The guest commentary below was written by written by Jack Raines, and originally posted on his blog Young Money. This piece does not necessarily reflect the opinions of Hedgeye.
On February 12th, 2021, Bloomberg published an article titled: The King of SPACs Wants You to Know He's the Next Warren Buffett.
The man in question was Chamath Palihapitiya.
Chamath didn't shy away from the label. In a Front Row interview, the investor said, "Nobody’s going to listen to Buffett. But there has to be other folks that take that mantle, take the baton, and do it as well to this younger generation in the language they understand.”
This quote came after another allusion to Buffett in November of 2020 when Chamath tweeted, "Buffett had GEICO. I pick MetroMile."
*MetroMile is, of course, a start-up insurance company Palihapitiya had invested in that went public via SPAC merger. The stock proceeded to crash by 90% before being acquired by Lemonade, an insurance startup whose stock has fallen by 80%.*
The now infamous Bloomberg article marked the top of the SPAC bubble. 18 months later, the 'SPAC King' announced that he is closing down his two largest remaining SPACs.
SPACs were all the rage in 2020 and early 2021. However, to his credit, Chamath was the first to the scene. In the fall of 2019, Chamath announced that his first SPAC, IPOA, was taking Richard Branson's Virgin Galactic public through a "reverse merger."
Normally, a private company seeking to go public would hire a bank to underwrite the deal and find investors. SPACs expedited the process by letting private companies "reverse merge" with these SPACs, which were basically publicly-traded bank accounts.
The private company would get the SPAC's capital in exchange for X% of the new company, and the newly merged entity would then trade publicly under the private company's name.
On paper, this was a no-brainer that benefited all parties.
SPACs' sponsors would get free shares for their work closing the deal. Private companies could raise capital more easily than they would through IPOs. And retail investors could invest in these SPACs before the deals closed, giving the little guy a chance to buy private companies before they went public.
Everyone was a winner.
That was the story, anyways. And SPACs loved stories.
Traditional finance teaches us that every asset can be valued on fundamental metrics alone. Cash flows, earnings, capital structure, and sales growth are all that matter. But in reality, we know that isn't true. Fundamentals don't have a monopoly on valuations.
Fundamentals are engaged in a perpetual game of tug-of-war with stories.
The story of what an asset "could be" plays a huge role in what investors are willing to pay for an asset. Steve Jobs understood the role of storytelling better than most. Elon Musk's storytelling has turned Tesla into the world's most valuable automaker. Bitcoin's entire value is largely predicated on ever-changing stories.
The value that the market gives these stories determines the price that you will pay for these assets.
The thing is, fundamentals and stories are dynamic, not static. They operate on a sliding scale. During periods of euphoria, stories reign supreme.
During periods of decline, fundamentals are the only metric that can stop the bleeding.
And that's why SPACs are the poster child of 2020 and early 2021. Most SPACs were valued on their stories. Nothing more, nothing less.
The traditional IPO process is intense, and companies have to produce detailed financial reports for the world to see. Any shady areas in your finances immediately come to light. The only thing you *can't* include is future projections, because projections are subjective.
SPACs publish financial reports as well, with a twist: SPACs *can* (and do) include revenue projections. And not just any revenue projections, but projections of 0 sales to billions in sales in five years.
Ambitious, to say the least. SPAC investor presentations also include Total Addressable Markets, forecasted margin expansions and profitability, competitor analyses (which always look so favorable!) and just about everything else that you can think of.
The only thing they tend to leave out is actual revenue.
Every SPAC had a story. Space tourism. Electric vehicles. iBuying homes. Sure, few of them had sold anything. And even fewer had done so profitably.
But when interest rates are 0% and pictures of rocks are trading for $1M and growth stocks are worth 50x revenue and everyone is stuck at home day-trading their stimulus checks and we inject literally trillions of dollars into financial markets, stories can be worth billions of dollars.
"Fundamentals" be damned. The more explosive the bull market, the more powerful the stories.
But interest rates can't remain at 0% forever. Should pictures of rocks really be worth $1M? Growth stocks stop growing. Workers return to the office. Stimulus checks disappear. And stories aren't so valuable anymore. And when stories aren't valuable, you better have fundamentals.
18 months ago, SPACs were spinning enticing narratives. But when your investor presentation from 2020 forecasts $2B in revenue in two years, and you barely cleared $100M in 2022, your story falls apart. And when you went public at a multi-billion dollar valuation, and you barely clear $100M in revenue, fundamentals won't save you.
The SPAC was pitched as an IPO disruptor. A way for companies to go public quicker. A way for retail investors to invest before the IPO. The SPAC was supposed to "democratize" investing.
In reality, the SPAC was the perfect medium for companies that didn't make money to convince investors that they would one day make a ton of money. And if enough investors believed the story, SPAC sponsors and company insiders themselves could make a lot of money by selling their shares to other investors who fell for the story.
And then when the former SPAC inevitably misses its earnings expectations and falls 80%? Well who cares, no one made you invest, right? Not financial advice.
Chamath was one hell of a story teller. He played the climate change and inequality cards well, and he was second to only Elon Musk in his understanding of the Twitter zeitgeist. At the peak of the SPAC bubble, Chamath could tweet out one-page word docs of his "investment theses", and any SPAC would double or triple on the spot.
But the contents of the word docs were never the real investment theses. The real investment theses were quite simple: tell a good enough story to the masses, and the masses just might believe it. If the masses believe a story, they might buy it. And if they buy it, you can make a lot of money selling it.
Invest in a company, hype it up to your followers, quietly sell (to manage your liquidity) once your lockup period ends, repeat. SPACs were nothing if not an opportunity for insiders to make millions by transferring risk to retail investors.
How else do you make $750M on investments that are collectively down 60%+?
Don't get me wrong, I support making big bets on long shots such as space tourism; that's how progress works. And I applaud those that are working to turn these long shots into realities. But he who stands to gain from a venture's success should also be exposed to risk if the venture fails.
Transferring this risk to retail investors by dumping your shares when your lockup expires, especially after spending months promoting these investments to this very same audience, may not be criminal, but it is certainly disingenuous.
Finance is a volatile, messy, chaotic field, but there are three constants:
- When a new innovation says that it will "democratize" anything, those being democratized will be left holding someone's bag.
- When someone claims to be the next Buffett, that should raise red flags.
- When something with zero-revenue is worth billions of dollars, the investment probably won't pan out.
But when you have all three at the same time? I call that a generational investment. RIP to the SPAC Bubble, it sure was fun.
- Jack
