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On today’s episode of The Financial Commute, we welcome Rajeev Das, a manager of SPACs (special purpose acquisition companies). A SPAC’s sole purpose is to facilitate a merger or a business combination between the SPAC and a privately owned enterprise to help that enterprise go public.

SPACs do this by issuing units to the public. Proceeds are placed in a trust account and invested in short-term U.S. Treasury bonds. Then, the SPACs team looks for a business combination within 18–24 months. If they are unsuccessful, the cash is returned to the investor with interest. If they are successful, the investors have the right to vote on the combination and request their money back if they disagree with the combination.

There are two ways to invest in SPACs: the pre-merger phase and the post-merger phase. Raj focuses on the pre-merger phase because investing in a company once it has gone public carries more risks. Raj says there is ample time to sell one’s shares if it is a well-received deal and there is no reason to stay past the post-merger phase.

Raj says the opportunity cost to investing in SPACs (rather than another investment) has decreased because we are no longer in a zero-interest-rate environment. An investor who pulls their money out from a pre-merger can now get their money back with 4% interest.

According to Raj, many people focus on how stocks of companies that were made public by a SPAC have done; however, this has been a rough year for the market in general, and SPACs may be worth examining for their safety and optionality.

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Thank you for joining us for another episode of The Financial Commute. I'm Chris Galeski, your host. I'm really excited to have Raj here. He's a manager of our SPAC Strategy special purpose acquisition company. It's a really unique way in terms of how they invest and why we use it. Raj, I know that there's a lot of acronyms that get thrown out in our world and some of it's over a lot of people's heads.

Tell us, like, what is a SPAC?

Okay, so a SPAC is a special purpose acquisition company, and it's a vehicle whose sole purpose is to facilitate a merger or a business combination between the SPAC and a privately owned enterprise. Okay. And the way the SPAC does this is by issuing units to the public. Each unit is issued at $10 per unit and comprises of one share and one warrant.

The proceeds from the issuance are placed in a trust account overseen by an independent trustee at a major U.S. financial institution. And the proceeds are invested in short term U.S. Treasuries, so very safe. Once that's done, the SPAC team then goes out and looks for a business combination. And what's important here is that they have a limited amount of time to do that.

It's usually 18 to 24 months. If at the end of that time period they're unable to find a business partner, the cash is returned to the investor with interest, no questions asked. If, on the other hand they are successful, then the investors have the right to review the business combination, vote on it. You can vote yes or no.

And you also have the right to ask for your money back if you don't like it. So again, no questions asked. Basically, you get a front row seat and you review the deal and if you don't like it, you can pull your money out.

So, SPACs have come into the news the last few years because of what happened during COVID. The access to capital was very difficult. But then there's all these vehicles, these SPAC vehicles that are sitting there with cash on the sidelines, and they allowed people to still transact businesses or find businesses to take public through the form of the IPO.

And that created this frenzy and this excitement. And then now SPACs, all of a sudden are in the news. How long have SPACs been around to help private companies go public?

They've actually been around since the late eighties and early nineties, but not in the form that we have today. Not with all the safeguards that we have in place. The current crop of SPACs that we see now with the right to redemption, with money sitting in treasuries, I would say that goes back to about 2005 when we first started investing in the space.

And it's kind of funny how we fell into it because we actually had climbed out Long Island who called us and said, look, you know, I have this broker calling me every day about this new IPO that he's doing. It's something called a SPAC. And he says, you can't lose. You know, yeah. So every time he tells me that I hang up the phone.

You know, most investment people say you can't lose. It's like run the other direction.

I guess. But he keeps calling me back. So can you guys take a look at this? And we said, sure we will, because a lot of what we do is do with shareholder activism and reviewing, you know, proxies and, you know, rewriting our own proxies and all that. So we are familiar with it. And you know, we did review the documents and, you know, and what the broker was telling us was correct.

So that's how we got involved with SPACs in a small way at first, just to make sure that everything that was being told was true and that it would pan out that way. Yeah. So yeah, so we have been doing this since 2005.

What do you like most about what you do with regards to investing in SPACs?

I think what's unique about SPACs is the structure. Okay. It gives investors the right to redeem if they don't like a deal. So essentially, you know, you're getting a free look at a deal. You review it, you don't like it, you get out. If on the other hand, the deal is good, you know, the shares and warrants that you get are going to trade higher.

And, you know, it's going to be profitable for you. So it's the safety plus the optionality. Yeah. Okay. So, you know, you grind it out. You know, you make you know, the rate that U.S. Treasuries are paying, you buy those at a discount. So you make a little more than that. And every now and then, you know, you have a SPAC that announces a well received deal.

And, you know, that's all gravy. So that's kind of what we like about the structure. That's where the edge is.

Whenever I think of a private company I'd like to go public, I think of In N Out, but that's because I'm out here in California. When you look at investing in SPACs, there's kind of there's two different ways to invest, right? There's the pre merger. So it's the raising of capital. And that money sits in U.S. Treasuries and then they go try to find a deal to then take it public.

And then there's the post-merger when that SPAC merges into that new company and becomes a publicly traded vehicle. You guys play it a little bit differently. Share with us how you like to invest in the space because of you mentioned the protection and the optionality.

Yeah. Yep. So we never stay in a SPAC once a deal is consummated. Okay. For us, it's all about pre-merger because once a deal is done and it's dispatched to use the term, what you really own is a small cap or a micro-cap operating company. It's no longer a SPAC. And, you know, all the risks that come with that and there's no edge in it.

We don't have any edge in analyzing, you know, companies in different sectors. And I don't think, you know, very many people do. So, the edge is, the pre-merger, which is really, you know the free look at a deal and your right to redeem. Now if it's a good deal, that time between the deal is announced and the deal is consummated can take anywhere from 4 to 7 months.

Yeah. Because of the SCC review process and allowing shareholders time to review the proxies and allowing them time to vote, there's ample time to sell your stocks and warrants if it's a well received deal and if the shares are trading higher. So there's plenty of time to do it. There is no reason to stay past the merger deadline because then

There's no protection optimization. Yeah. So you like to get in at the beginning or even a little bit below that $10 mark. If there's excitement or announcement around a deal and that goes from $10 to 12 or 13, you're going to take some money off the table to help protect investors. But along the way, if the deal doesn't go through or if no deal gets done, you're being returned your $10 at the end, plus the interest from the U.S. treasuries that you're making along the way.

That is correct. So, let's say it's not a well received deal, right? Yeah. So then the shares of the SPAC are going to trade below the cash that's in the trust and the trust account. So at that point, you know, you obviously don't want to sell it for a loss, so you'll just wait till you have the right to exercise and you know, you'll just get your money back.

And if it's a good deal, it's trading higher than the cash in the trust. You just sell it in the open market.

I know that we love this space from like a bond substitute, right? I mean, you have the protection on the downside. You can earn some U.S. Treasuries. It's a situation where it's very hard to lose principal money. So you're protecting capital, but then you have the opportunity to earn a really decent return over time. You know, call it 5 to 7% if certain deals get done. We're in an interesting time now with interest rates rising, inflation, how do you view the opportunity for investing in SPACs today and looking forward?

So with the short term U.S. Treasuries being 4% up from, say, you know, zero a year ago, the opportunity cost of owning a SPAC has gone way down. Okay. Because a year ago, if you owned a SPAC and they didn't announce a decent deal or if they liquidated, you would have gotten back, you know, your money plus interest.

But that interest was zero, right? So essentially, you know, you’re just getting 10 bucks back. But now that's changed, right, so now, if a SPAC doesn't announce a deal, then you know you're going to get your money back plus the 4%. So I think it just makes the space more attractive and interesting.

I think in the short term, what we're seeing is a bit of a hangover from, you know, the SPAC mania that we saw, you know, about 18 months ago where there was just tremendous issuance of SPACs. So like right now, if you look there's over 650 SPACs out there. Either they've announced deals, haven't completed it or they're still searching for deals.

And I think they control about $260 billion in capital. So there's a lot of competition if you're a SPAC sponsor looking for a deal. But in the first half of next year, about 50% of the SPACs are going to disappear. Okay, so the playing field is going to change. And I think for the SPACs that remain, you know, I think it's going to be a lot easier to find a well received deal because also don't forget that, you know, valuations are way down.

So if you're a SPAC sponsor, I think, you know, there's a lot more value to be extracted and just more ability to, you know, take advantage of the private public arbitrage that you know, that everybody talks about. So, I think it's going to get interesting again. I don't think we're going to see the frenzy that we saw two years ago where every deal that was announced, you know, the price would go from 10 to $20,000 overnight.

Yeah, yeah. But I think, you know, for deals that are well-structured and that has value, I think you will see the optionality. So it’d be on a case by case basis but also for the strategy to work and for you and your clients to hit your bogey. You don't need every deal to be a homerun. I think you have, you know, one or two deals that are homeruns.

If you have a few more that announce decent deals, you make a little money on the warrants and the rest, even if you get your money back with interest, you'll still get your bogey because don't forget, you're never losing, right? So you never have

You have that downside, but…

You never have to make up, you know that loss, you know, so that's very thoughtful.

I mean, you need 100% return to make up for a 50% loss. Exactly. So protection of capital becomes really important. Yeah. What are some of the biggest misconceptions or challenges that you face in investing in SPACs or communicating your story?

Yeah. So I think the press on SPACs is just 100% negative. You know, there's no focus on the structure. There’s no focus on, you know, where the SPAC has its cash invested, which is in short term treasuries. All the focus is on the SPACs and how, you know, those stocks have done and which, you know, I think look, I think for guys like you and me, I think it's good because it gives us an edge, right?

It's something that nobody else is focusing on. So we do our thing correctly. And I think that's great, but I think that's what the issue is. And, if you look at the SPAC index, it's down, I think about 49 or 50% year to date. But to be fair, if you look at an index of IPOs that's down, you know, over 50%.

You know, so one really has to, you know, factor in the climate that we're in. If you look at SPAC IPOs 2021, I think you had about 120 billion in IPOs. This year, you've had 13 billion. But if you look at traditional IPOs, I think that's down like overnight 95%. Yeah. And I think with the traditional IPOs have raised about six and a half billion this year.

So, you know, it's a tough time in the capital markets. And, you know, part of it is, of course, I think with SPACs, there was some mania as to what was going on and there were a lot of self-inflicted wounds. And, you know, just the sheer number of SPACs that were out there. But, you know, the market is, you know, self-correcting mechanism and, you know, all these SPACs in a way, two guys on a laptop and said, let's start a SPAC- that's going to be flushed out.

And, you know, at some point I think, you know, rationality will prevail, you know?

I think so. I mean, it's normal in the investing world to see irrational times at times. And that's just what happens. Yeah. You know, I think about the number of companies that went public through the form of the SPAC that were pre-revenue, never even sold a single unit, and their price went from $10 to north of 30, 40 or even a couple instances up to 80.

And now you look at those companies today and the stock price is probably down at five or six. Right? Right. I love the fact that you found a place to help protect capital, but also earn people a reasonable rate of return without taking on additional risk beyond the de-spac or the post merger. So thank you for talking with us today and sharing with us your story.

Thanks. Thanks for having me.

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DISCLOSURES:

Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and do not represent the views and opinions held by Morton Wealth. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your attorney, finance professional or accountant before implementing any transactions and/or strategies concerning your finances.