know what the eventual acquisition target company will be. That’s part of its mystique, however, since institutional investors with track records of success can more easily convince other investors to invest in the unknown. Due to this, a SPAC is also often called a “blank check company.”

How Does a SPAC Operate?

After the SPAC is legally created, it now needs cash to create the capital needed to do the acquiring of another company, for example, in the future. Remember, the SPAC is not going to raise money to buy equipment, computers, software, or even pay rent. It needs the money to buy what is often referred to as the “eventual acquisition target company”.

A SPAC will raise the money it needs through its own IPO. CNBC says that SPAC IPOs are usually priced at $10 a share. Once the initial capital is raised, the money goes into an interest-bearing trust account until the SPAC’s founders or management team finds a private company looking to go public through an acquisition.

Legal experts say that once an acquisition is completed (with SPAC shareholders voting to approve the deal), the SPAC’s investors can either swap their shares for shares of the merged company or redeem their SPAC shares to get back their original investment, plus the interest accrued while that money was in trust. The SPAC sponsors typically get about 20% stake in the final, merged company.

Time is of the Essence

Once SPAC sponsors raise the capital they need to go to work acquiring companies, they can’t sit on the funds forever, even if they are protected by trust and earning interest. SPAC sponsors also have a deadline by which they have to find a suitable deal, typically within about two years of the IPO. Otherwise, the SPAC is liquidated and investors get their money back with interest.

What are the Advantages of a SPAC and Who Benefits?

Owners of smaller companies find selling to a SPAC more profitable because the sale often adds about 20% to the price of the deal compared to a typical private equity deal. Additionally, being acquired by a SPAC can also offer business owners what is essentially a faster IPO process under the guidance of an experienced partner, with less worry about the swings in broader market sentiment.

Business owners are often worried about extreme market volatility or the fear that weak investor sentiment could force the postponement of an IPO. By dealing directly with the SPAC, these worries are essentially eliminated.

Furthermore, a deal with a SPAC can be wrapped up in just a few months versus the traditional process of registering an IPO with the SEC, which can take up to six months.

Basically, the key advantage is a business owner can get his money faster and without a lot of government tape.

Are There Any Pitfalls?

Nothing is guaranteed and SPACs are no exception to that rule. Although they are extremely popular in 2021 for large institutional investors and other billionaire backers, this trend can go away quickly if “something better” comes along.

Other factors that could determine its long-term popularity include the fact that target companies run the risk of having their acquisition rejected by SPAC shareholders. Even the rich get cold feet about a deal. Furthermore, investors are literally going blindly into the investment.

SPACs will probably retain their popularity until the major players decide to let the smaller investors into the game. That’s usually when the rules change and the government regulations get tougher in order to protect undercapitalized investors from losing all their money.

What are Some High-Profile Examples of SPACs?

We don’t know yet how the SPAC for Bullish will play out because it was just announced. But since it involves cryptocurrencies, it will probably become a profitable venture since investors looking to get aboard the craze have been throwing money at the asset class.

High-profile SPACs like DraftKings and Virgin Galactic have performed well for investors, but that hasn’t always been the case with average returns from SPAC mergers completed between 2015 and 2020 falling short of the average post-market return for investors from an IPO.

A noted prominent short-seller of SPACs said, “a business model that incentivizes promoters to do something – anything – with other people’s money is bound to lead to significant value destruction on occasion.”

Like any investment, it pays to do your homework before putting money into a SPAC.

Could DraftKings Be the Next Meme Stock?

The WallStreetBets Reddit forum is eyeing another stock for its growing list of the most shorted stocks. Sportsbetting site DraftKings is stumbling in today’s trading with, the stock down almost 5%. The reason for the declines has placed another target on short-sellers.

The sell-off in DKNG was triggered by a short position in the stock announced by Hindenburg Research. DraftKings went public via a SPAC in 2020 before blank-check deals were all the rage. Shares are still up 9% for the year, but investors fled the stock on the heels of Hindenburg’s disclosure.

This piqued the curiosity of the WallStreetBets crowd, who are wondering if there is a short squeeze in the making and profits to be had in the stock. Hindenburg says DraftKings’ tactics are “questionable,” accusations that were not lost on the Reddit investor bunch who could not ignore the irony.

Isn’t It Ironic?

In its report, Hindenburg Research dissected the DraftKings business model, alleging that the company is involved in:

  • “black market gaming”
  • “money laundering”
  • “organized crime”

The activist investor points the finger at tech provider SBTech, which is the entity with which DraftKings merged to go public. Hindenburg’s due diligence involved discussions with company alum, regulatory filings and internet research.

The Reddit crowd is crying foul, saying first that it is no surprise that “the gambling business is shady, to begin with” and calling the hedge funds out for their own unscrupulous trading strategies.

While retail investors may have made DKNG the latest object of their affection, the stock was still under pressure for the day, though it trimmed its 8% declines during pre-market trading by half. If the Reddit crowd is as relentless with DraftKings as they’ve been with GameStop and AMC Entertainment, Hindenburg Research might want to tread lightly.

Meme Stock Update

The selling pressure has spilled over to leading meme stock GameStop, whose shares are down nearly 7% in today’s session. The stock has advanced more than 1,000% year-to-date, so investors might just be taking some profits.

Meanwhile, movie chain AMC has been oscillating around the USD 60 level as investors continue to drive the stock price higher. Today’s gains of nearly 5% are indicative of bullish momentum that has been dominating the stock for the past few sessions as retail investors keep the squeeze on short-sellers.

DraftKings Posts Better-Than-Feared Quarterly Loss; Lifts Full-Year Revenue Outlook

The U.S.-focused gambling operator DraftKings reported better-than-feared loss and higher revenue in the first quarter and raised the 2021 revenue outlook but the strong results failed to lift stocks which have lost over 18% so far this month.

Boston-based sports betting platform said its revenue increased 253% to $312 million from $89 million seen during the same period a year ago. That was above Wall Street’s consensus estimates of $236.2 million. The company reported a loss per share of $0.36, better compared to analysts’ expectations for a loss of $0.42.

DraftKings raised their forecasts for its fiscal year 2021 revenue guidance to $1.05 billion to $1.15 billion, up from a range of $900 million to $1 billion, which equates to year-over-year growth of 63% to 79% and a 16% increase compared to the midpoint of our previous guidance.

The increase reflects solid performance in the first quarter of 2021, continued strong user activation due to the effectiveness of our marketing spend, well-executed launches of mobile sports betting and iGaming in Michigan and mobile sports betting in Virginia, and a modest contribution from our recently completed acquisitions, the company said in the statement.

At the time of writing, DraftKings shares traded about 5% lower at $46.06 on Monday.

Analyst Comments

“1Q revs and updated ’21 rev guidance meaningfully beat, showing how strong the US sports betting / iGaming mkt is and DKNG’s dominant position. However, DKNG suggested higher EBITDA losses and is issuing materially more stock comp than expected. Our price target drops $3 to $63, still attractive, Overweight,” noted Thomas Allen, equity analyst at Morgan Stanley.

DraftKings Stock Price Forecast

Twenty-three analysts who offered stock ratings for DraftKings in the last three months forecast the average price in 12 months of $70.86 with a high forecast of $105.00 and a low forecast of $50.00.

The average price target represents a 53.78% increase from the last price of $46.08. Of those 23 analysts, 17 rated “Buy”, six rated “Hold” and none rated “Sell”, according to Tipranks.

Morgan Stanley gave the base target price to $63 with a high of $182 under a bull scenario and $11 under the worst-case scenario. The firm gave an “Overweight” rating on the gambling operator’s stock.

Several other analysts have also updated their stock outlook. Craig-Hallum slashed the target price to $60 from $70. Needham lowered the stock price forecast to $73 from $81. Benchmark trimmed the price objective to $64. JP Morgan cut the target price to $54 from $58. Truist Securities slashed the target price to $54 from $65.

“The continued progression of beat and raise quarters, coupled with strategic substantiveness should draw a positive reaction in the shares and supports our bullish stance on the name. The degree of stock reaction should also lie in commentary from Mgt regarding more recent complex state legalizations and the roll-out of its tech platform through the remainder for the year. Execution and estimate progression are central to our call, rather than valuation,” noted David Katz, equity analyst at Jefferies.

Check out FX Empire’s earnings calendar

DraftKings Having Tough Time Attracting Shareholders

DraftKings Inc. (DKNG) is trading higher by a few cents on Wednesday after the New York State Legislature approved the legalization of mobile sports betting. The consent opens the door to one of America’s largest gambling populations at the same time the competitive landscape for betting sites is growing at a geometric rate. As with streaming-video-on-demand (SVOD), this crowded venue is likely to reward winners and punish losers in coming quarters.

New Venues Driving Growth

The state will whittle down the number of permitted operators, with special consideration to “tribal gaming partnerships”. DraftKings should make the final cut but as many as six companies could ‘go live’ when the law goes into effect in late 2021 or early 2022. Meanwhile, legalized betting in many states as well as recent deals with World Wrestling Entertainment Inc. (WWE) and the UFC should keep quarterly revenue growth on the fast track.

Oppenheimer analyst Jed Kelly posted upbeat comments after the approval, noting “New York approved a hybrid limited-operator online sports betting (OSB) model as part of its 2022 budget. We believe based on the RFP process and the high amount of taxes/fees, that well capitalized players with a strong presence in NJ and large customer data-bases such as DKNG and Fanduel are well positioned to be key operators when the state goes live”.

Wall Street and Technical Outlook

Wall Street consensus is mixed despite rapid state level approvals, with an ‘Overweight’ rating based upon 16 ‘Buy’, 1 ‘Overweight’, 8 ‘Hold’, and 1 ‘Sell’ recommendation. Price targets currently range from a low of $41 to a Street-high $105 while the stock opened Wednesday’s session more than $10 below the median $75 target. This low placement suggests Main Street investors are avoiding exposure due to growing competition and a long string of quarterly losses.

DraftKings cleared March 2020 resistance in the upper teens in May and took off in a strong uptrend that topped out in the 60s in early October. The stock got cut in half into November and turned higher once again, stalling in the low 70s in March 2021. Price action since that time has carved an aggressive selloff after each rally impulse, setting off a wave of bearish accumulation divergences that could signal lower prices.

For a look at all this week’s economic events, check out our economic calendar.

Disclosure: the author held no positions in aforementioned securities at the time of publication.