Bill Gates Is Right About the Crazy Rush for SPACs

(Bloomberg Opinion) -- When’s the right time to join the stock market? These days companies taken public by special purpose acquisition companies are raising billions of dollars based on little more than a few prototypes and a business plan. 

Never mind profits, many of the businesses targeted by SPACs for mergers don’t even have revenues yet, especially in the electric-vehicle industry. Money from blank-check companies — which raise cash in an initial public offering before finding a promising private firm with which to combine — is helping fund capital-intensive factories and technology development. But Microsoft Corp. founder Bill Gates worries that we’ve flipped from an environment in which companies were waiting too long to go public to one where they’re doing it too soon.

He’s right, and the pitfalls are becoming ever clearer. Companies that have gone public via SPACs have begun ditching financial forecasts made only a few months earlier at the time of their mergers, the Wall Street Journal and FT Alphaville have reported. This is something I’ve also warned about. It stems partly from a regulatory loophole that lets SPACs publish very optimistic financial projections, which isn’t so easy in a traditional IPO. 

For some, the baptism as a public company has been chaotic and unforgiving. Take Canoo Inc. Having joined the stock market only a few weeks ago, the electric-vehicle start-up has already replaced some of its top management and abandoned key parts of its strategy, while acknowledging its financial controls weren’t robust enough. Wall Street analysts are exasperated and some early investors are pursuing legal action. Canoo is a parable of the perils of premature listing.

Founded toward the end of 2017 and yet to generate significant revenue, Canoo was taken public in December by Hennessy Capital Acquisition Corp. IV, one of five blank-check companies set up by investor Dan Hennessy (a sixth is in the works). Canoo and Hennessy didn’t respond to a request to comment for this piece.

The transaction valued Canoo at $2.5 billion including the $600 million of cash it raised. About half of that cash came via a concurrent so-called PIPE financing anchored by BlackRock Inc. Now the wheels have come off. During a debut earnings call last week — described by one financial blogger as the worst he’d heard from a public company — Canoo’s executive chairman Tony Aquila dropped a series of strategic and financial bombshells.

Canoo’s original business plan, described in this investor slide deck and prospectus and agreed before Aquila was appointed chairman, aimed at providing contract-engineering services to other carmakers and technology companies. This was expected to generate $120 million of revenue this year, tiding the company over until it started manufacturing its first vehicles in 2022. 

Engineering services have now been “deemphasized,” Aquila said on the call, while a plan to offer customers vehicles via subscription will be scaled back. He declined to reconfirm previous financial guidance. A vaunted partnership with Hyundai Motor Co. appears to have hit the skids and Canoo’s chief financial officer and head of corporate strategy, who pitched investors on buying its stock, have left. The resignation of CFO Paul Balciunas was “not related to any disagreement regarding financial disclosures, accounting matters or other business issues,” Canoo said. The company is yet to remedy several material weaknesses in its internal controls over financial reporting, according to its annual report.

A slate of new financial hires, including an interim CFO, will aid the transition from private to public markets, the chairman said. But why, analysts inquired, wasn’t Chief Executive Office Ulrich Kranz on the call? The former BMW AG executive is “still currently the CEO,” Aquila said — hardly a ringing endorsement. 

Start-ups often announce strategy pivots and have high staff turnover, but doing all this when you’ve only recently gone public is unsettling. Canoo’s PIPE investors and those who bought shares in the SPAC after the Canoo deal was announced based their decision on the information available at the time. The prospectus compared Canoo’s business model to richly valued subscription businesses such as Netflix Inc., Peloton Interactive Inc. and Spotify Technology SA. That seems even more of a reach now.

Aquila wasn’t finished, either. In the past Canoo had been “a little more aggressive” and “presumptuous” in statements about prospective business opportunities, which didn’t meet “our standard of representation to the public markets,” he said. “This comes back to having an experienced public company team. You’ve got to be careful of the statements you make,” he added, referring to previous company statements about its contract-manufacturing relationships.

Unsurprisingly his remarks now feature in a pair of class-action lawsuits filed by investors who claim they bought the SPAC/Canoo shares based on misleading information. Shareholders haven’t given up entirely on Canoo’s promising technology: The stock is only 5% below where the SPAC sold shares to the public. Still, it’s an inauspicious start and won’t help future fundraising.

Start-up founders should think before hopping on the SPAC bandwagon. The potential valuation uplift and payday are appealing, but are they truly ready for the scrutiny and regulatory rigor of being public?  

As for investors, it’s pretty unwise to expect companies with accounting weaknesses to be capable of accurately projecting their future financial performance. While business forecasting is especially difficult right now because of Covid-19, it’s puzzling that the U.S. Securities and Exchange Commission lets SPACs publish such unreliable information.

Increasingly it seems as though companies are saying one thing when they want to raise money and another once the money’s in the bank. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies. He previously worked for the Financial Times.

©2021 Bloomberg L.P.