SPAC Boom Creates Fresh Targets for Short Sellers, Activists
(Bloomberg Businessweek) -- When Genius Sports Ltd. merged with a blank-check company earlier this year, it became part of the the hottest trend on Wall Street this side of meme stocks.
Its deal to combine with the publicly traded DMY Technology Group Inc. II was a relatively easy way for the then-private Genius to list its shares on the New York Stock Exchange. The newly merged company adopted the Genius Sports name while inheriting DMY II’s public status. That was the entire point of DMY II’s brief existence: As a special purpose acquisition company, it was essentially a corporate shell founded in 2020 to search for and buy a business. SPACs are also known as blank checks, since investors initially put their money in without knowing what business the company will buy.
All kinds of big names have been launching SPACS, from billionaire Bill Ackman and even celebrities including former New York Yankee Alex Rodriguez. There are 586 active SPACs in the market, with a combined capital of $175 billion, according to data compiled from the website SPACResearch.com. For SPAC sponsors, they are opportunities to earn fat fees. For the companies they acquire, SPACs are a way to tap public markets for cash without jumping through some of the hoops required in an initial public offering. Investors are often attracted to SPACs, both before and after the mergers, because they see them as early stage companies with prospects for blistering growth.
Now another group is getting interested: the short sellers and activist investors who hunt for companies they think are weak. Genius Sports has already found itself in the sights of one money manager who is shorting the stock—placing bets that its share price will fall.
The company, which provides data and technology to the sports-betting industry, has the kind of growth story SPAC sponsors look for. In a filing DMY II characterized Genius Sports as a “fast-growing business with significant scale, distribution and an expanding addressable market and opportunity.” When they merged, Genius Sports had just struck a $120 million a year deal to provide real-time information from National Football League games to its clients. It has since leveraged that agreement into a partnership to provide a suite of NFL-related services with DraftKings Inc., another company that went public via a SPAC.
Now short seller Spruce Point Capital Management is arguing that Genius Sports has an “inferior business model” that puts its profitability at the mercy of large sports leagues. Shorts often loudly proclaim their bearish arguments, since they make money if others agree and drive the price down. In a public letter Aug. 5, the firm said it believed Genius Sports shares were poised to tumble by as much as 80%, and that the pressure would start around Aug. 18, when a 60-day lock-up period expires and 35 million insider shares are finally able to be traded. “At the end of the day, Genius is an intermediary, or middleman, that provides data from sports leagues to sportsbooks and, as a result, will likely be subject to margin pressure from both sides,” Spruce Point said in the letter.
Genius Sports fired back with its own allegations that Spruce Point’s claims were “intentionally misleading” with the goal of advancing its own position in the stock. “Our data and technology is becoming ever more vital to the global sports betting industry as it continues its strong growth,” it argued. So far, Genius Sports is winning: Its stock has risen since the argument began.
This sort of public fight may become more common as investors digest hundreds of SPACs and SPAC-spawned public companies. As of July 16, total short interest in active SPAC securities hit $2.36 billion, up more than threefold from the start of the year, according to data compiled by S3 Partners. Critics of SPACs say many businesses choose this route because they have problems that might deter traditional IPO investors, including governance issues, regulatory risks, a lack of profitability, or, more generally, that they’re just not very promising.
There’s reason to think that the SPACs of the future could be weaker than those of the past. SPACResearch.com says about 75% of current SPACs are still looking for a business to buy, with about $131 billion of capital to be deployed. With so much money looking for takeover targets, the quality of acquisitions could fall as sponsors scramble to make deals. They typically have 24 months to find a target or they have to return the money to their investors.
Besides short sellers, activist investors try to profit from troubled companies. They buy shares when they look cheap and then pressure managers to make changes that will pay off for shareholders. “To the extent that there are going to be companies that are going to underperform, for whatever reason, including the fact that maybe they should not have gone public, that’s going to create the situation where an activist steps in,” says Ele Klein, co-head of the global shareholder activism group at law firm Schulte Roth & Zabel. Klein advises shareholder activists on their campaigns; while it’s still early, he says many clients are starting to monitor the SPAC world for opportunities.
It will probably be 12 months or more before traditional shareholder activists make a big push, he says. That’s largely because many of these newly public companies have lengthy lock-up periods for founders and other insiders, so there aren’t enough shares on the market for activists to build a sizable stake. It will also take a few quarters before the underperformers are identified. But that timeline could accelerate with any disruption to the SPAC market, such as additional regulation or a broader slowdown in mergers and acquisitions, Klein says.
Lawrence Elbaum, co-head of the shareholder activism practice at law firm Vinson & Elkins, says a lot SPAC targets are going public with outdated governance or complex capital structures—or senior managers who lack public market experience. That’s likely to make them vulnerable to activists who want changes, such as swapping out directors or senior leaders or an outright sale of the company, says Elbaum, who advises companies on their defense strategies against such activist attacks.
There are also going to be “zombie SPACs”—those that are unable to find a target or could be forced by an activist to do a deal quickly or simply return the capital they raised to investors, he says.
“The first steamroller is the short attackers—they’re targeting companies, saying they’re not ready for prime time or the numbers just don’t work,” says Elbaum. “If the company has cash or can generate cash, you can really easily see an activist saying: ‘I’m going to come in here and I’m going to make some changes.’” When that happens, company founders may start to see the downside of taking the easier route to a public listing.
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