Retail Investors Got Crushed As Scammy SPAC Sellers Cashed Out

Shares of half of the companies that finished SPAC deals in the last two years are down 40 percent or more and investors want their money back.

Space-tourism firm Virgin Galactic Holdings Inc., founded by British billionaire Richard Branson, is one of the worst performers. Billionaire investor Chamath Palihapitiya, one of the executives who helped take Virgin Galactic public, resigned last week as chairman, drawing renewed attention to his massive share selloff in 2021.

Virgin Galatic ($SPCE) closed its first day of trading in 2019 at $11.50. Shares rose as high as $62.80 in February 2021, buoyed by investor excitement about the potential of space tourism and commercial space travel.

Shares of Virgin Galactic are trading at $8.40 as of this writing.

Low share prices are a huge threat to SPACs because they can trigger a negative spiral, Wall Street Journal reported. Investors who put money into a SPAC before it announces a deal can withdraw their money before a deal goes through — typically the SPAC’s listing price of $10 plus a tiny bit of interest.

If shares of a SPAC trade below $10 before a deal closes, many hedge funds and other professional investors automatically choose to pull their money out to cut their losses.

With most SPACs trading poorly, the average withdrawal rate rose to about 60 percent in the fourth quarter of 2021 compared to 10 percent in early 2021, according to Dealogic data. For companies that complete deals, many are left with much less cash from their mergers and less money to expand with, which can put even more pressure on the stock price.

SPACs are a great deal for celebrity sponsors, but not for retail investors, according to Mergers And Inquisitions. Shaquille O’Neal, Colin Kaepernick, A-Rod, Ciara, and Palihapitiya all sponsor SPACs. Short for special purpose acquisition companies, SPACs are an alternative to the traditional IPO process and can go public faster, cheaper and with less regulatory scrutiny.

Unlike IPOs, SPACs have sponsors — often, celebrities — who get a 20 percent stake, called a “promote,” without having to invest almost anything in exchange. Even if the post-merger SPAC performs well, the sponsor earns a disproportionate amount of the proceeds.

“As a result, the sponsor could walk away with millions or tens of millions of dollars even if the SPAC performs horribly and the share price plummets, while normal investors will lose everything,” according to Mergers And Inquisitions. “A SPAC with these terms is like a call option that has a payoff if the company’s share price increases above the exercise price and if the share price falls by almost 90%!”

Virgin Galactic shares have steadily lost value, blamed in part on the disclosure in March 2021 that Palihapitiya had sold off about $200 million of his stake in the company. The filing at the time reported a sale of 6.2 million shares for an average price of $34.32, CNN reported.

“Keep in mind, @chamath cashed out $310 million of personal $SPCE stock, now stepping down from the board. He sold most of it at $34 a share — now trading at $9,” tweeted CNBC wealth reporter Robert Frank.

The SPAC mania bubble may have burst under pressure from the Securities and Exchange Commission, which issued new accounting guidance in April 2021 that could classify SPAC warrants as liabilities instead of equity instruments.

Sometimes called “blank-check companies,” SPACs go public as cash shells with sponsors later identifying an operating business to merge with. A “celebrity” or another notable person aka sponsor, raises capital by taking the SPAC public in an IPO. This SPAC then uses proceeds from the IPO and a large stock issuance to acquire a private company, taking it public. The private company ends up controlling the entire entity.

SPAC promoters claimed that their SPACs were the “poor man’s private equity” offering “mom and pop investors” early access to the best IPOs, The Hill reported. They were also a way “around the carefully constructed registration process designed to safeguard investors from questionable deals. Even worse, some of them seemed to resemble classic stock manipulations using shell corporations to pump up share prices so insiders could dump their stock on unsuspecting investors.”

Some of the stock sales by SPAC organizers may also have involved unregistered securities, making them in violation of the law.

Electric truck maker Nikola, one of at least four EV makers under investigation for misleading investors, has agreed to pay the SEC $125 million to settle charges that it defrauded investors in a SPAC.

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Former President Donald Trump is pursuing a SPAC merger that he said would result in the creation of a social media and streaming company. The deal is under investigation by the SEC.

Ivana Naumovska, a professor at INSEAD business school who researches the consequences of corporate financial fraud, predicted a year ago that the SPAC bubble was about to burst.

The telltale signs? Rapid proliferation of a controversial financial innovation, poor-quality players, bad publicity and regulatory concern. These have been seen in previous bubbles and they’ve re-emerged in the SPAC boom, she wrote for Harvard Business Review.

Crunchbase published a list in December 2021 of “truly terrible” SPAC performers multiplying among startups. “While many mergers with blank-check acquirers do OK initially, it’s quite common for these companies to see share selloffs in subsequent months,” Crunchbase reported.


Photo: Chamath Palihapitiya, left, and Sir Richard Branson, center, founder of Virgin Galactic, meet with specialist Peter Giacchi at the New York Stock Exchange, Oct. 28, 2019. (AP Photo/Richard Drew)

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