Wall Street Thinks Most SPACs are a Joke

Richard Branson celebrates the first Virgin Galactic trade on the New York Stock Exchange after merging with a special purpose acquisition company (SPAC). (Credit Virgin Galactic)

by Douglas Messier
Managing Editor

Over at Fast Company, William D. Cohan says professional investors and financial analysts have a low opinion of the special purpose acquisition companies (SPACs), which are being used by Virgin Galactic and six other space companies to go public. (SPACs are an inside joke on Wall Street, and the joke is on you)

SPACs are investment vehicles that are already publicly traded on the stock exchange. Their goal is to acquire or merge with other companies, which then go public under their own names.

Cohan writes:

The financial press has responded with astonishment and alarm: Andrew Ross Sorkin, the business columnist at The New York Times and CNBC anchor, wrote a column decrying SPAC excess as “rife with misaligned incentives between the sponsor and other investors, particularly those who come after a merger.” He also repeated a bad joke making the rounds on Squawk Box that more people on Wall Street have SPACs than have COVID-19—and Bloomberg Opinion recently ran a series of columns devoted to the froth in the SPAC market.

Perhaps more important, the sirens are ringing among Wall Street practitioners too. One senior banker tells me that SPAC bankers have become infected with Masters of the Universe Syndrome—think junk bonds in 1987, the dot-com bubble in 2000, or mortgage-backed securities in 2008—and he worries the market will crash and burn in similarly spectacular fashion. “Trouble is coming,” he says.

Even David Solomon, the CEO of Goldman Sachs, which was the third-largest underwriter of SPACs in 2020 (and is the second largest so far in 2021), has spoken publicly about the dangers of the new hot asset class. In January, Solomon wondered if SPAC issuance had “gone too far” and said he didn’t think such issuance “was sustainable” in the medium term. The ecosystem, he added, “is not without flaws.” In an interview with Yahoo News, no less a respected investor than Charlie Munger—Warren Buffett’s longtime sidekick—criticized the proliferation of SPACs in unusually colorful language: “The investment banking profession will sell shit as long as shit can be sold.”

Virgin Galactic became the first space company to go public via a SPAC in October 2019. Rocket Lab, Momentus, Spire Global, Astra Space, AST & Science and BlackSky have announced plans to go SPAC over the past year. None of these deals has closed yet.

Cohan wrote that SPACs are structured in ways that can encourage them to acquire immature companies that are not ready to go public. A SPAC’s sponsors pay millions of dollars in non-refundable fees to bankers, lawyers and accountants to raise money to fund the acquisition or merger.

There is a two-year time limit for a SPAC to complete a merger or acquisition. If it can’t do so, the SPAC returns money to the investors and goes out of business. The sponsors do not get back the millions in fees they paid to raise the investment capital.

Scott Galloway, a NYU business-school professor quoted in the article, praised Virgin Galactic’s merger with Social Capital Hedosophia, which was established by billionaire Chamath Palihapitiya.

“Occasionally a walk-on ends up being a great player,” he says. Virgin Galactic, which merged with one of Palihapitiya’s SPACs in October 2019, has practically sextupled in value since. 

Well, it had almost sextupled in value since opening at $11.79. The stock hit a high of $60.82 on Feb. 11. Since then, the stock has been in free fall due to additional delays in testing the company’s SpaceShipTwo suborbital rocket plane, Virgin Galactic’s large losses, and a lack of revenue. The stock is currently trading at $28.34.

Stocks go up and down; Virgin Galactic’s shares will likely soar when the company starts flying again. But, it’s a sign of how much trading on Wall Street is based on expectations and hope that Galloway can declare a SPAC deal to be successful because the stock price has increased, not because of anything the company has actually done.

It’s been two years since SpaceShipTwo VSS Unity‘s last powered flight. During that time, the company has conducted two glide flights. A powered suborbital flight test was aborted in December due to a technical problem. The company delayed a suborbital test scheduled for February until May because engineers had still not fully addressed the problem that cropped up in December.

In the 16 months since Virgin Galactic went public, its schedule for the start of commercial space tourism flights has slipped 18 months from June 2020 to early 2022. It’s yet another delay in the SpaceShipTwo program, which was originally supposed to carry space tourists 15 years ago in 2007.

Virgin Galactic had a net loss of $272 million in 2020. The company had zero revenues in the fourth quarter. Significant revenues are not expected until next year.

Virgin Galactic CEO Michael Colglazier has bold plans for the company. He envisions SpaceShipTwo vehicles flying from multiple spaceports around the world. Each spaceport would host 400 suborbital flights per year and generate $1 billion in revenues in ticket sales and ancillary revenues.

However, it’s not at all clear whether SpaceShipTwo and WhiteKnightTwo carrier aircraft are robust enough to support that kind of a flight rate. Nor has Calglazier made clear how long it will take to reach those numbers if it is possible.

While the stock has been taking a beating as of late, insiders have taken advantage of its rise to cash out. On Friday, it was announced that Palihapitiya, who serves as Virgin Galactic’s chairman, had sold his entire personal stake in the for about $213 million. In December, he sold nearly $98 million in personal shares. Palihapitiya’s personal investment when Virgin Galactic went public was $100 million.

Palihapitiya said he needed the $311 million for a new venture focused on battling global warming. He said he remains fully committed to Virgin Galactic. Palihapitiya continues to indirectly own a stake in the company through Social Capital Hedosophia.

Last year, Virgin Galactic Founder Richard Branson sold hundreds of millions of dollars in Virgin Galactic share. He has said the money helped to rescue his travel-focused Virgin Group, whose airlines and hotels have been hard hit by the global COVID-19 pandemic.