It's a rather slow year for IPOs, but Thursday we'll see an IPO floated at the NYSE that is getting more than the usual amount of attention.
The company is Social Capital Hedosophia, and they are planning a fairly healthy IPO of $600 million: 60 million shares at $10. (That's up from 50 million shares first indicated.). The company's shares rose 2.8 percent mid morning Thursday after it opened for trading.
Normally, of course, IPOs announce price ranges, say, from $9 to $11, not just one price of $10. Why is this just $10 with no range?
Because the company has no assets, at least not yet. It is a special purpose acquisition company (SPAC), a company that is being set up to invest in technology companies that are not yet public.
These SPACs are enjoying a banner year: more than 20 have gone public so far in 2017, the highest number since 2007, according to Renaissance Capital, a research firm that tracks IPOs and runs the Renaissance Capital IPO ETF (IPO), a basket of the most recent IPOs.
SPACs are based on a simple premise: a seasoned manager in an investment space (energy, tech, etc.) buys assets and assembles them in a portfolio for investors. They are sometimes referred to as "blank check" companies.
"What you're buying is a management team with a lot of experience, which is very attractive to investors," Carolyn Saacke, chief operating officer for capital markets at the NYSE, told me. "They usually have a lot of M&A experience in the companies and the industries they are coming from, so there's some faith they will be able to buy a company at a decent price."
In the case of Social Capital, the CEO is Chamath Palihapitiya, one of the original members of the Facebook management team. Palihapitiya spoke at on Tuesday.
Having an experienced manager buy companies for you sounds like a good idea, but there's a clear element of risk. The manager is essentially saying, "Trust me, I can buy companies at a price that will make money for you."
Still, it begs the question, why now? Why are SPACs suddenly such a popular investment vehicle?
The answer is twofold: it helps address the IPO logjam, and an "out clause" gives investors who are nervous about not knowing what they are buying a way to back out of the deal.
1) The IPO logjam. We've been talking about it all year: There are hundreds of companies waiting to go public that can't or won't in the current climate. There are more than 100 tech "unicorns" (those with valuations over $1 billion) seeking to go public alone. In the case of energy companies, they have trouble going public because the public wants nothing to do with energy companies with oil in the $40 range. In the case of tech, there is a huge "valuation gap" between the unicorns' private valuation and what the public is willing to pay for them.
2) The "out clause." The proceeds from the IPO are initially held in a trust account that can only be accessed to make the acquisitions. The SPAC has a time frame — usually two years or less — in which to make acquisitions. Once the acquisitions are made, the public stockholders can elect to have their shares redeemed for cash if they don't want to stay in the deal.
So the answer to "why are SPACs so popular now?" is that they help break the IPO logjam, while at the same time allowing investors an out in case they don't like what the manager is doing.
Still, why would anyone park a lot of money for up to two years and not know what they are ultimately investing in? Kathleen Smith of Renaissance Capital says to look at it from the perspective of a money manager: "Say you have cash you need to put to work, and you don't have a good place to invest immediately. You put it to work in the SPAC, you are still collecting a management fee, and it's not going to go down because the money is invested in a trust. It's like a hedge for a hedge fund."
Still, she is no fan of SPACs in general. The owners of SPACs argue that it is worth the cost to pay for the expertise, but Smith begs to differ: "The people who make the money are the bankers who make a fee on the IPOs and the proxy statement telling holders what they have, the lawyers, and the exchanges. There is a lot of expensive friction in getting a company to the marketplace. It's not a straightforward way to raise capital. It's better to go directly to the marketplace and get the deal done, because there are a lot less fees."
Smith also notes that the SPAC must include audited financials and a full description of the acquiring companies, essentially requiring the acquired company to go through much of the disclosure process as a full IPO.
There's another issue with SPACs, Smith points out: dilution. In the case of Social Capital, initial shareholders are getting 20 percent of the company at an insider price of $0.002 cent. That's not a typo: $0.002 cent. The public shareholders are getting the other 80 percent of the company for $10 a share.
That's a pretty sweet deal. A 20 percent finder's fee is "a very typical situation for SPACs," David Menlow of IPOfinancial.com told me.
Do SPACs make money for investors? It's not a simple question, since the company can do nothing for more than a year before it makes any acquisitions. Menlow notes that "Success has to be measured on a case-by-case basis."
One success story Menlow points to is Hostess Brands, the maker of Twinkies and Ding Dongs. A SPAC, Gores Holdings, was created in 2015 and merged with Hostess in 2016, which was then a private company. The stock, which was trading in the high $9 range prior to the announcement, was in the $12 range by the time the deal closed in November of that year.
As for Social Capital and Mr. Palihapitiya, Smith notes that the central question for investors is, "Can he buy unicorns or other tech companies at a bargain price, or even a fair price?"
Palihapitiya will appear at noon ET on "Fast Money Halftime Report. " This is only the fifth SPAC IPO of the year for the NYSE, which earlier in the year modified its listing requirements to attract more SPAC listings.
(Story updated to reflect the increased offering.)