Donald Trump enters SPAC frenzy. So what is a SPAC?
Former President Donald Trump announced last week that his nascent media and technology enterprise will soon become a public company. But the launch will not follow the traditional initial public offering, or IPO, route and will instead utilize an increasingly popular shortcut known as a SPAC. SPACs, or special purpose acquisition companies, have become all the rage on Wall Street, but relatively few investors know much about them.
The route to becoming a public company has generally involved a lengthy process beginning with an application to the U.S. Securities and Exchange Commission and encompassing a thorough review of the company’s financial statements and other documentation. The process is highly visible, costly, requires voluminous disclosures and can take upwards of a year to complete. The SPAC process is basically a clever workaround that has become an increasingly popular method for bringing companies public.
Rather than starting with a specific company and working to list it, SPACs are created with no particular company in mind. They are basically pools of cash raised from investors by the creators or “sponsors” that, once funded, will go in search of a target company. The SPAC vehicle itself is listed on an exchange like the NYSE or NASDAQ through an IPO, but the IPO process is simple and quick since the SPAC only holds cash. Shares are typically issued at $10 per share in sufficient quantity to account for all the invested capital.
The SPAC then sets about looking for a private company to take public by merging the company into the already public SPAC. At that point, the SPAC shares are converted into shares of the combined entity and the SPAC goes away, leaving a public company just as if it has followed the IPO path.
Note however some interesting features. First, unlike an IPO, very little due diligence is required of the target company, so SPACs have tended to focus on less stable or financially established companies presenting greater risks — companies with “hair” on them. SPACs have often served as the route of last resort to public listing, although deals like Virgin Galactic and DraftKings have garnered more mainstream respect.
Also, it is not much of an exaggeration to say that investors in SPACs are buying a pig in a poke, relying entirely on the sponsors to choose and execute merger deals with the money they have invested. For that reason, those entities are often called “blank check companies.” Most SPACs do not even limit their scope to a specific industry, although institutional investors establish relationships with SPAC sponsors in whom they have confidence based on prior experience. It is the retail or individual investors who trade the SPAC shares with little or no knowledge who are most vulnerable to losses.
This brings us to the former president’s SPAC deal. Trump was banned from Twitter and Facebook in the aftermath of the Jan. 6 insurrection at the Capitol. In February, Trump formed a company called Trump Media and Technology Group. The company plans to create a new social media platform similar to Twitter to be called “Truth Social.” The company also intends to launch a news network and entertainment streaming service.
Last week, the former president announced that Trump Media would merge with a SPAC called Digital World Acquisition Corp., trading under the ticker DWAC. Redolent of the recent meme stock mania in Reddit names like GameStop and AMC, shares in DWAC have soared by more than 900% since the announcement of the merger deal, even though virtually no details of the new company have been disclosed and a presentation to investors included no financial information. Two of the original hedge funds invested in the SPAC have cashed out their profits as individual speculators have driven the market value of the enterprise to $3.5 billion. The actual cash value in the SPAC is $293 million.
Consumers will ultimately determine whether the nation needs another Parler or Newsmax. For the original investors who ponied up $10 per share, the launch has already been wildly successful despite the absence of any details. For the l atecomers who paid $109 per share, it might bear remembering that hope is not a strategy.