The Looming SPAC Meltdown
What’s driving SPAC mania on Wall Street? Not the billionaires and bankers making headlines daily, but a mob of little-known hedge fund investors, the “SPAC Mafia,” who are incentivized to gobble up these opaque public offerings with little concern over w
What’s driving SPAC mania on Wall Street? Not the billionaires and bankers making headlines daily, but a mob of little-known hedge fund investors, the “SPAC Mafia,” who are incentivized to gobble up these opaque public offerings with little concern for whether they ultimately succeed or fail.
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you want to see the future of so many of the special purpose acquisition companies currently flooding the market, look to the recent past. Nearly five years ago, Landry’s Seafood billionaire Tillman Fertitta took Landcadia Holdings public to the tune of $345 million. No matter that, true to the SPAC “blank check” model, there was not yet any operating business—dozens of hedge funds piled into its $10-per-unit IPO.
In May 2018, Landcadia finally located its target: a budding online restaurant delivery service called Waitr that would merge with the SPAC in exchange for $252 million in cash. Fertitta touted the fact that the Louisiana startup, with $65 million in revenue, would now have access to 4 million loyalty members of his restaurant and casino businesses, and a new partnership with his Houston Rockets NBA franchise. Two years later, though, you very likely have never heard of Waitr. As such, its stock recently traded at $2.62, down more than 70% from its IPO price (the S&P 500 has climbed 76% over the same period).
Waitr was a disaster for pretty much anyone who bought the stock early. But the hedge funds that purchased Landcadia’s IPO units did just fine. Virtually all recouped their initial investment, with interest, and many profited by exercising warrants in the aftermarket. “SPACs are a phenomenal yield alternative,” says David Sultan, chief investment officer at Fir Tree Partners, a $3 billion hedge fund that bought into Fertitta’s Landcadia SPAC IPO—and pretty much any other it could get its hands on.
The SPAC boom of 2020 is probably the biggest Wall Street story of the year, but almost no one has noticed the quiet force driving this speculative bubble: a couple dozen obscure hedge funds like Polar Asset Management and Davidson Kempner, known by insiders as the “SPAC Mafia.” It’s an offer they can’t refuse. Some 97 percent of these hedge funds redeem or sell their IPO stock before target mergers are consummated, according to a recent study of 47 SPACs by New York University Law School professor Michael Ohlrogge and Stanford Law professor Michael Klausner. Though they’re loath to talk specifics, SPAC Mafia hedge funds say returns currently run around 20%. “The optionality to the upside is unlimited,” gushes Patrick Galley, a portfolio manager at Chicago-based RiverNorth, who manages a $200 million portfolio of SPAC investments. Adds Roy Behren of Westchester Capital Management, a fund with a $470 million portfolio of at least 40 SPACs, in clearer English: “We love the risk/reward of it.” What’s not to love when “risk” is all but riskfree? There’s only one loser in this equation. As always, it’s the retail investor, the Robinhood novice, the good-intentions fund company like Fidelity. They all bring their pickaxes to the SPAC gold rush, failing to understand that the opportunities were mined long before they got there—by the sponsors who see an easy score, the entrepreneurs who get fat exits when their companies are acquired and the SPAC Mafia hedge funds that lubricate it all. It’s about to get far worse for the little guy. Giant quant firms—Izzy Englander’s Millennium Management, Louis Bacon’s Moore Capital, Michael Platt’s BlueCrest Capital—have recently jumped in. Sure, they all raised billions based on algorithmic trading strategies, not by buying speculative IPOs in companies that don’t even have a product yet. But you don’t need AI to tell you the benefits of a sure thing. And that means torrents of easy cash for ever more specious acquisitions. Says NYU’s Ohlrogge: “It’s going to be a disaster for investors that hold through the merger.”
In the first 10 months or so of 2020, 178 SPACs went public, to the tune of $65 billion, according to SPACInsider—more than the last ten years’ worth of such deals combined. That’s just one indication that the current wave of blank-check companies is different from previous generations.
In the 1980s, SPACs were known as “blind pools” and were the domain of bucket-shop brokerage firms infamous for fleecing gullible investors under banners such as First Jersey Securities and The Wolf of Wall Street’s Stratton Oakmont. Blind pools circumvented regulatory scrutiny and tended to focus on seemingly promising operating companies—those whose prospects sounded amazing during a cold-calling broker’s telephone pitch. The stockbrokers, who typically owned big blocks of the shares and warrants, would “pump” prices up, trading shares among clients, and then “dump” their holdings at a profit before the stocks inevitably collapsed. Shares traded in the shadows of Wall Street for pennies, and the deal amounts, were tiny, typically less than $10 million.
In 1992, a Long Island lawyer named David Nussbaum, CEO of brokerage GKN Securities, structured a new type of blank-check company, with greater investor protections including segregating IPO cash in an escrow account. He even came up with the gussied-up “special purpose acquisition company” moniker.
The basics of the new SPACs were as follows: A sponsor would pay for the underwriting and legal costs of an initial public offering in a new shell company and have two years to use the proceeds to buy
an acquisition target. To entice IPO investors to park their money in these new SPACs as the sponsors hunted for a deal, the units of the IPO, which are usually priced at $10 each, included one share of common stock plus warrants to buy more shares at $11.50. Sometimes unit holders would also receive free stock in the form of “rights” convertible into common stock. If a deal wasn’t identified within two years, or the IPO investor voted no, holders could redeem their initial investment—but often only 85% of it. GKN underwrote 13 blank-check deals in the 1990s, but ran into regulatory trouble with the National Association of Securities Dealers, which fined the brokerage $725,000 and forced it to return $1.4 million for overcharging 1,300 investors. GKN closed in 2001, but Nussbaum reemerged in 2003 running EarlyBirdCapital, which remains a big SPAC underwriter today. SPACs fell out of favor during the dot-com bubble years, when traditional IPO issuance was booming. In the early 2000s, interest in SPACs returned with the bull market, and the deals started getting bigger. Leading up to the 2008 crisis, dealmakers Nelson Peltz and Martin Franklin both turned to SPACs for financing, raising hundreds of millions of dollars each. Around 2015, SPACs began to offer IPO investors 100% money-back guarantees, with interest; the holder would also be entitled to keep any warrants or special rights, even if they voted against the merger and tendered their shares. Even more significantly, they could vote yes to the merger and still redeem their shares. In effect, this gave sponsors a green light on any merger partner they chose. It also made SPAC IPOs a no-lose proposition, effectively giving buyers a free call option on rising equity prices. As the Fed’s low-rate, easymoney policy propelled the stock market higher for over a decade, it was just a matter of time before SPACs came back into vogue. And so they have, with unprecedented force.
Hedge funders may be the enablers of the SPAC boom, but they certainly aren’t the only ones getting rich. In September, a billionaire-sponsored SPAC called Gores Holdings IV said it would give Pontiac, Michigan– based entrepreneur Mat Ishbia, owner of mortgage lender United Wholesale Mortgage, a $925 million capital infusion, which would value his company at $16 billion. If the deal is completed, Ishbia’s net worth will rise to $11 billion, making him one of the 50 richest people in America. “I never knew what a SPAC was,” Ishbia admits. There are also the sponsors, underwriters and lawyers who create SPACs, each taking their pound of flesh from the deals. Sponsors, who pay underwriting and legal fees to set up and merge SPACs, normally wind up with a generous shareholder gift known as the “promote”—roughly 20% of the SPAC’s common equity after the IPO.
Alec Gores, the private equity billionaire who helped take United Wholesale public, has listed five SPACs and raised over $2 billion. In the United Wholesale deal, Gores and his partners are entitled to purchase $106 million worth of “founder shares” for $25,000, or $0.002 a share. Gores’ private equity firm hasn’t raised a new fund since 2012. With easy scores like this, why would he?
Among SPAC sponsors, few can match Chamath Palihapitiya’s frenetic pace. Palihapitiya, 44,
A HANDFUL OF BILLIONAIRES ARE STRUCTURING FAIRER DEALS WITH THEIR SPACS. BUT MOST SPAC DEALS DON’T COME WITH BENEVOLENT BILLIONAIRES ATTACHED.