Reading the fine print
“We are a recently incorporated company with no operating history and no revenues, and you have no basis on which to evaluate our ability to achieve our business objective”
Over here at Bedrock, we care about corporate disclosure and transparency. Long-form text may be inefficient to read (if you are not a natural language processing algorithm), but contains a glut of information. Once you find a way to separate the signal from the noise, these disclosures are predictive of future corporate crises.
Which brings us to SPAC disclosures. The opening quote is standard, boiler-plate language for Special Purpose Acquisition Corporations and has appeared in over 2,500 filings this year . Some other standard disclosures include:
“We are a blank check company with no operating results.”
“Our management has limited experience in operating a public company.”
“Our officers and directors allocate their time to other businesses thereby causing conflicts of interest in their determination as to how much time to devote to our affairs. This conflict of interest could have a negative impact on our ability to complete our initial business combination.”
“As a private company, we were not required to document and test our internal controls over financial reporting”
These are real risks, of course, and they highlight the fact that SPACs have risks that well-known and well established public companies do not have. But they do little to help an investor differentiate between SPACs.
Access <<<<<>>>>> Protection
Public company compliance is costly, and non-compliance may be worse. Although it is not the only factor that contributed to the delay in companies going public during the past decade, it has certainly contributed. But this creates opportunity asymmetry.
Companies staying private longer meant the exclusion of retail investors from much of the tech explosion. Watching unicorns develop just out of reach was not ideal, and it is likely the feeling of missing out on the last ‘next big thing’ that drives the impulse to make sure we get in early on the next one.
Access and opportunity are good things. Having available funding for great ideas that can change the world is a good thing.
But so far oversight hasn’t been optimal, and restatements, forecast reversals, and class action lawsuits are more frequent than one would like. Lack of oversight allows for embellishment, leaves room for errors, and attracts bad actors.
Promising Unicorns, Delivering Donkeys
Our algorithms ‘read’ corporate disclosures, evaluate risk, and pick out companies and disclosures of interest. We summarize weekly highlights in our (paid) Filings of Interest reports, and former SPACs have had the dubious honor of making frequent appearances.
Here are some quick highlights from the Electric Vehicle SPAC class of 2020: Romeo Power (RMO)
Romeo Power is a vehicle battery supplier that went public via SPAC in December 2020, and was named in a class action lawsuit in April 2021. On March 30, 2021 the Company announced a supply shortage, and reduced revenue projections for 2021 from $18-$40M to $140K. In their 2020 annual report, the Company names Nikola Motor Company (currently under SEC and DOJ investigations) as a key customer, and one of only 16 existing customers.
Immediately following the ‘SPAC merger’, the company spun-off $35M to a company controlled by a pre-SPAC investor of Romeo Power.
The company not only identified a material weakness in internal control over financial reporting, but failed to complete their assessment of internal controls in time for their annual filing.
Lordstown Motors Corp (RIDE)
Lordstown Motors is an electric truck company that went public via SPAC in October 2020, and was named in a class action lawsuit in March 2021.
The class action alleges the company failed to disclose that all pre-orders they reported were fully cancellable. This is now disclosed in their SEC filings, but investors rightly should know the difference between committed sales and empty promises when putting up their money. The SEC has requested documents relating to pre-order of vehicles that the class action alleges were false or misleading.
Canoo Inc (GOEV)
Canoo is an electric vehicle company that went public via SPAC in December 2020, and was named in a class action lawsuit in April 2021.
The company’s 10-K for 2020 (filed March 31, 2021) discusses a partnership with Hyundai, however in an earnings call two days before the filing was released, on March 29, 2021, the company announced the end of the partnership. They also announced a substantial change in the direction of their business, moving away from engineering services to vehicle production. The company’s EVs are still in development, with deliveries expected in 2022, 2023 or “not at all”. Vehicle reservations are cancellable without penalty.
In a press release, the company disclosed that their Chief Financial Officer stepped down on March 29, 2020.
There have been notable transactions with the new Executive Chairman, including reimbursements for company use of aircraft totaling $541k. Maybe this is all perfectly reasonable, but paying the Chairman’s company for use of its aircraft may not be what retail investors had in mind.
Velodyne provides LIDAR sensors for autonomous or assisted driving. Velodyne went public via SPAC in September 2020 and was named in a class action lawsuit in March 2021.
Velodyne identified misstatements in revenue and deferred revenue in Q4 2020. In their annual filings they included a one-time stocking fee of $11M in revenues, and their customers include related parties (these tend to be less reliable measures of performance).
The company’s founder and executive chairman resigned in March 2021. The company issued a statement that he “behaved inappropriately with regard to Board and Company processes, and failed to operate with respect, honesty, integrity, and candor in their dealings with Company officers and directors.”
Electric vehicles and related technologies are cool and exciting and the industry has the potential to change the world. Where issues are isolated we can look to individuals, when issues are prevalent, the problem is systemic.
In their daily risk and compliance Newsletter, the Wall Street Journal (citing Audit Analytics) noted a restatement rate of 11.7% in the first year and 15.7% in the second year after SPAC transactions. This is a startling statistic, a restatement means a change to previously audited and reported numbers, and within two years we are expecting an error for about one in six of these companies. With the current SPAC explosion, I’d guess this will get worse before it gets better.
There is a significant class action industry in the US so the mere existence of a class action doesn’t prove much, but as with restatements the frequency signifies a problem (there were 90 new filings from Jan 1 to April 16, 2021, and our four companies above all managed to make this list) .
Where do we go from here?
Last week the SEC made a statement warning that forward looking financial statements associated with SPACs likely have the same legal liabilities as those statements made in traditional IPOs. For a discussion of Safe Harbor and why it matters, I don’t think I can outdo Matt Levine, so I won’t try. Suffice it to say, going forward we may expect to see more couched language relating to product feasibility, total addressable market, and customer growth prospects.
It will be interesting to see just how much this cools the SPAC market. Surely the pre-merger forecasts for acquisition companies were more highly read than the annual filings, but the number of people actually reading these docs is limited. Companies are point blank saying investors have no basis to believe they will be successful, and yet people are still investing.