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Editor's Note: Below is a complimentary Early Look note written by our Industrials analyst Jay Van Sciver. We are also pleased to announce our new Industrials Pro product. Click HERE for further in-depth research. |
Jack Barker: “Do you know what Pied Piper’s product is, Richard?”
Richard Hendricks: “Is...Is it me?”
Jack Barker: “Oh God, no, no, how could it possibly be you? You got fired. Pied Piper’s product is its stock"
- Silicon Valley, Season 2 Final Episode
The Big Picture
A core problem for ESG investing is that very little human activity is ‘good’ for the ‘environment’. ESG, an abbreviation for investment approaches that considers Environmental, Social, and Corporate Governance aspects of capital allocation, is usually focused on the ‘E’. The lack of suitable eco-friendly investment options has contributed to excessive valuations. Not enough choices? Just gross up the ones that are available via bubbly price levels!
ESG inflows may prove a persistent trend. ESG-aware strategies have the potential to be the best of capitalism, with investment dollar votes better matching broader externalities. But the ‘magic of markets’ doesn’t work if buyers and sellers are suckered by unrealizable investment mandates and misleading corporate disclosures. The tsunami of ESG money has contributed to problematic distortions. Many arbitrary and excessive SPAC share price gains are likely among them.
NKLA was a notable early 2020 SPAC success. Amazingly, it remains a success. Despite credible fraud allegations and SEC + DOJ investigations, shares of NKLA still trade at roughly twice the SPAC offering price. Promising to reduce carbon dioxide emissions from trucking checked key ESG allocator boxes, even if the claims were extraordinarily suspect. The raging bull market in SPACs, especially ESG-oriented SPACs, has suffered no lack of enthusiasm or naivete. We flagged NKLA as a promising, if risky, short in June with some success. To date, NKLA’s only substantial product remains the shares of stock themselves. Many in the NKLA ecosystem generated exceptional wealth from this dubious offering. Former CEO Trevor Milton, now a billionaire on paper, apparently left the company to spend more time with his lawyers.
It’s tempting to dismiss all SPACs as low-quality issues avoiding IPO scrutiny, but we don’t want to fight the SPAC tide if our investment process can remain intact. We’ve found some genuinely good companies amid the SPACophony. Take MP Materials. Chinese rare earths elements (REE) are extracted in a much more ecologically destructive manner than those at the Mountain Pass facility. By substituting MP’s surprisingly small environmental footprint for the Chinese REE Bigfoot, MP is producing lasting environmental gains relative to existing practices. Unlike NKLA, MP Materials is a profitable, growing company with top shelf management. We added MP (FVAC at the time) as a Best Ideas long in August, with a favorable macro backdrop and quantitative signals increasing the odds of success. MP has been better than a double during de-SPAC. We also added EOSE (BMRG at the time), with a similar approach and favorable returns, along with other ESG friendly names. But when do we exit?
To answer this, it is worth reviewing the SPAC process. When a SPAC raises money, buyers get an asymmetric deal: you will like the merger the SPAC finds, or you can get your cash back. Once the SPAC finds a deal, there is a ‘vote’ that is largely a pre-ordained ‘YES’. A key for the sponsor and target alike is to have a share price over that ‘cash back’ redemption price heading into the redemption deadline, typically >$10. This is a period of uncertainty and ambiguity, often providing the best entry opportunity. Weak longs keep the share price closer to the redemption price; after all, if those weak longs are willing to take their $10 back, they’d certainly rather sell in the open market at, say, $11, especially as the optionality fades near de-SPAC.
The best performance period for SPACs is often the few weeks after the merger closes. Weak holders have exited; the remaining shareholders chose to remain. Ambiguity and uncertainty collapse into a uniform desire to promote the newly public company. The SPAC gets a shiny new ticker, an industry designation, and a much larger market cap. Institutional investors see it dumped into their ‘universes’ and ‘benchmarks’. Options may become available, or at least become more liquid. This confluence of positive changes generates upward pressure, typically during 3 to 4 weeks of often wild trading.
We hope readers forgive the above ‘narrative’, as the de-SPACs price chart just represents buyers and sellers transacting. Our job isn’t to tell stories but to generate Alpha, to play the game in front of us, to dance until the music stops…but with one hand on an open chair. It isn’t about morality, the correctness of what is happening, political views, or valuations, or anything else except generating P&L within the rules.
Still, we acknowledge that the current SPAC story is yet another Fairy Tale that will almost certainly devolve into a Cautionary Tale. When the ESG money cannon inevitably stops firing, investors and regulators may well uncover inappropriate or illegal behavior from the SPAC frenzy. If so, there will be some tasty irony in the ethical mindset of ESG investors massively enriching some of the most unethical stock promotors – those selling shares via misleading promises, outright misrepresentations, and greenwashed money pits. In the meantime, we’ll keep looking for another tolerable ESG-friendly SPAC long.
Back to the Global Macro Grind…
Here are the Top 3 Things that Hedgeye CEO Keith McCullough has highlighted for this morning:
“Rotating” out of NASDAQ in #Quad2 (November launch) was dead wrong – another all-time closing high it is…
- 10YR – rotating out of Deflation/Duration (i.e. rate sensitive Asset Allocations) is what Full Cycle Investors did in November, and that’s getting them paid, again, in December – UST 10yr Yield +2bps to 0.94% with immediate-term upside to new Cycle Highs of 1.01% ahead of tomorrow’s inflation accelerating report (CPI)
- GOLD (bearish) – evidently I’m triggering some Perma Bulls on this one now, but that’s just emotional and/or silly – even if I didn’t have a nowcast for nominal and real rates up in #Quad2, my Gold TREND signal = Bearish @Hedgeye TREND with immediate-term downside towards $1764 – the #Quad2 alternatives to being Long Gold are ripping
- JAPAN – one of the many alternatives to being long a Deflation/Duration (Treasuries, Gold, Utes, Housing, etc.) portfolio is being long both Japanese and South Korean Equities which were up another +1.3% and +2.0% overnight as GLOBAL #Quad2 expectations become crystal clear to Full Cycle Investors
Have a great day out there!
Jay Van Sciver
Managing Director, Industrials
