The SPAC-tacular Rise of SPACs

Markets worldwide are having a frenzied rally, with Indian markets touching an all-time high every other day. Many private companies are leveraging this opportunity to launch an IPO. The retail and HNI Participation have been robust, with many companies generating hefty listing gains. But Imagine if a Company asks you to invest money and there is no underlying business, revenue, or assets to show for. Would you invest in that company ? or even would a regulator allow such companies to raise money from the primary markets?

Well, this is happening in developed markets around the world, especially in the US. These Companies are Known as Special Purpose Acquisition Companies (SPAC).

What are SPACs?

SPACs are Shell Companies without any commercial operations but are created for the sole purpose of raising money through IPO and using that to acquire a private company. This is formed by an experienced management team or a sponsor, with nominal invested capital typically equal to 20% interest in SPACE. The remaining 80% is held by the public. With the shares, investors are also provided with warrants, which can then be converted to shares later.

What is done with money after it is raised?

Once the money is raised, it is placed in an escrow account and is invested in certain risk-free assets, typically government bonds. The SPAC Stock is traded like any other company shares in the stock market. Following the IPO, management has two years to find an acquisition target and complete the merger with the target company. If the management or the sponsor fails to do so, the SPAC is liquidated, and the money is returned to the shareholders. Whereas if the Sponsor identifies a target company, the SPAC needs a shareholders approval, if and then the merger can proceed.


 Who could raise money through the SPAC?

Probably anyone who has a good reputation is well known and can persuade people can raise money. The closest analogy that I can think of is mutual funds, where the money is polled, and the fund manager invests in various public companies. The investors don’t have control of the fund manager in which company the fund manager is going to invest, but they can judge whether the fund manager would be able to grow the capital or not.

Why is SPAC Preferred?

There are several ways a private company can go public, the most common route is through the traditional IPO, then there is a direct listing, and the last one is through SPACs. Traditional IPOs have to go through regulation, investor scrutiny, Underwriting process, roadshows. This is a long, time-consuming, and costly process for companies. Few companies like Slack and Spotify went public through Direct Listing, saving on fees and investor scrutiny. Direct Listing does not allow you to raise capital. SPACs, on the other hand, are just shell companies, so their success depends on the track record of the management team. There is not much regulation involved as there is no underlying business. 

 Well Renowned SPACs 

  • Reid Hoffman (co-founder of LinkedIn) and Mark Pincus (founder of Zynga) raised a $600 million SPAC through Reinvent Technology Partners.
  • Chamath Palihapitiya (a prominent Silicon Valley investor) formed a $600 million SPAC called Social Capital Hedosophia Holdings, which ultimately acquired a 49% stake in the British spaceflight company Virgin Galactic.
  • Gary Cohn (former president and COO of Goldman Sachs and former President Trump adviser) raised $828 million through the Cohn Robbins Holdings Corp. SPAC.
  • Hedge fund manager Bill Ackman raised a $4 billion SPAC, Pershing Square Tontine Holdings.
  • Palihapitiya and Ian Osborne raised $2.4 billion through three SPACs (Social Capital Hedosophia Holdings Corp. IV, V, and VI) to effectuate business combinations in the tech sector, in offerings by Credit Suisse as sole bookrunner.
  • A $2.57 billion SPAC combination was proposed between E2Open (a supply-chain software provider) and CC Neuberger Principal Holdings.
  • A $1.3 billion merger was announced between Billtrust and South Mountain Merger.

How Does the Sponsor Make Money?

The Management receives the Shares at a heavily discounted price.SPAC Sponsor gets 20% of  Equity Share in the SPAC for an investment of 3% to 4% of the IPO Proceeds. For Example, the initial Shareholders of Chamath Palihapitiya’s Social Capital got a 20% share at $0.002, while the public got the remaining at $10 per share. In a $250 million SPAC, the sponsor typically receives approximately $60 million of common stock for a $7 million investment in warrants.

The recent popularity in SPACs is likely due to various reasons. Many companies, especially loss-making startups, have risk going through the IPO route. The other reason might be the improvement in regulation of SPACs. Many famous investors like Bill Ackman, Chamath Palihapitiya have been quite vocal, increasing the investor’s confidence in SPACs. 

Financial Ratios negatively impact Innovations!

This article is inspired from a June 2014 Harvard Business Review publication, “The Capitalist’s Dilemma”, by Clayton M. Christensen and Derek van Bever.

Clayton Christensen

Clayton Magleby Christensen was an American academic and business consultant who developed the theory of “disruptive innovation”, which has been called the most influential business idea of the early 21st century.

Most B-school folks have known Clayton Christensen for his theory of “Disruptive Innovation”. However, in this article, I will focus on a lesser talked theory of him; it doesn’t have a formal name, but it focuses on the negative impact of financial ratios on innovation. Clayton originally presented the idea at the 2011 Gartner Symposium. For those who don’t know, Gartner Symposium is an annual conference which addresses the strategic needs of enterprise CIO’s and their leadership teams.

What is the idea behind this theory?

The idea of the theory is that innovation is slowing down due to an over-zealous focus on financial ratios by “Financial Analysts”. This is true because financial markets have a tremendous influence on the “real” economy. It is further aggravated by the rise of B-school graduates turned managers who have been fed the chronicles of CAPM, DDM, EMH, and ours truly, the Black-Scholes Model right from the start of their career. What they try to do is, they fit innovation ideas into an excel software and fancy call it “Capital Allocation Framework Model” and work backwards in making decisions from there.

These so-called “Financial Ratios” were popularised by Wall Street in the 1980s to compare stock of different companies. But, this developed a new class of managers who made these ratios as a standard to formalise decision making around new projects.

Hyper-focusing on ratios like ROA, ROIC, ROCE, and IRR can cause even brilliant people to make wrong decisions. They do work as long as we talk about “Sustaining an innovation”, e.g., innovation like new Software to optimise Workflow, new Supply-Chain process etc. 

But, there is a separate class of innovations that are severely underrepresented by these ratios.

They are called “market-creating” or “Transformative innovations.” Things like the first Virtual Reality, first Airplane, first Microchip, first Air-Conditioner falls under this class. These innovations can’t be evaluated on those “flawed” financial ratios; these innovations are very different as they enable a series of other innovation via network effects and thus unlock significant unexpected economic value. 

Network Effects

Network effect plays a vital role in bringing innovations. To put out a vague example, a few days ago, I was watching this movie, “The Old Guard” in which it was revealed in the climax that each time when the lead saved a family from war, the descendants of that family(s) saved even more families, and eventually this went on; This saved a lot of humankind. Although it was a fiction, it very well explained the benefits of network effects. 

Imagine if the first computer were never invented just because of low/negative Return on Investment, we would never have seen the Silicon Valley, the mammoth  IT Industry, and you won’t be reading this article. On Finnick. On your Smartphone!

Why don’t these innovations fit under the orthodox Financial Ratio’s/Cash Flow model?

The timeline for such innovations is relatively uncertain and can sometimes be on the order of decades. As such, they require significant investments of capital without any return in the short-run.

The below Graphic Summarizes the Idea :

Image result for clayton christensen ratios

As a result, these innovations appear as relatively poor choices under an orthodox IRR/NPV/Cash Flow type analysis. Between choosing to invest in Driverless Car and a new, more improved CRM Software, our beloved IRR analysis will always declare the latter as the winner. But we clearly know that the former is much more valuable. 

Due to excess reliability on Spreadsheets, firms today are under-investing in disruptive innovations. Jokingly, If Excel was invented before Microsoft, we might not see Microsoft today; because the Excel software returned a low NPV for Microsoft. Heh! 

Case: How the hyper-focus on Financial Ratios affected the US Laptop Industry?

In the early 2000s, major US Laptop manufacturers like HP and Dell chose to outsource manufacturing to China. The Spreadsheets “dictated” that it would be capital efficient to outsource some of the processes of the manufacturing chain to Cheap, low-cost Chinese players (Lenovo). Now because of this, initially their net assets went down, and ROA and ROE went up as the standard theory would suggest. 

Wall Street initially welcomed the move, and the stock rose.

Little did they know it helped China achieving the scale. They went away from being a mere assembly player, and forward integrated into design and distribution. They mastered the art of in-house design and set up their own distribution agreements. As a result, Lenovo, a mere one-time outsourcee became the largest laptop manufacturer in the world.


The crux of the discussion is that investments in different types of innovation affect economies and companies in very different ways- but are evaluated using the same (flawed) metrics. Reliance on those metrics is based on the outdated assumption that capital is a “scarce resource” that should be conserved at all costs (It is still a guaranteed question for three marks in an 11th-grade Business Studies question paper). But, as we all know, it is no longer scarce!

‘It turns out God has never created data; every piece of data was created by a person. It isn’t real. It’s a representation of phenomena… but there’s a lot about the context in which customers live their lives that don’t get incorporated into data of the type most of us imagine.’

Clayton Christensen

Applying BCG Matrix in Investing

BCG Matrix is a simple yet powerful tool

The BCG Matrix or the Growth-Share Matrix is a very popular portfolio planning model that was developed by Bruce Henderson, founder of the Boston Consulting Group (BCG). It is a handy business tool that evaluates the strategic position of the business brand/product portfolio and its potential. It classifies business portfolio into four categories based on industry attractiveness (Market Growth Rate) and competitive position (Relative Market Share).

Relative market share. One of the dimensions used to evaluate a business portfolio is relative market share. Higher the corporate’s market share, the higher the cash returns. This is because a firm that produces more benefits from higher economies of scale, and the experience curve, which results in higher profits. Nonetheless, it is worth noting that some firms may experience the same benefits with lower production outputs and lower market share.

Market growth rate. A high market growth rate means higher earnings and sometimes profits, but it also consumes lots of cash, which is used as an investment to stimulate further growth. Therefore, business units that operate in rapid growth industries are cash users and are worth investing in only when they are expected to grow or maintain market share in the future.

On a 2 x 2 Matrix [High and Low] and [Market Growth and Relative Market Share], it produces four quadrants, which are shown in the infographic below:-


Originally, the BCG Matrix was made to analyze the product portfolio and to provide a strategy for analyzing products according to growth and relative market share.

Below is the original breakdown of the BCG Matrix, according to Wikipedia

  • Cash cows are where a company has a high market share in a slow-growing industry. These units typically generate cash in excess of the amount of cash needed to maintain the business. They are regarded as staid and boring in a “mature” market, yet corporations value owning them due to their cash-generating qualities. They are to be “milked” continuously with as little investment as possible since such investment would be wasted in an industry with low growth. Cash “milked” is used to fund stars and question marks that are expected to become cash cows sometime in the future.
  • Dogs, more charitably called pets, are units with a low market share in a mature, slow-growing industry. These units typically “break-even,” generating barely enough cash to maintain the business’s market share. Though owning a break-even unit provides the social benefit of providing jobs and possible synergies that assist other business units, from an accounting point of view, such a unit is worthless, not generating cash for the company. They depress a profitable company’s return on assets ratio, used by many investors to judge how well a company is being managed. Dogs, it is thought, should be sold off once short-time harvesting has been maximized.
  • Question marks (also known as adopted children or Wild dogs) are businesses operating with a low market share in a high-growth market. They are a starting point for most businesses. Question marks have the potential to gain market share and become stars, and eventually, cash cows when market growth slows. If question marks do not succeed in becoming a market leader, then after perhaps years of cash consumption, they will degenerate into dogs when market growth declines. When the shift from question mark to star is unlikely, the BCG matrix suggests divesting the question mark and repositioning its resources more effectively in the remainder of the corporate portfolio. Question marks must be analyzed carefully to determine whether they are worth the investment required to grow market share.
  • Stars are units with a high market share in a fast-growing industry. They are the “graduated” question marks with a market- or niche-leading trajectory, for example: amongst market share front-runners in a high-growth sector and/or having a monopolistic or increasingly dominant unique selling proposition with burgeoning/fortuitous proposition drive(s) from novelty, fashion/promotion (e.g., newly prestigious celebrity-branded fragrances), customer loyalty (e.g., greenfield or military/gang enforcement backed, and/or innovative, grey-market/illicit retail of addictive drugs, for instance, the British East India Company’s, late-1700s opium-based Qianlong Emperor embargo-busting, Canton System), goodwill (e.g., monopsonies) and/or gearing (e.g., oligopolies, for instance, Portland cement producers near boomtowns), etc. The hope is that stars become the next cash cows.

Stars require high funding to fight competitors and maintain their growth rate. When industry growth slows, if they remain a niche leader or are amongst the market leaders, stars become cash cows; otherwise, they become dogs due to low relative market share.

As a particular industry matures and its growth slows, all business units become either cash cows or dogs. The natural cycle for most business units is that they start as question marks, then turn into stars. Eventually, the market stops growing; thus, the business unit becomes a cash cow. At the end of the cycle, the cash cow turns into a dog.

Applying BCG Matrix in Investing

In this article, we will see how BCG Matrix can also be used for making investment decisions.

When you analyze a company, it is very instructive to look at the portfolio of the company. Let’s take an example of one of India’s most debated scrip, ITC Limited. 

Cigarettes and tobacco verticles (Gold-Flake, Insignia, etc.) are Cash-cows for them as they have a substantial market share with slow/low growth prospects. When the verticles like Food and FMCG (Aashirvaad, Sunfeast, Classmate) were introduced, they were a question mark, which quickly became Stars. Hotels and Lifestyle (Wills Lifestyle, Fiama, Engage) are still a question mark, i.e., they can make it to stars or degenerate to dogs. Verticles like ITC Infotech are Dogs.

Today, ITC is busy milking this cow and hopefully use the cash to fund new Question Marks that will help the company grow (and survive) in the coming years. If the Question Marks (also called “pipeline”) is bare, that raises a lot of questions about the future of the company.

The above also holds true for companies as a whole (and not just the products in their portfolio). Generally, Big Retail and FMCG companies that sell a sticky product are Cash Cows. Startup companies are Question Mark (even those heavily funded Startups), and a fast-growing Crypto-tech or an AI-based company may be a Star. Companies with low or negative growth rates and loss-making enterprises are Dogs.

What do Investors look out for?

There are two types of approaches to investing, i.e., Value Investing and Growth Investing. Growth stocks are considered stocks that have the potential to outperform the overall market over time because of their future potential, while Value stocks are classified as stocks that are currently trading below what they are really worth and will, therefore, provide a superior return.

Value investors focus on good companies and often look for businesses with competitive advantages; thus, they are attracted to Cash Cow businesses. The valuation of the stock has to be attractive as well. Sometimes, Classic value investors also look out for mispricings in Dog businesses. 

Growth investors, as the name suggests, like to invest in Star businesses. They invest with the expectation that these stars will continue to grow until they become Cash cows.

Cash cows aren’t always permanent.

Some Cash cows are permanent while some aren’t able to stay as a cow for long, i.e., they become dogs. Coca Cola is a well-known business that has been operating as a Cash cow for more than a century now. Whereas, Kodak, one time the world’s biggest film company, could not keep up with the digital revolution and eventually became a Dog from a Cash cow.


Companies use BCG Matrix to analyze their product portfolio. In the same way, you can use BCG Matrix to analyze your portfolio (here, for you, companies are the product). You will obviously need to amend some of these metrics because here, you are more concerned about stock prices and their returns.