The Question of Q’s - Quality or Quantity?

When I was growing up, I had two types of friends - ones who were quality shoppers and the others who were quantity shoppers. Ones who would buy a nice pair of quality jeans from Banana Republic and the others who would buy 3 pairs from H&M. Both trades had their pros and cons - the BR pair cost more, so you could only afford one. But it lasted longer. But as a young university student trying to attract guys, you were limited in your dressing options. On the other hand, if you bought from H&M, the cost was cheaper and so you could buy more but you ended up sacrificing on the quality. But hey, perhaps you had better odds of scoring with the boys…who knows! I definitely don’t know because I preferred the quality camp. To all the boys I could have dated...ok I am already digressing!

Although I can afford to buy more than one pair of quality jeans now, I have been observing a similar dilemma unfold in the SPAC market recently. As I wrote a couple weeks ago, the oversupply of SPACs has caused the asset class to underperform recently and while the supply tap is slowly turning off, finding a good SPAC has been akin to searching for a needle in a haystack. So let’s go back and take a look at what happened. 

When the OG Chamath started the IPO 2.0 revolution in 2017, few were astute enough to marvel at the elegance of it, but thankfully those few included my bestie Jojo. We were having lunch one day and he couldn’t stop gushing over how smart Chamath was, and how he was all-in on IPOA. Jojo convinced me, and yes now three years later looking back, I do count myself as an original ‘true’ Chamath fan, as Kevin Kelly would say. Chamath’s first SPAC, IPOA merged with Virgin Galactic, a deal that took almost 24 months to materialize (the max amount of time a SPAC has to find a merger before returning the money), and while right after the deal closed in October 2019, the stock (NYSE: SPCE) dropped below NAV to $7.25 at the lowest, it did bounce back and currently trades around $29. 

Now let’s fast forward to April 2020, when Draftkings went public by merging with Diamond Eagle Acquisition Corp, the stock (NYSE: DKNG) went quickly from $10 to $40 and partly, it was the pandemic that people were home and day traders were being born, and partly the nature of the business, it’s a digital sports gambling & gaming company that the public took notice. The google searches for “SPACs” were just starting to rise and then in June 2020, we had Nikola, the Tesla wannabe go public via another SPAC Vector IQ Corp, and the stock (NYSE: NKLA) literally shot to the moon by going from $10 to $67, a whopping 570% return in less than two months! 

After bottoming in March 2020, we were already in a bull market for equities, but those outsized gains in SPAC land had the SPAC bull market running on steroids. Suddenly, everyone understood the elegance of SPACs and the premiums started going up with major pops happening just on deal announcements. The trade of the day was to buy the SPAC at NAV, sell on deal announcement and roll your money to the next SPAC at NAV, and rinse and repeat. On the SPAC sponsor side, you couldn’t wait to get your SPAC out the door, and all the bankers were busy and so were the law firms burning the midnight oil. 

Things got so hot that another great trade was to buy the SPAC units at NAV, hold for 6 weeks for the units to split and then sell the warrants for a quick 6-8% return. This only fueled the demand for more issuance as it became apparent that no one really cared for the quality anymore, both on the sponsor side and the target side. Sponsors had their foot on the gas pedal and were busy filing for more SPACs and target companies got smart by starting to get ‘SPAC ready’. On the deals side, there were more preferred flavours like EVs and gaming relative to others like fintech, enterprise saas but overall, there was just too strong of a bid for this new asset class. It was like the labels had been ripped off from the jeans, and you couldn’t tell if it was the good quality BR or the inferior H&M (unless of course, you were a quality shopper originally). 

No one cared for the quality dilution, both on the sponsor and the target side as the momentum carried the day. The SPAC premiums reached a high of 27% in mid February and so did the google searches for the word “SPAC” reaching peak popularity.

But what did Isaac Newton say, “What goes up, must come down”, so the SPACs did as well. Suddenly the SPAC pops went away. Average SPAC went from trading at a 27% premium to a discount. And although, just as on the upside the rally was quality agnostic, on the downside, the sell-off didn’t spare the good quality SPACs either. But as Warren Buffett says, “Only when the tide goes out, you see who’s been swimming naked”, we saw that on a relative basis, the BR quality SPACs fared much better than their H&M quality peers. The bad flowchart below describes in a nutshell what happened. 

The SPAC market bottomed a couple weeks ago, and seems to be on a cautious rebound. The inundation of new SPACs has really slowed down with only 7 SPACs going public in the first 9 days of April compared to 44 in the first 9 days of March. But with 556 SPACs actively searching for a deal, picking a good quality SPAC is still like sifting grain from the chaff.

Jojo and I caught up last week and we agreed that while the conundrum is real, we need to go back to the first principals because quality always prevails. From an action perspective, that means loading up on the OG Chamath ($IPOD, $IPOF), Barry Sternlicht ($JWSM), Betsy Cohen ($HERAU, $FTAAU) and Bill Foley ($AUS) to name a few. 

We also identified a new class of high quality sponsors in Altimeter ($AGC, $AGCB), Khosla Ventures ($KVSA, $KVSB) and Tribe Capital ($ATVC). These crossover sponsors have an impeccable track record investing in the private markets, and have a natural edge in sourcing high quality targets, which will prove to be very beneficial as they look for companies to merge with. 

As the market readjusts from this supply shock, we will find where the new equilibrium lies in time. Until then, remember quality over quantity! Now you must be a quality person for reading this blog, so thank you and I appreciate you! Go share it with your other quality friends too :)