Last Friday, Sports Ventures Acquisition became the latest sports-, media- and entertainment-centric special purpose acquisition company to file paperwork with the U.S. Securities and Exchange Commission (joining the likes of RedBall Acquisition Corp., Sports Entertainment Acquisition Corp., Bull Horn Holdings, Forest Road Acquisition Corp. and Acies Acquisition Corp.). According to Sports Ventures Acquisition’s prospectus, the group, led by Atlanta Falcons limited partner Alan Kestenbaum, intends to raise $200 million in an IPO and then use the money to pursue a business within the sports, media and entertainment sectors.
We recently explained how the valuation arbitrage between Wall Street and Main Street is driving privately-held companies to the public markets. Less clear is why SPAC principals are opting to tap the public markets for funding rather than the $3.5 trillion of ready capital private equity has at its disposal. Conversations with several of the parties associated with the sports-, media- and entertainment-focused SPACs indicated that the ability to play companies for a much longer period of time than P.E. allows, and the access to perpetual capital by way of the markets, attracted them to the blank-check company model.
Our Take: It is important to understand that private equity firms are in the asset management business. By nature, their funds have limited life spans. After a period (typically five to 10 years), fund principals have a responsibility to sell out of—or otherwise harvest gains from—their investments. By contrast, SPACs have no obligation to define an exit time frame on the capital invested. The SPAC shareholders make that decision. A SPAC is simply a flexible vehicle for private businesses to use to access the capital markets. That allows the SPAC’s principals to select a counterparty with a different mindset, one focused on the best long-term interests of its shareholders.
While there are some businesses for which recycling capital every five to 10 years doesn’t matter, others have business plans that require access to money on a more permanent basis, which is what the public markets provide. In the current economic environment, privately-held, high-growth companies are well-suited for SPAC acquisition—even if the business has no profits to show. That is because with the capital markets rising, a result of historically low interest rates, investors are looking for growth opportunities (think: 10-20% YoY). And because the cost of capital is very low, the risks associated with chasing that growth are also low (in other words, dividends and other forms of cash returns are minimal right now). Case in point: DraftKings. Shares are up nearly 200% since the company began trading in late April, despite the company being nowhere near profitability.
Speaking of DraftKings, it would have been a risky endeavor for the company to go public via a traditional IPO. Companies are prohibited from offering projections on profitability during the IPO roadshow, and there were no real comps for the DFS turned sports betting operator at the time. But because Diamond Eagle Acquisition Corp. was already listed, all DraftKings had to do was convince the SPAC’s shareholders to buy into the company’s plan in order to go public. In essence, the SPAC enabled the company to test the waters before going through with the IPO process (and before they absorbed all of the costs that come along with it).
The increased presence of retail money in the market is not among the catalysts for the SPAC craze within the sports and entertainment world. The initial public offering of a SPAC is an institutional product that separates into hedge funds and long-term investors. Trading volume between the time of a SPAC IPO and when the acquisition is announced is very low, so the day trader isn’t interested, and the average retail investor doesn’t understand that when a SPAC IPOs, the stock unit is sold with a piece of the warrant stapled to it (a cheap option to buy more stock). Once the stock unit and warrant can be separated (roughly 60 days after the IPO), the investor has an opportunity to sell the stock for roughly the cost of the unit and keep the warrant—and upside—for free.
Word of caution: there are people getting into the SPAC craze in the hopes of making a quick buck. They’re planning to capitalize on a trade and sell out of their shares at the first opportunity. While some might find success, others are bound to realize that identifying an acquisition target within two years is tougher than they imagined. Those groups will lose their initial investment.