Challenges Of Direct Listing And How SPAC Deals Work

Hello and welcome back to The Deal Room. And on the agenda with Stephen today, we are going to talk about the IPO market, but more specifically, two things: direct listings and SPACs. You've probably heard of the latter, but maybe not for a while. We had that SPAC boom. I remember Trump going into the SPAC space himself. But why has it come off the boil? What exactly is it? So hopefully Stephen's going to explain. But before that, Stephen, one thing I saw on Yanfaimi LinkedIn just quickly was something called the Deal of the Week. What is that post and what can people expect from that weekly release from you?

Yeah, sure. Thanks, Anthony. And yeah, good to, good to have you back on the, on the Wednesday pod. Flying solo, it's never as fun. So So every Monday on, on the Amplify Me LinkedIn, we are doing a Deal of the Week. So this is a bit of a wrap-up of the biggest or the most interesting deal, merger, acquisition that has happened during the previous week. And what we're trying to do is we're trying to give you the key takeaways within a couple of hundred words. Think about this as your crib sheets or your revision notes if you're going into an interview, uh, you know, for an internship at an M&A house or something like this. They often ask, you know, talk to me about a deal that you've been interested in. Hopefully these little snippets, the rationale, who's doing the deal, what are the terms, will give you that, that overview that you need. So check it out every Monday, post a comment, tell me if I'm wrong, tell me if there's another deal that you want to talk about. Always up for hearing from you.

Okay, good stuff. And you could expect that every Monday. And so look, let's dive in then. Let's talk about direct listings. And I think there's a company here, Surf Air, to use as a real tangible example. So who is this company and what is the direct listing process?

Yeah, so Surf Air is a company you probably, quite frankly, you probably wouldn't have heard of, but I picked up on this headline earlier on the week uh, from Bloomberg: Surf Air's rough debut serves as cautionary tale for direct listing. So, so what does this mean? So Surf Air is a small commuter airline in the US. So the US is obviously a lot larger than the UK, and people don't just travel via car or by train. There are airlines that do really, really small intercity or inter-town flying. And Surf Air is one of those, but it's also got a part of its business that is aiming to electrify some of its fleet. And obviously electric powertrains for the airline industry is a much hyped and always around, just around the corner, uh, area of the market and something that investors get quite excited about. But this is less about maybe the company and more about this concept of direct listing. So we spoke on the pod last week about the IPO process and how IPOs might be just coming back, you know, book building, offer price, launch on the day, hopefully get a pop, green shoe options, price stabilization, all of the good stuff that we spoke about last week. The normal way of getting yourself into the public markets, making, making sure that you can raise money from the public markets. But direct list— a direct listing is something slightly different. So Surf Air, instead of going through the IPO process, instead of going through the roadshow, instead of hiring an underwriter and book building and getting your anchor institutional investors and getting the price stabilization mechanism such that when you launch at an offer price, you know that it's not going to tank and slightly embarrass yourself. They went for a direct listing. So direct listing is slightly different in the sense that you're not creating any new shares, you're just selling existing shares from existing shareholders. So it's almost like a secondary, it's an exit event or a liquidity event for these founders or these investors that want to get out. There is no book building process. There is no roadshow. So instead of building price discovery through that process and then establishing a range, a price range, and then landing at the upper or lower end depending on interest, you just have a reference price, a kind of slightly advanced finger in the air as to what this thing could debut at on the stock market. Now, in Surf Air's case, the reference price when it decided to undertake this direct listing, where a percentage of its existing shares would be floated for retail investors or institutional investors to buy on the market, on the, on the public market, the reference price was $20 a share. So that's kind of what, uh, Morgan Stanley, the advisors, and, uh, Mollis and Canaccord thought, all right, this is kind of— this is roughly what we hope to expect the demand to be for Surfairs shares. Reference price $20, opened market opening, bell sounded, $5. So So the reference price just totally overshot the initial demand in the market. And remember, because there's no, uh, support structure or stabilization mechanism, there are no anchor institutional investors that have got an incentive to keep the price up on day one, this thing could continue to tank. And by the end of the day, the shares traded at $3.15. And now, one week later, they're trading at $2. So they've now got a market capitalization of $125 million. This is tiny, where they expected at a reference price to have a market capitalization of $1.725 billion. So they're basically 10x off.

This sounds like a classic sham. As in, the founders just will be banging the drum about hybrid electric, fully electric powertrains. They have this event, they're going to set a reference price high. What's the comeback for them? Is there any? I mean, they surely— there's not. So then, I mean, could you not just have the, the process of creating this build, this company, hyping it around a particular sensitive technology and then you exit, make a ton of money, and then who cares what happens thereafter? I mean, what, what, what is the success or failure ratio of these direct listings in, in a more broader context?

Yeah, yeah, well, let's, let's, let's talk about that. But I, I think, I think your sentiment is absolutely right in the sense that this feels like a little bit of a back door to, for pass on risk from, well, from founders or venture investors to unsophisticated, potentially retail investors that might get a little bit excited about the notion of electric planes, even though their core business is just doing little kind of turboprop planes from one small city in the south to another small city. So I think your sentiment's right. And quite frankly, this company would never be able to go, would be able to IPO through the traditional means with any chance of success. It's a, you know, $28 million of revenue. It makes a loss of $15 million a year. This is, you know, this is not a particularly exciting story. So, so, so you're absolutely right. And maybe, maybe we can take a look at some of the previous direct listings, uh, to give it a, give a bit of an example.

But just, just before that, the, the timing as well, like just given the broader macro climate right now, and yes, it looks more like potential soft landing in the States, but a slowdown nonetheless. And so you're talking about aircraft carriers, which is probably not the go-to play in an economic downturn to be investing in. So what, why have they persevered and just gone with now? I know we've said there's general green shoots maybe emerging in the IPO space, but is there any, um, sense of their timing and why they decided to just persevere with this?

Yeah, I think possibly out of desperation. I was just looking at the history of the company and they had a failed SPAC merger, which we're going to talk about in the second half of the pod. They had a failed SPAC merger with Tucson Holdings Corporation in May 2022, uh, that would have generated $467 million of proceeds at a $1.4 billion valuation. So if you're a founder or you're a venture investor in this company and you've anchored yourself at a $1.4 billion SPAC merger valuation and you really want that exit event because you've had it dangled in front of you, you're going to do almost anything you can to try and get another exit event. And maybe it was Morgan Stanley, you know, saying, "All right, we're going to benchmark the reference price off of the SPAC price." Maybe that was a bit of failed logic. But I think, but in terms of the wider market, I think you're absolutely right in the sense that this probably isn't the right time for a super, or a relatively speculative company to go through this kind of direct listing, uh, method. The direct listing market has basically been shut since 2021, and a lot of stuff got through the direct listing market that maybe wasn't well enough scrutinized and was representative of a market that wasn't maybe as discerning as it is now. And what's quite interesting about the market now is if there's a good company, and lots of people think that the examples that we gave last week of Oddity and Carver, you know, good companies that actually make profits, they maybe deserve that IPO pop. But companies that don't really have a presence and are really struggling for market share, maybe such as Surf Air, maybe they should deserve to be pretty cheap. Badly treated in the public market. So that maybe this is an example of a well-functioning public market.

Yeah, and I was just having a look at your— some of your previous comments, and I saw Spotify and Slack, Coinbase all went through, which I didn't know.

Well, this is interesting. There's, there's a lot of talk about this, and there's a lot of talk about, uh, whether it is appropriate to pass risk on to the retail investor in this format, right? So if you look at previous direct listings, you've got Spotify, Slack, Roblox, Coinbase, Warby Parker. These are all— these have all generated a decent amount of retail interest and retail traction. We all kind of know these companies. The hope with a direct listing, bearing in mind that you don't have these big institutional investors anchoring the demand for this sale, the hope is you gain a load of momentum. Coinbase would be pushing this saying, "Look, we're going to list." By the way, there's no— One positive for the retail investor is there's no— You get first dibs. There's no book building process that goes on beforehand. You potentially get the pot. That's maybe one way of putting it. But Coinbase, which is a relatively flawed business model, Coinbase reference price, $250. That's what they thought they'd get when they direct listed. By the end of the day, they got that pop because in 2021, everything was popping, $328. But now it's at $98. Has the risk been passed on? And quite frankly, who's selling these shares? The founders, the original investors. They're cashing out. There's no lockup period like there would be for an IPO process. So this all smells pretty bad when it comes to— and actually makes the traditional IPO process look pretty robust, actually.

Yeah, it's interesting. I was just thinking, given my job, I work quite closely with marketing. Writing a lot of content, I was just thinking Coinbase is like the marketing man's dream to sell this direct listing to the masses. Because it's kind of like you would just tap into that psychological kind of aspect of what crypto represents and its embodiment. And then it's like, this is your chance to have your piece. I remember the Coinbase activities around that time. There was a lot of hype and it was just as crypto was peaking. Oh, and then the whole world came on.

Yeah, look, and, and the original investors and the original founders got pretty rich because, look, they, they sold their shares. They sold a percentage of their shares for that, you know, between $250 and $328 a share. And now, and kind of the retail investors as the suckers have been holding it down to $98. Without the institutional investor coming in and really providing that, maybe that floor, so to work.

Yeah, one of those names there was Slack, because of course Slack got acquired by Salesforce in the end. So I guess there's like a bit of a journey that they've been through then, direct listing. I wonder how long it was before then they got acquired.

Not very long. Maybe you can, maybe you can have a look, but I think 18 months. But it got acquired. So its reference price was $26 a share. By the end of the day, it was $38 a share. And I think it got acquired for $46 a share. So that's— we like to be nice and balanced on this podcast. It's not all bad. Spotify's reference price was $132. It now trades at $149. These aren't remarkable gains, but it's not like every direct listing is a fail. And Slack is probably one of the biggest successes. But I would say the, from a retail investor perspective, the kind of excitement of getting on board early may be tempered with the fact that there's not all of this infrastructure to support the price that there is in the IPO process.

Yeah, it was, uh, they, Salesforce paid $27.7 billion for Slack. I remember when that was happening. That was kind of like amid the kind of peak tech kind of COVID bubble at the time. So they'd absolutely nailed it. Salesforce did a lot for Slack at the time. But yeah, well, look, should we move on to the next one?

Let's do it.

So yeah, let's move on and talk a little bit about a Vietnamese company. So it's unusual to go geographically there, but let's do this. So VinFast targets August US listing, and this is not a small SPAC deal at all. Sounds pretty large for a company that I've never heard of. So who is this company? And maybe we could dive into this kind of mysterious SPAC world a little bit.

Yeah, so I think, I think this is a really good opportunity to take, uh, well, hopefully take the listener on a journey from how to set up a SPAC in the first place, all the way through to a SPAC merger, and maybe how the mechanics of a SPAC work. Because I think we all superficially know what a special purpose acquisition company is, but maybe we can, uh, dive a little bit into the, the technical elements of it and the investor incentives and why people set them up. So very quickly, we are going to be discussing VinFast, which is a Vietnamese EV manufacturer that is currently owned by Vingroup, which is the largest conglomerate in Vietnam, owned by the wealthiest person in Vietnam. And it is a company that I think only sold 7,500 EVs in 2022, but wants to grow at the kind of speed— think of it like a Rivian or a Lucid, um, and what I want to scale much like those companies. So high valuation, this SPAC is going to be valued, or it's valuing the company at $27 billion enterprise value. And the SPAC merger consists of a company, special purpose acquisition company called Blackspade Acquisition Company, merging with VinFast. So let's rewind and take it back to the beginning. So back in July 2021, during the kind of SPAC hype cycle, a wealthy investor from Hong Kong set up Black Spade Acquisition Company with the intention of going out and finding a business that was private to merge with and take public. So Black Spade in July 2021 listed or IPO'd, closing a $150 million IPO. They actually had, by the way, a green shoe option from Citi, who were the sole bookrunner, and ended up being a $169 million IPO. So what does this mean? This means that Black Spade Acquisition Company now has $169 million to go out and find a company to merge with and buy either a minority stake or a majority stake and basically take that company public through the back door. Worth saying that typically in a SPAC origination, the Originator of the SPAC, the person that is running, that's owning the SPAC, Lawrence Ho in this example, going out and trying to find the target, gets 20% of the SPAC and 80% is floated. So already, Lawrence Ho has 20% of the potential upside of this SPAC. And you sell shares for $10 a share. This is pretty typical, right? And it doesn't get traded because there's no liquidity at $10 a share until something happens. So it just stays listed at $10 a share. If you look at the share price charts, it's $10 a share. Right? Now, Lawrence and his team have 2 years to go out and try and find a potential target that they think is appropriate to take public into the US. So the 2 years started in July 2021. Bearing in mind, what are we now? The 2nd of August 2023. 2 years passed and actually they couldn't find a target. They couldn't find the target. So, so what usually happens is if you can't find a target within 2 years, you have to return the funds to the investors, less of any— so the way that it works is you return the funds, less of any SPAC winding up costs, plus any interest costs, because you put the $10 a share into a trust and it earns a little bit of interest. But what actually happened is that this SPAC asked for an extension from its investors. And said, "Look, we've got this company VinFast that we're really interested in. Can you just hold on? Can we get an extension to this SPAC period for another year?" Interestingly enough, about $140 million worth of shareholders decided to withdraw, to redeem. So actually, this SPAC now sits on $28 million of available dry powder to invest. So when we talk about VinFast coming into the public markets at a $27 billion enterprise value, $23 billion equity value, it's still 99% owned by its existing shareholders. Effectively, because Black Spade only has $28 million to play with, effectively, that $28 million is buying a 1% float of VinFast. So yes, it's valued at $23 billion, but only $28 million is going to be made public through the SPAC merging process. So, and that's the story that we're talking about today. You know, we're talking about VinFast, hopefully over the next few months, becoming a US-listed company by merging with BlackSpade. BlackSpade will change the name of that company to VinFast, and it will float on the— I think it's on the NASDAQ. So that is a little bit of just how the process of a SPAC works. Obviously, there are a lot of intricacies there as well.

Yeah, I got two questions. You mentioned there the kind of Lucid, Rivian, who have been— who are absolutely crushed after that EV bubble that we had. I think there was one, what was it, Polestar was valued bigger before its IPO than Volvo, who is the parent company. So it was like really going pretty nuts at the time. But Just makes me think, looking at VinFast's numbers you were just mentioning, the volume and the amount that they lost last year, and looking at the performance of Lucid and Rivian, and looking on the macro landscape of people buying EVs, which are expensive comparative to diesel products in terms of cars. So it's like How— I don't understand how people can even entertain as an investor this is a good idea other than just, um, facilitating, as you said, the process on behalf of the existing.

Yeah, I guess I think, I think, I think you're probably right. And yeah, I think Rivian's— Rivian IPO'd and popped to $110 billion market cap. I remember speaking to some students back in the, back in the day when it happened, and they were quite bullish on Rivian. Yeah, back in 2021, its market cap's It's now $26 billion. So, you know, riding the crest of the hype cycle right down into the bottom. But I think from an investor's perspective, maybe you would say much like a venture capital strategy, you would say, all right, I'm going to invest, you know, 2% of my net worth across 10 of these different EV manufacturers. And look, if one of them hits the Tesla explosive growth, then it doesn't matter if all the other ones go to zero. Yeah, I don't really know which one's going to be the winner or the winners, so maybe I'm just going to go across 3 or 4 of them and not, not risk too much of my capital. But from just to kind of step back into the Black Spade, uh, the reason maybe to invest in Black Spade— well, A, you know, you're investing something where you don't know what you're going to end up merging with. So A, you need to trust the credibility of the person setting up the SPAC, in this case, Lawrence Ho, but also just a little bit about the mechanics. So whenever you buy into a SPAC, whenever you buy into a SPAC IPO, you actually buy a unit as opposed to a share. So a unit consists of— this is just typical. A unit consists of a share worth $10 and a warrant or a fraction of a warrant. Which is basically an option to purchase shares in the SPAC for a price determined within the prospectus. So these investors in Black Spade, they bought, they spent $10 buying a share, which gave them half an option, half a warrant to buy shares in the future at $11.50 a share. And bearing in mind that after the announcement of the merger with VinFast, the SPAC, the BlackSpace shares, which should be trading at $10, suddenly popped to about $12.50. Suddenly you've got an in-the-money warrant, in-the-money option that you can exercise and actually get some upside. So from a, I kind of get that from a new investor's perspective, God, FinFast, it loses $2 billion a year. But actually from an initial SPAC IPO investor perspective, there's a little bit of a sweetener or a kicker in the form of that warrant.

Feels again like the retail person is getting a little bit of a rough ride here. They're kind of used as a mechanism for rich people to make more money, it seems, or more sophisticated investors to see some upside. But look, one of the things here, my final question was about, I think you mentioned Citi was the sole bookrunner, right? On this particular last one you've discussed. So, um, in terms of an investment bank, what proportion of their activities, um, I know it's like now is probably not quite the optimal time to ask this question because activity generally has been very low and is slowly returning, but what would you expect in like normal times, let's just call it, would be a proportion of deals that they'd be working on as a sell-side institution that would be SPAC or direct listing as opposed to just a normal IPO process?

Yeah, it's a good question, and obviously it depends on business cycles. And quite frankly, you know, SPACs have been around for a long time, but they only really started to become part of the kind of public, uh, discourse in 2019, 2020, as markets look for new ways of basically making money, maybe at the expense, as you say, of retail investors. And in 2021, there was actually more money raised in SPACs than there was in IPOs, which is quite a remarkable rise of the SPAC market. 613 SPACs in 2021, 86 in 2022. So the market just died. So you would be expecting in a typical— let's say the market settles into the rhythm that we expect it, whereas SPACs are still going to be a thing. But they're not gonna be the main thing. You'd expect it to be 5% of your equity capital markets desks, kind of public listing revenue. Bearing in mind that they get revenue from all sorts of other things, kind of rights issues and dividend recaps and things like that. It shouldn't be a big, it should be super, super niche because it is a, it's a really, really niche, uh, financial product, right?

So on that point then, I assume that just like you mentioned before, you'd have sector-focused teams. You'd basically have the SPAC person or SPAC team that are optimized to have all the know-how, the legal know-how, the process.

Yeah, yeah, you would have, you would have within an execution team, maybe if you were a large enough bank, maybe you would have a whole team that's dedicated SPACs. But again, that's super frothy, uh, and you could hire a team and then fire them the year later. So it'd probably be someone within an equity capital markets team where if there is a, if there is a potential SPAC, they'd be the ones that are interested. But I wouldn't yet say that it's become a cornerstone, uh, revenue stream. Well, I hope it hasn't become a cornerstone revenue stream for, for investment banks.

Yeah. Well, you know, just like the job cuts and lack of bonuses or anything like that in the current context for a lot of investment banks, I'm sure, as you just said, how frothy it was and how the boom was so huge just, what, 2 years ago. I'm sure everyone got handsomely paid at that, that point in time, um, for the banks. So look, I feel like there's quite a lot there to digest for anyone listening, so 100% encourage you to drop any comment on Spotify, use the Q&A function. I can notify Stephen, get him to reply, or we'll share this on our normal social channels. Feel free to leave a comment, and if there's anything there that wasn't crystal clear, I'm sure, um, Stephen can do a bit of a wash-up on those comments and, and help out. So yeah, Stephen, thank you very much as ever, and good to be back with you, and, and see you next week.

Thanks, Anne.