How to Invest in SPACs Like the Pros

With many recent SPACs trading at close to their redemption levels, it's now possible for regular investors to play the same game as sophisticated hedge funds.
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In addition to the rise of individual investors, one of the most fascinating market developments recently has been the popularity and abundance of SPACs -- Special Purpose Acquisition Companies. There are currently around 361 actively traded SPACs. About 112 of them have entered into Letters of Intent to merge with target companies, leaving around 249 SPACs competing to find a deal.

Many market strategists are convinced that this explosion in the numbers of SPACs will lead to sub-par performance as there are fewer quality deals remaining and more SPACs competing for the best ones. That is likely to be the case, but there will continue to be some very interesting opportunities among the SPACs that are able to find great deals.

SPAC stocks can be divided into two main groups -- pre-deal and post-deal. Both groups have already corrected from recent highs, but it is the pre-deal sector that has been under the most pressure in recent months as worries about finding deals increase. 

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One of the primary reasons that so many SPACs were able to go public in recent months is that it has been so easy for them to raise money. What makes SPACs special is that if you invest in one and it doesn't find a deal, then you will be able to recoup a certain minimum amount of cash, which typically is $10. The sponsors of the SPAC are obligated to return those funds, minus some miscellaneous expenses, to investors if they can't close a deal.

As a result, many hedge funds and large investors have subscribed to nearly every SPAC that they could because they had no real risk. They could buy units at $10 and be guaranteed that they could redeem them at close to $10 at some point in the future if there was no deal.

Like a hot IPO, the best SPACs have the potential for substantial upside. A couple of the biggest winners in the past year are QuantumScape  (QS) - Get Report, which jumped from $10 to over $130 at its peak, and DraftKings  (DKNG) - Get Report, which is up 700% since its inception as a SPAC. With the potential for a SPAC to double or more, and risk limited to $10, there exists an asymmetrical risk pattern. This means that there is little downside but potentially very big upside if you can spot the next SPAC with a hot deal.

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Because of the deluge of pre-deal SPACs that are now hitting the market, there are more and more that are trading with little premium over the $10 redemption price. A few months ago, by contrast, many of the pre-deal SPACs would trade higher due to investor optimism that a deal would be found. That optimism has eroded, but that makes for better entry points for investors that are willing to hunt for the most promising SPACs.

The big risk for holders of SPACs is opportunity cost. It may take months or even years for a SPAC to find a deal if they find one at all. The carrying costs of these SPACs may not be very high in a low-interest-rate environment like we have today, but if there is no deal, then funds will have dead money on the books. Many funds will use leverage in various forms to help enhance potential return, and that creates some additional carrying cost.

With the price of many recent SPACs very close to their $10 redemption levels due to concerns about an oversupply of pre-deal SPACs, this creates some potential opportunities for small investors that are normally shut out of the IPO process. 

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Specifically, it's now possible to play the same game as sophisticated hedge funds by holding a basket of SPACs with relatively small downside risk and the potential for some big upside potential if they pick the right names. With five or six carefully selected SPACs, there's a good chance that at least one finds a deal and that several will make moves on eventual deal rumors.

The trade is to buy a basket of SPACs that are trading at close to their $10 redemption price, and hope that a few will hit it big and offset the small losses that result when other SPACs are sold or closed at the redemption price. One or two winners will likely more than offset the losses in several other small losers. 

The big challenge is finding the right names to hold in that basket of SPACs. 

Two pre-deal names that I'm currently holding are Soaring Eagle Acquisition Corporation SRNGU and Cohn Robbins Holdings Corp. CRHC. The main reason for holding these two names is the pedigree of the sponsors. 

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Soaring Eagle is my favorite play right now. The deal is sponsored by the most successful group so far in the SPAC industry. Harry Sloan, Jeff Sagansky, and Eli Baker sponsored the DraftKings and Skillz  (SKLZ) - Get Report deals, both of which have been highly successful, and all six of their SPACs have cut deals to take companies public. This team obviously knows what it is doing and has extensive connections that are necessary to find a great company to take public.

One other positive with SRNGU is that it is currently the second-largest pre-deal SPAC after the Ackman Pershing Square Tontine PSTH. Large SPACs tend to do the biggest and highest-visibility deals, and PSTH is still trading at more than 30% above its redemption price. 

The primary appeal of the Cohn Robbins deal is that its co-chairman, Gary Cohn, is a former head of Goldman Sachs and an ex-White House advisor to Donald Trump. He is extremely well-connected, and the likelihood he finds a deal is better than average.

Other pre-deal SPACs that have interesting connections are SVF Investment Corp. SVFA, which is sponsored by Softbank, and Supernova Partners Acquisition Company SPNV, which is headed by Spencer Rascoff, the founder of Zillow and a director at Palantir Technologies.

There are also some post-deal SPACs that are trading close to redemption levels as they work toward finalizing their deals. One that I am watching is Forum Merger III Corp. FIII, which is merging with Electric Last Mile and will trade under the symbol ELMS. ELMS is focused on last-mile delivery solutions and has 45,000 non-binding pre-orders for its Urban Delivery class 1 commercial EV. 

Another post-deal name that is around $11 is Good Works Acquisition Company GWAC, which is working to close a deal with Bitcoin mining company Cipher Mining. GWAC offers an opportunity to play upside potential in Bitcoin with limited downside risk due to the $10 redemption price. 

There are dozens of other opportunities developing in the SPAC sector. While there may be an oversupply of SPAC deals right now and many that will fail, investors that do the hard work of sorting out the best ones will likely be rewarded well.

James "RevShark" DePorre is a regular contributor to Real Money, TheStreet’s premium site. Click here to learn more and get great columns, commentary and trade ideas from Jim Cramer, Helene Meisler, Stephen Guilfoyle and others.

Disclosure: At the time of publication of this article, DePorre held positions in SRNGU, CRHC, FIII and GWAC.