The Man With Six SPACs
SPAC Series Part 1: How Chamath Palihapitiya ignited Silicon Valley's obsession with an unusual financial mechanism to take companies public.
Chamath Palihapitiya is an exceptional pitchman. He knows how to get you excited in four-minute bursts on CNBC about a tech company that flips houses or about a data-savvy Medicare insurance company. “He's willing to saddle up on CNBC and tell the story,” says venture capitalist Bill Gurley. “Chamath – he’s figured out the process for crushing it as a SPAC sponsor and I think a lot of the others are just sitting still and don't know what he knows.”
SPAC is the four-letter acronym on everyone’s lips in Silicon Valley right now. That’s special-purpose acquisition company. Many enterprising finance-types hope to make a killing in the next two years with their own SPACs. Anxious venture capitalists are more than happy to offload their private portfolios onto a euphoric public market. And cash-hungry companies see it as a speedy path to a becoming publicly traded stock.
There are lots of reasons to care about what happens in SPAC world. Some believe that the process (the mechanics of which I sketch out at the bottom of this post) could represent the future for small and mid-sized tech public listings. Maybe your favorite Silicon Valley company is considering the complicated financial maneuver. There are a ton of big egos in the mix. And SPACs could end up instigating the culmination of a long-prophesized-but-never-materialized dot-com crash redux.
“The SPAC thing – that is going to be a crazy bubble,” says Jeremy Levine, who sits on the boards of Shopify and Pinterest and is, truth be told, a perpetual doomsayer. “It will look like the 1999 internet bubble where basically all of those companies went to zero,” Levine says. “There will be some good ones. Most of them will be true disasters.”
This is Part 1 in a series looking at SPACs. Today, I’m going to dig into Chamath Palihapitiya’s starring role.
If there’s anyone spearheading Silicon Valley’s love affair with the SPAC, it’s Palihapitiya, the former Facebook growth machine whose venture capital firm Social Capital saw partners depart acrimoniously, starting in August 2017. (His former Social Capital partner Mamoon Hamid is now leading the rebuild at Kleiner Perkins.)
In 2017, the same year of the exodus, Palihapitiya began exploring this big idea. “I noticed that in my portfolio, over the preceding six or seven years I had constructed, I thought, an incredibly high performing portfolio of private companies,” Palihapitiya told me in a phone call. “But when I looked at the time to liquidity I noticed something that bothered me: These companies were taking 10, 11, 12 years before they would go public and they were consuming enormous amounts of capital, so much so that the founders, employees, and the early investors were getting really diluted.”
Palihapitiya started talking to bankers about the possibility of launching a SPAC. It’s important to note here that SPACs have existed for a long time and saw an uptick in popularity in 2017. But they’ve generally had an iffy reputation reserved for obscure, cashflow-positive companies. Palihapitiya came to realize that a SPAC could be a perfect fit for hot, unprofitable tech companies.
“That's when the bankers explained to me that raising money in a traditional IPO can be complicated and take a long time and the rules that the SEC have defined make an IPO very well suited for cash-flow generating companies,” Palihapitiya says. “But if you are a high-growth company focused on future profits rather than current profits – this is a big limitation of a traditional IPO process because you can't talk about the future.”
That last line is so important. Let me spell this out for you. People will give you lots of reasons why SPACs make more sense than an IPO for a company, but one core reason is simple: regulatory arbitrage. In a traditional IPO you cannot safely offer detailed projections about your expected future financial performance. You’d be running into legal risk if you went on CNBC and made all sorts of predictions about the future financial performance of the company. You’d have to be careful.
With a SPAC, things seem to be much looser. SPACs are governed, in part, by a regulatory regime designed for mergers and acquisitions. SPACs have had a lot more freedom to pitch their growth stories. So if you’re a company that’s losing a lot of money and whose revenue looks flat because, after all, we’re in a pandemic, a SPAC gives you the chance to project a brighter, more profitable future. And public investors are then left to decide whether those projections are realistic or not. (The law firm Fenwick gives its perspective here and warns of future potential litigation on this matter. Deloitte has an analysis here. I am, it should go without saying, not a lawyer and this is not legal advice.)
Palihapitiya’s top three reasons to SPAC:
They’re faster to get done than an IPO.
The participating company knows how much money they will raise and how much dilution it costs before they agree to merge with the SPAC.
The SPAC sponsor can go out and help explain the deal to both Wall Street and retail investors.
He describes his promotional strategy (likely shaped by too many dinners at Michelin-star restaurants) thusly: “The amuse-bouche is the 4 minutes on CNBC. The appetizer is the one pager. The secondi is the 50-page deck and the main course is a 300-page S-4,” he says.
SPACs can also be wildly lucrative for sponsors like Palihapitiya. He takes 20% of the value of a SPAC. So in a hypothetical $100 million SPAC, he would take $20 million, he explains over text message. If that SPAC turned around and merged with a company worth $900 million before the investment and worth $1 billion post-money, Palihapitiya would end up with about 2% of the company. (His stake in the target can end up much larger than that because he’ll also invest alongside the deal.) “This is the same economics as a typical venture fund,” he texts.
Of course, a venture fund contains a portfolio of companies. If any one company goes to zero, that hurts the overall returns of the fund, depressing the carry an investor takes home. With a SPAC, each deal stands on its own, meaning that a failed deal doesn’t cut into a sponsor’s returns in a great one. It’s a much better structure for a sponsor. SPAC sponsors can make money even if the combined company’s value decreases on the public markets.
Palihapitiya is building out quite the SPAC résumé. He has de-SPACed successfully with one company, Virgin Galactic, and announced agreements with two others, Opendoor and Clover Health. There’s a theme running through all three companies: In 2019, their GAAP net losses exceeded $200 million.
Palihapitiya’s first SPAC took Richard Branson’s space company Virgin Galactic public on Oct. 28, 2019 on the New York Stock Exchange. In 2019, the company lost $211 million on $3.8 million in revenue. The stock has traded up by more than 60% and has become popular with retail investors. “Owning it is basically as close as you can get to being a VC as a public markets investor,” one poster in the Reddit forum r/wallstreetbets wrote after Virgin Galactic began to trade. “It’s a bet on an idea.”
Opendoor, one of Palihapitiya’s upcoming listings, lost $339 million on $4.7 billion in revenue in 2019, according to a financial filing. In some ways that makes it a perfect fit for the SPAC boom. It’s a costly business that needs investors to bet on an emerging trend (selling your house quickly to a tech company). Opendoor is competing against publicly traded companies, Zillow and Redfin. One bright spot: Opendoor has said it maintained its margins during the pandemic. But the company expects its revenue to fall below the $4.7 billion it generated in 2019 both this year and next (slide 39). The company doesn’t expect to turn an adjusted EBITDA profit until 2023. How much does it expect to earn? Just $9 million.
While the company has plenty of blue-chip investors, it also has lots of skeptics. “You know Opendoor is a dog of a company?” one former banker mused to me.
A venture capitalist said about the planned Opendoor SPAC: “The Opendoor one didn't surprise me because that just seems like a company that is so capital intensive and is such a story stock, but with fundamentals that are so suspect.”
Opendoor declined to comment.
Palihapitiya’s other impending SPAC merger, Medicare provider Clover Health, lost $364 million on $462 million in revenue in 2019. The company projects its revenue will reach $1.7 billion in 2023 (slide 101). The company doesn’t offer a projection for its net loss that year. The company’s adjusted EBITDA loss was $176 million in 2019 and the company expects to earn $16 million in adjusted EBITDA profit in 2023, according to the slide deck.
Virgin Galactic provided the roadmap for SPAC mania. “We were able to show all the best features of why the SPAC works through Virgin,” Palihapitiya says. “Virgin is about the future. It was about to start commercial operations. They needed to be able to talk about the next five years in detail.”
Palihapitiya has worked closely with Credit Suisse, Connaught and the law firm Skadden Arps on all six SPACs so far. Beyond the SPACs for Virgin Galactic, Opendoor, and Clover Health, he’s raised $400 million, $700 million, $1 billion for three additional SPACs.
“We should give all the credit to Chamath for being the first one who saw it and he jumped in and took advantage of it, and the other amazing thing about Chamath is he has figured out how to perfect it,” Gurley says.
As I’ll write about in an upcoming post, everyone is trying to follow his lead. There have been more than 140 SPACs this year, according to CB Insights, up from 58 last year.
“People are very, very quick to be the second,” Palihapitiya says, “but they are not quick to be the first.”
What to expect next in the SPAC Series:
I’m going to write about other SPAC sponsors and potential target companies. I’ll weigh the trade-offs between SPACs, IPOs and direct listings. And I’m going discuss whether SPACs are here to stay or whether they’re more akin to initial coin offerings or the dot-com boom. Reach out if you have thoughts. email@example.com
How SPACs work:
In the broadest terms, someone (referred to as a sponsor) publicly lists a company (the SPAC) whose sole purpose is to merge with a private company, effectively taking it public.
In more detail, when a man or a woman loves money very, very much, he or she can decide to create a special-purpose acquisition company. That person is called the SPAC “sponsor.” The sponsor usually recruits some big-name board members and advisers to add to the SPAC’s clout. The sponsor goes to a bank and hires some lawyers and asks them to help put together a bunch of complicated financial paperwork. The sponsor often takes a “promote,” meaning that the sponsor takes 20% ownership of the special-purpose acquisition company. Then that blank check company goes public. A bunch of sophisticated hedge funds typically buy shares in the SPAC. The money that’s raised is held in a trust that will be returned if the SPAC doesn’t ultimately buy a company in the next 18-24 months. The hedge funds are playing a weird financial game and aren’t necessarily the final investors once an acquisition goes through. Investors who bet on the initial SPAC often get warrants in addition to shares. The sponsor searches far and wide for a company to invest in. The sponsor may secretly have a company in mind when they launch a SPAC, but they’re not allowed to have an agreement with a company before creating the SPAC. The SPAC negotiates with the company, agrees on terms, and often arranges a PIPE – a separate private investment in the company that’s being acquired. The PIPE (a private investment in public equity) gives the target company a particular valuation. The SEC reviews the deal. The shareholders have to approve the transaction. Within a couple months of filing with the SEC, the two entities hopefully merge, making the acquisition target a publicly traded company without ever having undergone a traditional initial public offering. This is called “de-SPACing.” That’s how a public company is born through an unnatural act.