SEC cracks down as billionaire space race leads to rise in space SPACs

According to some, the SEC crackdown and the skepticism around how realistic these space-exploration company projections are, could cause problems for the space industry as a whole, making it more difficult for these capital-intensive companies to grow at the rate they need to.

What are SPACs, again?

• Special Purpose Acquisition Companies (SPACs), are public companies established for the sole purpose to merge with a private company, and through that merger, enable that private company to go public.

• Typically SPACs are set up well in advance of the merger, earning public investments and projecting astronomical growth, even though it isn’t offering any sort of product or service. It’s sole purpose is to just get acquired by a private company.

• On top of that, most of a SPAC’s money sits in a trust fund, meaning that it can’t be touched until the merger happens.

• Going public can be a long process that involves new rounds of investments, scrutiny of growth projections and layers of financial disclosures that can take years, and it’s for this reason that it isn’t always viable for companies to wait and go through the whole traditional Initial Public Offering (IPO) process.

• So instead, private companies wanting to get investments quickly can merge with a SPAC, which is already publicly traded, and with that, the company can receive public funding through that SPAC.

Why might SPACs be good for space companies?

• At the moment at least, space companies don’t really make money.

• Take Rocket Lab, an American company with its head offices in New Zealand. In an investor presentation, it reported having US$48 million in cash, projecting US$76 million worth of negative cash flow in 2021.

• All the negative cash flow comes from the fact that the company needed to design and build a new rocket for launches to keep up with the demand of their launches.

• So, Rocket Lab turned to Vector, which is affiliated with private equity firm Vector Capital, and worked with them on a SPAC deal that would both allow Rocket Lab to go public and receive public funding.

• For space companies in general, merging with a SPAC offers the opportunity to receive a lot of public funding for relatively less amount of time, effort or cost compared to a traditional IPO.

• The idea is that these companies can then move more quickly onto the things that will eventually make them money.

Are there any risks though?

• A risk of being publicly traded is that the company value is subject to the whims of the market.

• Virgin Galactic is maybe the biggest example of these whims as it relates to the space industry.

• After the company’s billionaire founder Richard Branson completed a space flight, the company thought it would shoot its company stock value up.

• The idea was that the space flight would get investors excited about how much money they could make with space travel. So after Branson landed, Virgin Galactic filed to sell US$500 million in shares.

• But, less than a week after the flight and after the sale announcement, the company saw its lowest stock prices in more than a month.

Are there any other downsides?

• Not going through the traditional IPO process can mean that some things that should probably get disclosed through all that due diligence, isn’t.

• Think about an IPO as sort of a doctor’s visit, where the doctor can tell you that you have a heart problem and to cut down on red meat. Merging with a SPAC, on the other hand, can sometimes lead to incidents more like going to the emergency room from a heart attack because no one ever told you to cut out the cheeseburgers.

• Another cautionary tale of SPACs in the space industry came from a company called Momentus, which announced in October it would be merging with a SPAC called Stable Road Acquisition Corp.

• The company saw problems on two fronts. It was denied Federal Aviation Administration (FAA) payload approval in January, a review performed as part of a launch authorization, because two of its co-founders were Russian citizens raising, which national security concerns.

• But also, according to the SEC, Momentus misled investors saying that it had “successfully tested” its technology in space when actually the company had tested its technology in space only once, and failed. And, although Stable Road said that it had conducted due diligence on Momentus, Stable Road never reviewed the results of this test.

• “This case illustrates risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors,” said SEC chair Gary Gensler in a statement.

So, what’s next?

• Some of the initial hype around SPACs seems to have passed now. The second quarter of 2021 saw 62 SPACs raising US$12 billion, which is a 80% decrease compared to the previous quarter.

• On top of that, according to some, the SEC crackdown and the skepticism around how realistic these space-exploration company projections are, could cause problems for the entire space industry, making it more difficult for these capital-intensive companies to grow at the rate they need to.

• But without any clear reason not to merge with a SPAC, we’re likely to keep on seeing SPACs appear in the near future especially because these space companies generally need funding, and they need it fast.

• Although the SPAC process has trade-offs, " … they fill a current gap in the landscape created by the arduous traditional IPO process," writes venture capital data company Pitchbook.

• The other possibility is that the SEC regulatory scrutiny around SPACs will force the traditional IPO process to change.

• “This new SPAC market that really began in 2018 and 2019 is still developing and changing drastically, but given all of the activity and now regulatory scrutiny, we expect that this shift toward SPACs may accelerate changes to make the traditional IPO process more company-friendly," writes the report.

Have a tip or story? Get in touch with our reporters at tips@themilsource.com