It’s time to talk about SPACs and how they compare to IPOs
Hyliion, and its young CEO, who is set to become a paper billionaire, is poised to go public using a special-purpose acquisition vehicle
After the troubles at Nikola you’d think stock market investors would have had their fill of start-ups that promise to revolutionise the trucking world.
Yet this week, another Texas-based truck electrification business, whose founder is even younger than Nikola’s, is poised to go public. And once again, a special-purpose acquisition vehicle (SPAC) is in the driving seat and making piles of money.
Hyliion’s CEO Thomas Healy, 28, will become a paper billionaire — a fact that’s sure to capture plenty of attention — as long as the shareholders of cash shell Tortoise Acquisition vote on Monday in favour of a merger with his company.
A Carnegie Mellon mechanical engineering graduate, Healy doesn’t spend a lot of time on Twitter and seems more modest than Nikola’s boastful chair Trevor Milton, who resigned last week after a scathing short-seller report raised awkward questions about his company.
Unlike Milton, Healy isn’t trying build an entire truck. Hyliion’s main goal is to supply hybrid and electric propulsion systems that can be slotted into various manufacturers’ existing heavy truck models and thereby lower their emissions and the total cost of ownership.
One can debate whether a truck component supplier that won’t generate meaningful revenue until 2022 should be valued at about $7bn, as it will be after the deal. But ignore the technology — and Healy’s $1.5bn anticipated net worth — for a second, and focus on the SPAC.
Before we decide traditional IPOs are outdated, it’s vital that investors understand the financial interests that SPAC sponsors have
Considering the limited financial risk involved, the riches Tortoise’s creators are poised to reap are every bit as astonishing as Healy’s. Based on regulatory filings, I calculate the sponsor has sunk less than $7m of its money into the SPAC and yet it will receive about $450m in equity value from Hyliion.(1)
To put that in context, this is about 80% of the $560m cash proceeds Hyliion gets by merging with Tortoise.(3) In a traditional initial public offering (IPO), bank underwriting fees usually don’t exceed 7% of the gross proceeds. This outcome may add fuel to the debate about whether SPAC’s high fees (known as “the promote”) are justified. There’s a question, too, about whether these fees are disclosed in a way retail investors can easily understand.
The dream of making such stonking returns is what’s driving the mania for launching SPACs. North American SPACs have raised more than $40bn so far in 2020, according to Bloomberg data.
Tortoise is led by Vince Cubbage, a former oil and gas executive and former investment banking sector head at Banc of America Securities. He and Healy declined to be interviewed ahead of the shareholder vote, citing a regulatory quiet period.
In fairness, Hyliion almost certainly wouldn’t be on the cusp of becoming a public company if Cubbage hadn’t alighted on it as a target in March. By June, Tortoise had completed due diligence and the two parties agreed Hyliion would be valued at $1.5bn, including its cash. In their rush it looks like Healy left a lot of money on the table.
The retail investor frenzy that propelled Tesla to a $380bn valuation this year — and valued Nikola at $29bn — has boosted Tortoise and Hyliion too. Hyliion encouraged the association by comparing the merits of the three companies’ technologies.
Tortoise shares have more than quadrupled in value since the merger announcement. This is the SPAC equivalent of the first-day IPO “pop” that critics dislike because it short changes founders. Going public via a SPAC is less time-consuming than a regular IPO and it lets the target negotiate a sale price directly with the sponsor, rather than letting the price be determined by the whims of institutional investors or prevailing market volatility. But it doesn’t alleviate the pop problem, as my colleague Matt Levine has often noted.
SPAC sponsors are typically handed 20% of the SPAC shares for free, which can allow for a profit even if the target they find is a dud. The really big money is made if the SPAC merges with a target whose value soars, as Hyliion’s has. That’s because a sponsor also receives warrants giving the right to purchase more stock if the price rises above a certain level.
Jay Clayton, chair of the Securities and Exchange Commission (SEC), said last week it was examining how SPAC sponsors disclose their pay structures. The SEC reviewed Tortoise’s proxy statement and must have been happy with the way it disclosed the SPAC’s potential compensation. The information on shareholdings is all there but investors wishing to know the total potential financial return to the sponsor, including the warrants, must do a little maths themselves.(2)
Before we decide traditional IPOs are outdated, it’s vital that investors understand the financial interests that SPAC sponsors have. Otherwise founders and regular shareholders risk losing out.
In Hyliion’s case, I doubt anyone’s upset as everyone involved is getting rich — for now. Fresh from his success with Hyliion, Cubbage has raised $345m to find another target via a second SPAC. But if the hype around SPACs and their zero-revenue targets fades, investors won’t always be so accepting of those fees.
(1) The sponsor paid $25,000 for its founder shares and another $6.7m for the warrants. At current prices, the Tortoise sponsor will own Hyliion shares worth $532m following the merger. I’ve subtracted from that the cost of exercising the warrants. The sponsor’s actual return may be affected by financial arrangements with directors and an investor, Atlas Point Energy, described in this proxy statement. Sponsors also incur costs outside the SPAC structure.
(2) A figure that includes the separate pool of institutional money, known as a PIPE, that Tortoise arranged.
(3) Tortoise’s proxy statement prominently explains the sponsor has interests in the merger that are different from regular shareholders, that the sponsor’s founder shares are worth $233m and that it holds millions of private placement warrants. The proxy statement also discloses the percentage share ownership if the warrants are exercised.
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