Cashing Blank Checks: Why the Foolhardy Favor PSPC
NEW YORK: Dimitri Kazarinoff launched his first earnings call last month as Managing Director of XL Fleet Corp.
When the maker of electrified vans and pickup truck powertrains agreed to a billion-dollar merger with a special-purpose acquisition company (SPAC) in September, it made a financial forecast rarely seen in an introduction in stock exchange (IPO).
XL Fleet predicted that its revenue would more than triple in 2021 to reach $ 75.3 million.
However, during the XL Fleet earnings call on March 31, Kazarinoff said the COVID-19 pandemic and a shortage of microchips had weighed on the fleet’s orders and its ability to meet them, which would mean that he would miss the revenue forecast.
Amid a broader sale of SPAC, shares of XL Fleet are now down more than 50% since its merger with SPAC, Pivotal Investment Corporation II, was completed in December.
XL Fleet said it did not anticipate supply chain challenges when it gave its forecast last September, and that the “fluid” situation prevented it from issuing formal guidance for 2021 a. once it became a publicly traded company.
Reliable financial projections are common in PSPC deals and have been a decisive factor in attracting companies seen as riskier, often loss-making, and years before they even have sales, to IPOs as a gateway, Industry insiders and a Reuters said review of the data compiled by University of Florida professor Jay Ritter confirms.
This is because IPOs are excluded from U.S. securities regulations that protect companies from lawsuits by investors for financial estimates they violate.
PSPCs enjoy this protection, so lawsuits against companies that go public must pass a higher hurdle of proof of wrongdoing or negligence in making the projections. Companies have taken advantage, opting for PSPCs, even though the lucrative stock-based compensation of PSPC executives leaves their existing shareholders with less equity, making them almost three times as expensive as IPOs, investors and investment bankers say so.
Three out of four companies that went public between 2020 and early 2021 as part of a PSPC merger were unprofitable, up from 61% in an IPO, compiled by stock market expert Ritter.
“Some companies cannot sell their story based on valuation multiples until 2025 or 2027, that would reduce their valuation,” said Vik Mittal, portfolio manager at Glazer Capital and one of the largest US investors in SPAC.
Crazy projections of some PSPC deals have made them the darlings of hobbyist traders, who scour social media platforms like Reddit in search of “meme” shares to rack up.
But these stock market rallies are generally short-lived; Companies that went public through SPACs from January 2019 to June 2020 have average negative returns of 12.3% six months after their merger and negative returns of 34.9% after one year, according to research by the professor Michael Klausner at Stanford University.
Their 12-month return is 47.1% lower than the IPO index, according to data from Klausner.
“Some of the companies that go public through PSPCs are early and pre-profitable. They probably would not have been able to go public through an IPO, which does not provide a safe haven for projections shared with investors, ”said Anna Pinedo, partner of the financial markets of the Mayer Brown law firm.
Regulators have started to take notice.
A US Securities and Exchange Commission official said this month that companies’ ability to freely publish performance projections during their PSPC transactions was “overrated at best.”
An SEC spokesperson declined to say whether the financial regulator plans to change the safe harbor provision in its rules, which allows companies that go public through PSPCs to make projections.
Nonetheless, several successful companies, including sports betting company DraftKings Inc. and chip maker Utz Brands Inc., went public through PSPCs and saw their shares continue to rise several months after their deal.
Some choose a PSPC because the sparkling market for blank check acquiring companies, which have already raised more this year than the whole of 2020, may give them a higher valuation.
And companies get that valuation up front, removing one of the big uncertainties in the IPO process.