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What made the froth in transportation SPACs go flat?

AskWaves: Hedge funds that plowed money into SPACs are taking early exits

Nikola Corp. was in the vanguard of SPACs in 2020 and hype surrounding the startup swept up other SPACs, driving up share prices that have since tumbled. (Photo: Nikola)

Special purpose acquisition companies targeting startups to take public have not gone away. On the contrary, more than 500 SPACs are currently searching for targets across all sectors. But in almost all cases, SPACs that have completed mergers with transportation companies are performing more like risky investments than they did in 2020. 

What happened?

FreightWaves spoke on background to SPAC experts who agreed to share insights without attribution. They laid out several reasons for the hot-to-not state of SPACs that raise money to merge with companies that may not be ready for prime time.

SPAC initial public offerings are sold primarily to institutional investors, and the follow-on private investment in public equity (PIPE) is sold exclusively to those investors. SPAC shares are available to all investors, including retail traders who sometimes create volatile pricing through so-called meme stocks and unregulated message boards that distribute legitimate and non factual information on the company or transaction. 

SPACs completing mergers with their targets have fewer restrictions than traditional IPOs, which are prohibited from making projections of future revenue and profits. Traditional IPOs also are tightly managed by investment banks that primarily make the market and sell shares to institutional investors and insiders, leaving the public to buy shares after the stock is priced. 

Retail investors can get on board a SPAC anytime after the sponsoring company is listed — to their profit or their peril.

Few deals rejected in SPAC world

As little as a year ago, practically no SPAC deals were rejected because of the tremendous excitement around the decarbonization possibilities of electrification and hydrogen. In the SPAC world, investors elbowed each other to to get bigger stakes, often without doing the diligence necessary to see if the target company could stand on its own. 

Is there a better example than Nikola Corp.? The startup electric truck and hydrogen company was in the vanguard of SPACs. Heavily hyped by founder Trevor Milton, some of the claims he made were found to be untrue, and Milton awaits trial next April on federal fraud charges.

But his hyperbole drove shares in SPAC sponsor VectoIQ more than three times higher than their $10 price. When the business combination closed in early June 2020 and Nikola (NASDAQ: NKLA) stood on its own, the share price kept rising, touching $93.99 before beginning a long retreat. Nikola closed at $10.46 a share on Friday.

“Nikola really had a big impact not only on their own company, but all the other companies in the whole SPAC sector because Trevor made the stock a cult following,” one SPAC expert said. “He really courted retail investors with all his TV appearances. And the media was all too happy to have his big personality on their shows — and the stock ran because of it.”

Now, in the post-Milton era, it is up to Nikola to prove it can produce trucks at scale and make hydrogen. If the company does that, investors will return, another SPAC expert said.

Rising tide raises all boats

Nikola’s rising tide-raises-all-boats effect on other transportation SPACs in electrification and transportation acted as a tug boat to Hyliion Holdings, at the time a little-known maker of hybrid-electric powertrains. 

Hyliion (NYSE: HYLN) engaged in little promotion outside the world of traditional investors. Founder Thomas Healy was the antithesis of Milton, a straight-talking engineer who avoided excess. But retail traders pushed Hyliion shares above $58 before it went public in October 2020. Excited investors didn’t see the business plan for a natural gas-battery electric hybrid truck was several years out. 

With no revenue and rising costs to get to production, Hyliion’s stock could not sustain its price. After a recently announced one-year delay in its Hypertruck ERX, Hyliion shares closed Friday at $6.69, just pennies above its 52-week low. Hyliion, too, has to perform to win back investors. Company followers on Twitter clamor for Hyliion to show ordering momentum. 

SEC scrutiny

The SPAC frenzy continued beyond the first quarter of 2021, but the size of the deals with some exceptions shrank as scrutiny grew.

The Securities and Exchange Commission, which for months approved most SPAC IPO deals with few comments, began raising red flags to slow the SPACs roll as it lobbies Congress for changes in how SPACs are regulated.

First, it required accounting changes for stock warrants given in fractions to SPAC IPO investors, requiring them to be listed on company books as liabilities rather than equity.

Later the SEC questioned the length of share lockups for SPAC sponsors, who typically get 20% of the new SPAC’s initial common shares as a “promote” fee. The commission more recently expressed concern for retail investors. Similar calls are now being heard from members of Congress.

“It’s such a technical trade, that’s why I think the SEC is worried about the retail investor,” one SPAC expert said. 

Hedge funds and early redemptions

More recently, heavy redemptions of SPAC shares before the business combination closes are becoming the norm. SPAC IPO investors essentially take no risk. They pay $10 a share, get a fraction of a warrant to purchase shares in the merged company at $11.50, and they can get all their cash back up to 48 hours before the business combination concludes. 

Holders of SPAC shares are privy to all of the details of the proposed combination before having to make their redemption decision. And they get to keep the warrants generated by the original purchase whether they redeem or not.

In the case of hedge funds, which are big investors in SPACs, it is a win-win trade.  If the SPAC announces a deal that trades up, the fund stays invested or sells in the open market at a profit.  If the announced deal fizzles, they can redeem before the deal closes and keep the $11.50 warrant option as a bonus. 

This arrangement led to an oversupply of hedge fund capital willing to invest in SPACs.  More recently, as SPAC deals have traded down, redemption has also become a no-cost way of raising money to pay investors who choose to exercise their monthly right to withdraw their funds. And the hedge funds participating in a SPAC are largely unknown before the merged company files a registration statement after the close. Names like Black Rock and Fidelity get the up-front attention for investing.

“You see those names advertised in the PIPE because the SPAC and the companies are thrilled that those fundamental investors are participating,” one SPAC expert said.

Hedge fund managers can redeem SPAC shares at no loss. And they may use the proceeds to cover the cost of prior commitments to purchase PIPE shares. Those shares are not registered for sale until 30-60 days after a SPAC merger closes. Many newly public companies are trading below the $10 price the PIPE investor agreed to pay.

Significant redemptions hit the SPACs of recently public autonomous trucking companies Aurora Innovation (NASDAQ: AUR) and Embark Trucks (NASDAQ: EMBK) pretty hard. Aurora had $755 million worth of SPAC shares redeemed and Embark $300 million before their mergers closed, reducing the available proceeds they were counting on to fund their business plans.

Left holding the bag

Retail investors who buy shares in a SPAC and elect not to redeem can be left holding the bag. In the case of Embark, the shares in sponsor Northern Genesis Acquisition Corp. traded around $9.90 before the business combination. When Embark began trading, shares opened more than $1 less.

“SPAC retail investors who pay $10 or less per share enjoy a riskless trade until the redemption date. But the day after closing, the risk is on,” one SPAC investor said. “And if they don’t really understand all the levers, they can make [unwise decisions leading up to and past redemption because they really don’t understand the financial implications.”

Embark Trucks concludes SPAC but bolting investors take back $300M

Self-driving startup Aurora Innovation trades 14.67 lower in public debut

SPAC shareholders approve merger to make Hyliion public

Click for more FreightWaves articles by Alan Adler.


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Alan Adler

Alan Adler is an award-winning journalist who worked for The Associated Press and the Detroit Free Press. He also spent two decades in domestic and international media relations and executive communications with General Motors.