Choppy Waters

I enjoy kayaking, and so one of the ways by which I enjoy exploring the new places I visit is on a kayak. This one time, my sister Ash and I were in Victoria and we decided to go for a kayak. It was early spring, and although the sun was shining bright, it was quite windy. But we (mostly me) were undeterred, and googled for nearby kayak shops and found one right by the harbour. As we walked down to the shop, we could see the waters were quite choppy, and the boat and water taxi traffic was only exacerbating the choppiness. Having only kayaked once before and that too in a small lake, Ash was quite deterred at this point and suggested we grab beers on the patio instead. But I tried convincing her that it would be fun and even offered to get a tandem kayak (I am too competitive to enjoy tandem kayaking). 

The poor sis finally relented, and we got a tandem kayak. The rule of the thumb is that the more experienced kayaker takes the back seat, and acts like a helmsman. So that’s what I did, and told Ash to just relax and enjoy our beautiful adventure for the next couple of hours. The ride started out choppy but we paddled quickly to get away from the boat traffic and the tailwinds helped immensely. I could tell my sister had relaxed and was enjoying the scenic view and we were chatting and laughing as we kayaked along the upper harbour to Rock Bay. The water was quite calm when we got there and we took a little snack break while soaking up the glorious sun. 

Then it was time to head back. At the back of my mind, I was aware the headwinds would make the ride back not as smooth, but I was confident (read irrationally exuberant) that it’ll be no big deal. It was considerably more work to get back and we were pushing through until we got close to the harbour and now in addition to the headwinds, there were crazy choppy waters and the boat traffic seemed to have doubled from when we had left. The water was so choppy and the winds so against us that it didn’t matter how much we paddled, we weren’t getting anywhere. It was either our kayak would hit a boat and/or capsize any minute. We were completely drenched and had both lost our caps to the wind. I joked to my sister that it felt like we were in the war and had to defeat the enemy to get to the dock. But she didn’t find it funny. We narrowly escaped hitting a couple boats, and very luckily, drifted enough to hit the edge of the dock. The boys at the kayak store had been watching our war action live and pulled us in. We came out physically unscathed (mentally I’m not sure), albeit wet and that was the last time my sister ever kayaked. 

The reason I told you this story is because markets, especially the SPAC market seems to be in the choppy waters phase right now, where no matter how good the kayaker, the water is just too choppy and the winds too strong and the goddamn boats, just way too many of them. I had quite a few people reach out to me this past week asking why there was no “pop” on $AGC announcement of GRAB acquisition this week (because 30% pop ain’t no pop), does the SEC intervention of the warrants reclassification mean doom for SPACs (no, just an administrative back end issue but yes more intervention should follow) and has Chamath lost his title as the SPAC King because Bloomberg said so? (also, no).

There are two ways to understand the SPAC-a-lack-o-pop: one is the macro environment and the other is SPAC trading environment. Let’s try to dissect each below. 

When Diamond Eagle Acquisition Corp. took Draftkings public last year, the COVID pandemic had just recently hit the West and the stay-at-home routine was still very new to folks. They were at home playing video games and engaging in fantasy sports betting when they saw one of the big names in the sports betting industry go public via this esoteric new vehicle called SPAC. Since both the company that marked the advent of SPACs to the retail world (NYSE: DKNG) and the outsized return that the merger produced was something that they natively understood as consumers of sports betting, there was an instant match.

In a way, COVID helped Chamath democratize access to the IPOs because these stay-at-home investors turned out to be early and smart adopters. They understood the trade: Take the stimmy check and use it to buy the SPAC at NAV, and then flip it on deal announcement when it pops, and roll the returns on to the next one. Rinse and repeat. 

Fast forward a year, the situation is a bit different. People have stayed in their homes far too long, and the end of COVID seems to be in sight as more and more people get vaccinated and want to use their stimmy check to buy flights to Hawaii instead of Joby Aviation, which promises commercial electric flights starting in 2024. The macro economy has shifted - the ten year rates have gone up, which has reflected in contraction for the (over-extended) multiples in the growth stocks in general, including SPACs. The SPAC supply has hit record levels with 560 SPACs with $179B in trust searching for targets in the next 18-24 months. This has led to sub par SPAC deals where we are starting to see lawsuits against the companies that were a bit too bold in their projections, and where the sponsors are struggling to get deals done because they can’t line up PIPE financings. The SEC has entered the chat as well. And there is only so much capital that you have to buy the dip, and crypto > SPACs, I get it. 

Because of the aforementioned factors, I do feel that the easy winning trade of buy at NAV, sell on deal announcement is over for now. There is still the trade of buying the units and waiting 52 days before they split into commons and warrants, and make double of what the ten year is yielding. But even there the warrants are increasingly trading at depressing levels and this trade generally works better with volume. 

I may be the messenger of bad news here, but the choppy market is telling us that the trade going forward is to buy and hold. To buy SPACs at NAV and hold them for a while. To earn those pops. To do some due dili on what you’re buying. It’s really Econ 101 - for the asset class to go back to equilibrium, the SPAC supply has to come down and the SPAC quality has to go up. The supply side has already slowed down considerably, and this new trade effectively addresses the demand side of the equation by removing the non-quality investors from the market as they are already off chasing $DOGE. It also improves the quality of SPAC sponsors in searching for better deals as they know that once the deal closes, the minimum floor of $10 no longer remains and they still have lockups that expire later and also potential future SPACs to sponsor.

All is to say that yes the market gyrations continue and have been squeezing out the easy alpha that we have all been hooked on but we are only going through the necessary cycle of getting back to the equilibrium. And as the asset class evolves, it goes from being a short term trading vehicle to being a conduit for the retail investors to be early investors in growth companies, something that the traditional IPO structure has failed to do. This is why I agree with Howie when he says that SPACs are an elegant feature that are here to stay.