Why SoftBank’s Possible SPAC Ain’t All It’s Cracked Up to Be

Total Wealth Staff Dec 27, 2020
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If you didn’t read Wednesday’s Total Wealth, you need to because today’s picks up where it left off. Click here for the full story.

SoftBank Group Corp. (OTC:SFTBY) and its Vision Fund are promoting a new SPAC (special purpose acquisition company) which, when it IPOs, will raise $525 million.

The SPAC will use that $525 million, and at least another $200-$300 million, that SoftBank says it will provide in the form of a forward financing agreement, otherwise known as a PIPE (private investment in public equity), so the SPAC can buy a worthwhile, and maybe expensive, target operating company.

Here’s how expensive a potential target could become…

Not a Pretty Picture

SPACs must use at least 80% of the money they raise to buy a company, but they usually go after companies with a valuation much higher than the amount they raise in their IPO. One reason is buying a company with a much higher valuation than the amount of the IPO proceeds results in less dilution for existing shareholders.

But there’s another reason SPACs go after higher-valuation companies. And it’s not a pretty picture.

The sponsors of a SPAC, for a mere $25,000, buy between 20% and 25% of the SPAC’s equity. Almost always, they end up with 20%, with 5% of the original 25% having been diluted down to 20%. That chunk of ownership is called “founders’ shares,” “founders’ equity,” or the “promote.” Yeah, it’s really called that, the “promote.” That’s a lot of equity to promote a merger and your own wealth.

Let’s use round numbers and look at what that really means.

If a SPAC raised $100 million, its sponsors who paid $25,000 for 20% of the shares of the SPAC would have shares worth $20 million. Not a bad deal.

If the SPAC was to buy an operating company with a valuation of $500 million (using the $100 million it raised in the IPO and getting the rest by raising money through PIPES) the sponsors’ shares would be worth $100 million. That’s the value of their promote.

That’s really why sponsors go after bigger game.

But there’s more. And it’s not pretty.

What if the target company the $100 million-SPAC was going after was valued at $250 million? What they could do, what a lot of them do, is infuse or invest in that target company, maybe $25-$50 million that they borrow, maybe less, and buy shares in the target company at a price that values the company at $500 million. That happens.

So, for a $25 million to maybe $50 million investment in the target company, the sponsor gets to raise the valuation of the target to $500 million.

Other investors are supposed to look at the target and say, wow, that company that was worth $250 million a few quarters ago is now worth $500 million and that SPAC is buying it, good for them, because if its valuation is rising that fast it must be a hot company. Oh, I want to buy that SPAC.

Do you get it?

What if SoftBank’s SVF SPAC had SoftBank invest another $1 billion in WeWork, which was worth $2.9 billion on SoftBank’s books last spring, making it worth maybe $5 or $10 billion, based on how SoftBank’s investment round gets calculated into WeWork’s valuation.

And the SPAC buys WeWork for $7 billion. Investors might think, wow, WeWork was once worth at least $47 billion and the SPAC just bought it for $7 billion (incidentally giving its sponsor equity worth $1.4 billion, which it paid $25,000 for) I want to own that SPAC, now called WeWork Inc. Because, you know, it’s appreciating fast, again.

That’s not what I’m saying is happening or might happen. I’m just saying that’s how SPACs work.

But there’s more, a lot more. And if you think what you just read is scary, you ain’t seen nothing yet.

I’ll be back.

Sincerely,


Shah

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