Free of IPO Constraints, SPACs Can Make ‘Absurd’ Financial Projections — And This Hedge Fund Manager Says The Fallout Is Coming

“You can get away with saying anything you feel like if you sell to the SPAC market,” says Orso Partners co-founder Nate Koppikar.

(Michael Nagle/Bloomberg)

(Michael Nagle/Bloomberg)

A hedge fund manager is sounding the alarm on special purpose acquisition companies, warning that SPAC promoters have been making outlandish financial projections about their merger targets.

Such “absurd” projections would be illegal for target companies if they chose instead to go public via an initial public offering, according to Nate Koppikar, co-founder of hedge fund Orso Partners. He believes that lax disclosure requirements for blank-check companies are one of the biggest reasons why SPAC valuations have recently hit nosebleed levels.

“They are often pump and dumps,” Koppikar said in an interview with Institutional Investor. He said the lofty projections made by SPACs are “100 percent helping create a bubble mentality.”

And now, with the IPOX SPAC index down more than 13 percent over the past week, the bubble shows signs of bursting, he said. “If this continues for another week or two, the SPAC market is dead,” he added.

According to Koppikar, U.S. companies would prefer to go public via a merger with a SPAC instead of a traditional IPO largely because of a SPAC’s looser disclosure requirements. “You can get away with saying anything you feel like if you sell to the SPAC market,” he said. “When people buy into SPACs, they’re often buying incredibly overvalued companies.”

Koppikar, who left a career in private equity to form Orso Partners in 2019, said that this year he has shorted at least ten SPACs.

The structural problems of SPACs, which include virtually free shares for the sponsors and free warrants for the hedge fund investors who have to approve the mergers, have been viewed as the main risks to the market, as II previously reported. But now SPAC observers like Koppikar are starting to look at other issues — and they worry about what can be done about them.

[II Deep Dive: Egregious Founder Shares. Free Money for Hedge Funds. A Cluster***k of Competing Interests. Welcome to the Great 2020 SPAC Boom.]

When a U.S. company goes public with a traditional IPO, it is generally prohibited from including forward-looking financial projections in its prospectus and during the quiet period, when companies are barred from publicly sharing additional information until 40 days after the stock starts trading. But because SPAC deals are based on the Securities and Exchange Commission requirements for mergers, there is no such prohibition for target companies.

“What you see now is that these flimsy companies that should not be going public have found a backdoor way into the public market,” Koppikar said. “You can’t take their projections seriously.”

One person who has benefited from the looser rules around SPACs is Chamath Palihapitiya, a venture capitalist with a wide following who has become a serial SPAC promoter. Palihapitiya has publicly shared projections about SPAC deals that he is involved with, including the recently announced SPAC merger with Berkshire Grey, a deal in which he is the lead PIPE investor. In a February 24 tweet about the deal, Palihapitiya predicted that Berkshire Grey will have a “CAGR of 99 percent in 2021-2015.” In other words, its revenues will almost double every year over the next five years. He said it had an enterprise value of $2.2 billion.

“This is an amazing company building robots, AI and software that automate warehouses for customers like Walmart, Target, FedEx and TJX,” Palihapitiya tweeted.

By comparison, when Palihapitiya spoke on CNBC in 2019 about Slack Technologies — a VC investment of Palihapitiya’s firm Social Capital that was preparing to go public at the time — the online messaging firm had to disavow his “unauthorized statements” as they were in violation of the quiet period rules. During the CNBC interview, Palihapitiya had said that Slack was “going to be one of the most important tech companies in the world.”

Palihapitiya became a prominent SPAC promoter after his first blank-check company, which merged (or deSPACed, in industry jargon) with Virgin Galactic, turned out to be a home run for investors who got in early. As of Friday afternoon, however, the stock was down more than 35 percent from its peak close on Feb. 11.

A more recent Palihapitiya SPAC, which merged with Clover Health, has done worse. Clover, which was the target of a short seller report by Hindenburg Research after it went public last month, has fallen about 40 percent this year and is now trading below its offering price of $10 per share.

According to Koppikar, both venture capital and private equity firms have been “sitting on companies they could not sell” and SPACs have provided a much-needed exit.

But if the companies fail — as historically many SPACs have done following their mergers — investors may have little recourse. A class action lawsuit against the sponsors of Waitr, a regional rival to GrubHub that has collapsed since it merged with SPAC Lancadia Holdings, could be a test case, according to Koppikar.

Investors allege that that the prospectus issued in connection with the SPAC merger gave false and misleading statements, including that the food delivery company was on the verge of profitability. At the time the merged stock began trading, the lawsuit alleges, none of Waitr’s financial statements, SEC reports, or Sarbanes-Oxley certifications were “true, accurate, or reliable.”

Defendants Waitr and its sponsors, Lancadia Holdings, Tilman Fertitta, and Jefferies CEO Richard Handler have said they believed the projections when they made them and asked the federal judge to throw out the case. Bloomberg reported last week that a ruling on the case could come shortly after a March 16 hearing.

“If that lawsuit does not survive the motion to dismiss, it would be a green light for people to make absurd projections,” said Koppikar, who fears the lawsuit will get tossed. He said that it is difficult for investors to get to the discovery phase of such lawsuits, due to a 1995 law that made it harder for investors to sue without evidence that the defendants had an intent to defraud. The Catch-22 is that such evidence is typically only found through discovery.

Under the SEC’s new chief Gary Gensler, the agency is expected to focus on SPACs. But although the regulator has been sounding the alarm about blank-check companies, it’s not clear what more the SEC can do without congressional action.

SPAC sponsors aren’t allowed to choose their target companies ahead of their IPO. So to start with, Koppikar thinks the SEC should subpoena target companies and their sponsors to see if they had any communications, via emails or phone calls, ahead of the SPAC IPO. “If they were having communications ahead of time, they used the SPAC to get around the IPO,” he said.

Should the SPAC market implode, as Koppikar thinks it will, the fallout could be intense. He pointed to possible congressional investigations and eventual government action as potential consequences.

“You think GameStop was bad?” he said. “This could be worse.”