New investments in the Forager International Shares Fund were made at a rapid rate during the quarter. Two of them were thanks to the huge level of activity in the Special Purpose Acquisition Company (“SPAC”) market. SPACs are publicly-traded vehicles formed to raise capital for the purpose of acquiring a single business down the track. It’s like raising money for an Initial Public Offering (IPO) before you know what the investment will be.
Investors park their capital for up to two years while the managers go looking for targets, in exchange for downside protection (redemption rights) and additional upside (fractional warrants). SPACs have been extremely active this year, with $48bn raised in 2020 to date—more than double last year’s total volume— and there is currently more than $54bn of SPAC cash seeking acquisitions in the market.
There have been a number of highly successful SPAC transitions this year, such as DraftKings (NASDAQ:DKNG) and Virgin Galactic (NYSE:SPCE). Over 40% of IPOs this year have been through this avenue rather than the traditional public offering route. We haven’t any interest in putting in money blind, but Forager has invested in a few of these vehicles after the deal had been done, including Open Lending (NASDAQ:LPRO) and APi Group (NASDAQ:APG).
Navigating through a landscape of companies with limited public market history and only a few years of financials can sometimes be a minefield. It also allows funds such as Forager to get an edge versus the broader market and buy some high quality businesses at very attractive prices before the herd discovers them.
Open Lending owns a technology platform that provides lending enablement and risk analytics solutions to credit unions, regional banks and auto lenders in the United States. Their solutions include loan analytics, risk-based pricing, risk modeling and default insurance to help ensure profitable auto loan portfolios for financial institutions.
The US auto loan market has historically been bifurcated—you are either a prime customer and get very attractive interest rates or you are sub-prime and find yourself paying sky-high rates. There is a whole cohort of “near-prime” customers that have low default risks but are being charged sub-prime rates. It is these potential customers that Open Lending allows loan providers to target.
Open Lending has facilitated more than US$7bn automotive loans and currently serves over 300 automotive lenders. The company generates revenues through program fees that are paid by lenders as well as profit share and claims administration service fees paid by insurance partners. We were drawn to the business due to its high margins, explosive revenue growth (expected to double in 2021) and a potential rebound in auto loan originations post COVID-19.
We expect the accelerated revenue growth to be sustained over the mid-term given a large US$250bn addressable market and secular growth driven by increased auto sales and the expansion of the near-prime customer market. In addition, its proprietary risk-based pricing model, based on more than 15 years of data and a fully integrated, cloud-based platform, provide a moat around the business. More importantly, when we first bought the shares a few days after the SPAC transaction closed at US$15, our entry price implied a price-to-earnings multiple of only 16 times, highly attractive for a business with these kinds of growth prospects.
APi Group is a slightly less exciting business, but its maintenance services in the fire safety, utilities and telecommunications sector provide predictable revenue and profitability, and its capacity to buy and improve smaller companies in the same sectors provides a long runway for growth. In fact, the company has grown revenues at an annual rate in excess of 12% over the past decade. APi also trades at an attractive valuation of just 12 times earnings. We feel this is far too low given the secular growth that it is exposed to.
These opportunities are COVID-related, with the SPACs able to make their acquisitions at attractive prices. The window is closing fast, though, and with so much money sloshing around it is almost certain to end in tears for investors that don’t tread carefully.
This post is an excerpt from the September 2020 Quarterly Report. If you would like to receive all future Forager reports in your inbox, you can subscribe here.
Thanks Steve.
Really interesting – the naive question – why haven’t the Hedge Funds and Vulture Funds dominated this arena? Looks like their dream situation.
Hi Craig,
Hedge funds have been heavily involved on the issuing/sponsoring side. It’s a gravy train and part of the reason we’re sure the average SPAC will underperform the wider market, we’ve been very selective here.
Hedge Funds are also heavily present on the investor side. One of our positions, Open Lending, has sponsors and founders at the top of the register, but below that it’s mostly hedge funds. That’s normal. Those that are able to deal with the information void have a higher risk/higher potential reward opportunity. Over time, if the company is successful, then the share register will transition to a more conventional one dominated by traditional managers and indexers, hopefully at a higher stock price.
I just lost some respect for Forager. The long run performance of SPACs is worse than a drunk throwing darts at the stock tables. And if you look at the massive incentive for the sponsor to get a deal (however lousy) done it’s no wonder. And why would a company incur ~20% dilution to go public vs a 7% underwriter fee? Because the SPAC promoter can get them a price that is more than inflated enough to offset the 13% difference. Either that or there’s something awful that no decent bank wants to sign off on.
It-is-not-different-this-time.
I understand the distaste for SPACs, no argument from us if investors choose to avoid them. But when a whole segment gets written off by most investors, it increases the potential for mispricings (both overpriced and underpriced). We think the average SPAC will underperform. We’re not in it for average, we’ve only bought a few after looking at a hundred. Time will tell but the fund has done very well out of them so far.
Hi Michael,
I’m revisiting this post doing prep for our annual performance report due out in a few weeks. This is not intended as a told-you-so but I do hope you read the report when it comes out. We’ve had five investments from the SPAC universe add massively to our returns this year, and stepped on no landmines. Our thesis was that the very hesitancy of other investors was creating the opportunity. And that by being very selective we’d do well. We think that’s played out to thesis, although one can never be sure of luck vs skill from 5 rolls of the dice… Anyhow, give it a read if you get the chance.
Hi Steve,
‘dispersion opportunity to recycle’ blogs from monthly/quarterly reports is most effective with a re-iterating factor in knowing of Forager investments – tick tick
“It’s like raising money for an Initial Public Offering (IPO) before you know what the investment will be”
What wd persuade investors to take that risk?
They’re mostly structured so that if you don’t like the deal, you can get your cash back out. As such, when the stock trades below issue/redemption price, arbitrageurs tend to step in (while they’re in the cashbox phase)