Special purpose acquisition companies, or SPACs, have been all the rage with investors this year. These special companies give investors a new way to invest in IPOs and some of the hottest companies on the planet.
Even better, investors have the chance to reclaim their investment if they don't like the deal their SPAC makes.
As usual, there's more to the story than that, and we're here to help.
To help you understand what these investment vehicles are and whether they're worthy of your money, we're taking a deep dive into them today.
We'll show you exactly how these investments work, and we'll show you the best SPAC stocks to buy now too.
How SPACs Work
SPACs, also known as blank check acquisitions companies, raise money via an IPO to buy or merge with another company. The sponsors may focus on a particular industry or type of company they are interested in acquiring, but there are no predetermined targets. In short, SPAC investors are giving the company a blank check to buy a business. Investors expect the SPAC to acquire companies that can be turned around or have great potential, which will lead to higher returns.
It is a bit like private equity investing or venture capital investing in that you are giving money to a sponsor to buy a business that will pay off with high returns. There have been some deals this year that have done exactly that and given shareholders a huge profit.
The way it works is like this. You buy shares in a SPAC that has an approach to investing you like - usually purchased during their IPO - and then you wait to see what the company does.
Once the IPO is completed, the SPAC has a fixed time period - usually 18 or 24 months - to get a deal done. If the SPAC doesn't find any other company to acquire in that time, your initial investment is returned to you.
And if you do like the deal, then you simply hold on as your shares are converted into the new company. Often times, this means you're one of the first investors in a newly public company without having to buy at the inflated IPO price.
Take a look at a few of the big winners over the last year and the exciting new companies they created.
Social Capital Hedosophia Holdings did an IPO at $10 a share. A year ago, it announced it was merging with Virgin Galactic Holdings Inc. (NYSE: SPCE). Virgin Galactic stock has more than doubled since then.
In December, Diamond Eagle Acquisition announced a merger with DraftKings Inc. (NASDAQ: DKNG). That stock has more than tripled since then.
VectoIQ Acquisition announced in March that it was merging with electric truck manufacturer Nikola Corp. (NASDAQ: NKLA), and that stock has also more than tripled too.
As you can tell, SPACS can work and deliver huge profits to their investors. But keep in mind that not all of them work. We have seen many SPACs announce deals the market didn't like, and the stock fell through the floor. Several SPAC stocks bit off more than they could chew and went bankrupt.
How to Know When a SPAC Makes a Good Deal
One of the other benefits of SPACs is investors have the chance to take their money out if they don't like a deal.
Once a deal is announced, shareholders get to vote on the deal. If shareholders reject the deal, all the money is returned. The key thing to understand is that at that time, you can also choose to back out of the deal individually and get all or most of your initial investment back.
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You have the opportunity to pull out after a deal is announced too. All of the money invested in the SPAC goes into a trust invested in short-term treasuries. If you do not like the announced deal, just ask for your cash back. If you like the deal, keep the new stock.
It is a straightforward matter to determine if you like a deal. If shares of the SPAC go up when the transaction is announced, you like it. If they do not pop when a transaction is announced, you do not like the deal. Get your cash back.
If you have a deal that pops and then the SPAC price begins to slip, sell your shares and book the profit.
In July, Landcadia Holdings II, a SPAC sponsored by Landry's CEO and Houston Rockets owner Tilman Fertitta, said it planned to merge with Fertitta's Golden Nugget gaming franchise. The shares initially jumped by 50% before drifting back a little later in the month.
Investors who set a stop when the SPAC popped 30% to 40% kept their profits when the stock eventually dropped.
The decline tells us that after further review, the market didn't like the deal that much.
Now that you know all about SPACs, here are two of the top SPACs on the market right now...
The 2 Best SPAC Stocks to Buy Now
One of the biggest SPACs right now is Pershing Square Holdings Ltd. (OTCMKTS: PSHZF). The SPAC is managed by Pershing Square's Bill Ackman and raised more than $4 billion last month to go unicorn hunting.
The units consist of one-ninth of a warrant to buy the stock at $23 in addition to the shares in the trust. Right now, you are paying a premium of about $1 over the value of the trust. It is probably worth risking $1 to bet that Bill Ackman gets the deal done right. The last time he did a SPAC was in 2012, and that company, Justice Holdings, ended up buying Burger King and becoming a massive success for this who bought the SPAC.
Given Mr. Ackman's track record in 2020 with his main fund up 34%, it makes sense to bet with him and not against him. Should the shares dip closer to the trust's value, or fall below the total value of the cash in the trust, increase your bet accordingly.
Another SPAC to keep your eye on was just registered last week. RedBall Acquisition filed for a $500 million IPO. It plans to use the money to buy a sports-related business.
The Founder of Redball, Gerald Cardinale, has 25 years of experience building a range of multibillion-dollar platform companies. He worked for 25 years for the private equity division of Goldman Sachs (NYSE: GS). In 2001, Mr. Cardinale partnered with the New York Yankees and the Steinbrenner family to create the Yankees Entertainment & Sports Network. He also helped the Yankees and the Dallas Cowboys develop Legends Hospitality.
Billy Beane, the Oakland A's General manager who was the subject of the best-seller and film "Moneyball" is also part of the management of Redball Acquisition. He will serve with Mr. Cardinale as co-chair.
Goldman Sachs is managing this offering. If you have a Goldman account, call your broker now and reserve as much stock as they will sell you. If you do not have a Goldman account, check with your broker to see if there is any availability. This is a unique opportunity to partner with a management team with a fantastic track record with little to no risk.
If you cannot get IPO shares, watch the aftermarket to buy shares of Redball Acquisition at as small a premium to the value of the trust as possible.
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Uber, Airbnb, Slack, Pinterest, and Venmo have something big in common - something other than their big names.
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About the Author
Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.