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SPACs: Some EV companies are ‘close to valueless,’ strategist says

Muddy Waters Capital CIO Carson Block joins Yahoo Finance Live to discuss why SPACs have risen in popularity and the outlook for electric vehicle SPACs.

Video transcript

BRIAN SOZZI: Right, from jobs back to markets, the hype is giving way to reality when it comes to the SPAC market. Shares of many companies that came public via SPAC last year remain under pressure this year as investors sour on loss-making startups. So what's next for the SPAC space? Joining us now is Muddy Waters Research founder Carson Block. Yahoo Finance's Akiko Fujita is here as well. Carson, always nice to get some time with you. Help us understand this pressure we continue to see on the SPAC market. Why that loss of investor appetite?

CARSON BLOCK: Well, I mean, obviously, we've got broad dynamics that have impacted this to some extent, right? Which are the rise in interest rates leads to a sell-off in speculative assets. But I think structurally, the problem with SPACs-- and over the long-term, maybe a few of them will turn out to be reasonable investments. The structural problem, though, is you're generally giving 20% of the company away to the SPAC promoter.

So these are not designed really to create wealth structurally. They're designed more to transfer wealth. And so the incentives to put a SPAC together are very strong to just do something, just close some transaction. And then you as the SPAC promoter get hundreds of millions of dollars in your pocket, and you can sell out of that. So that, I think, is the structural issue that's really been-- like, been catching up or the chickens that have been coming home to roost here.

The other thing that pushed it along was the SEC publicly stating that, OK, you actually as SPAC promoters, you know, you previously assumed that you could make whatever public projections you wanted that could have really little connection to reality. So the SEC said in actuality, you might be liable for that. Now, that's a legal gray area, but that also dialed back the willingness of company managements and SPAC promoters to get out there and tell these fairy tales about, you know, like, sales growing 700 times in five years.

AKIKO FUJITA: Carson, on that front I mean you've kind of been raising the red flag since spring of last year when we really started to see the peak of the SPAC boom. You've particularly been focused on SPACs in the EV space, saying essentially-- and I'm paraphrasing here-- that they're preying on retail investors. When you look at names out there, you know, like a Lucid, like a Lordstown, Nikola, I mean, are there any in particular that you think are especially egregious?

CARSON BLOCK: I mean, Lordstown and Nikola. I think it's a really interesting commentary on where we are today that these companies, which, I mean, the businesses-- and I haven't looked at them in any detail to be clear. But I think there's a good chance that these businesses are essentially close to valueless when all is said and done. Yet, there's still real market cap there. And so I've taken to joking for a little while that $700 million is the new zero. But, you know, when you look at those companies, the new zero is actually multiple billions.

So there's still a lot of froth there. And I think one of the things that it's a really interesting behavioral finance phenomenon that it's similar to negotiations, right? Studies show that if you're the first to try to frame a price or frame deal terms, it kind of anchors the discussions there.

And when these companies have gone public with market caps that are enormous, it seems like, you know, there's this sense that as they shrink, even though the market caps are still way too big for these businesses, there's this attitude that like, well, they started out this big, and now they're only this. So this is probably OK. It's probably a value. So I don't know. I think in future years, behavioral economists are going to have, like, a field day analyzing this period of time.

JULIE HYMAN: Carson, it's Julie here. There have been so many SPACs or companies that have been public over this method over the last year. I should say there have been so many de-SPACs perhaps. In and of itself, is the fact that a company chooses to come public that method a warning sign, all else being equal? In other words, you know, do you sort of just not invest in these out of hand and look to IPOs and direct listings for example, if you want a new listing?

CARSON BLOCK: Well, look, I mean, there certainly has been a track record of IPOs that haven't been great either, but the SPAC process is a much lighter touch way for a company to go public. Now you can't look at it and say per se every company that's gone public via SPAC is uninvestible because it's gone public via SPAC. But if you're going to look at probabilities, the probabilities are much higher that something that went public via SPAC versus IPO should be deemed uninvestible.

AKIKO FUJITA: Carson, specifically on the SEC, obviously, they're reviewing the structure of these SPACs. You know, we've heard Gary Gensler talk more about the need for transparency. And I wonder if you think that really is the issue here. Is it the structure of these deals, or is it the fact that investors don't often really know what they're putting their money behind?

CARSON BLOCK: Well, I think it's all of the above. But I guess when we look at things structurally and what the legal framework had been assumed, what the assumption was as to the legal framework there, there are two points to make. So first of all, the structure. Again, the SPAC promoter is going to get usually 20%.

So I'm friendly with somebody who is a major shareholder in a company that did go public via SPAC. And it was actually a real business. And the SPAC promoter is a SPAC promoter that's been successful in doing SPACs. That SPAC promoter told the shareholders, major shareholders, said, look, I don't care what I pay for this business, OK? I'm going to get my shares, and I'm going to blow out of them. So you tell me how much we pay, and we'll do it. And so that's the perverse incentive that that structure creates. So that's number one.

Number two, if you're going to bring a company public via IPO, you're generally not allowed to make projections of future results. That's called conditioning the market. That's prohibited. Now, with the SPACs, though, because it's not an IPO-- the company already went public-- it's an acquisition of a business-- they've made these projections that really have almost no basis in reality. And so I think for a lot of investors who were, you know, especially the new retail investors who came in the market post-COVID, I think that they didn't understand that you really can't trust this.

So when the company is coming out and saying, yeah, we did $7 million in revenue last year. In five years, we'll be doing $1.4 billion or that's our projection, they didn't know enough to be skeptical of that. So I think that that issue-- and that's what the SEC has tried to address. It's tried to say, you know what? You don't have Carte Blanche to just throw predictions out there that have no basis in reality. So that kind of dialed back the hype that's been-- that surrounded a number of these de-SPAC transactions.

JULIE HYMAN: Carson, I want to bring it back to what you do. And I wonder if you have current short positions or short recommendations on any SPACs that we don't know about already.

CARSON BLOCK: Well, nothing-- I mean, so I don't want to announce shorts until we're ready to announce shorts and generally release in research. But no, I mean, we've closed out the-- we've actually closed out nicely the SPACs that we had publicly shorted. So, you know, we've been happy with that, although, in retrospect, we were a little bit early to close out. But since you never have a crystal ball on where the market's going, I'm not going to cry over that.

AKIKO FUJITA: Carson, I think the last time we spoke, we were talking about the risk of investing in Chinese stocks, particularly those listed in the US. Obviously, you know, you were early to raise the concerns around Luckin Coffee as well. When you look at the landscape right now, is there a case for investing in Chinese companies, or is the risk just simply too high?

CARSON BLOCK: So, all right. So I guess when people ask me about, you know, should I invest in China, the answer that I give is, look, stocks go up if there are more buyers than sellers. So will there be a point in the near future in which massive-- allocators of massive pools of money say, hey, you know, like, China's GDP is expected to grow. Blah, blah, blah. Of course, nobody believes the GDP numbers, but that gets ignored in these conversations. It's expected to go-- blah, blah, blah. Let's increase our allocation to China equities to this.

And then you've got money flowing into the space. Plus, you have the passive flows into it. So those can push stocks up, regardless of the quality of the numbers and the quality of the companies. Now I guess what I would say to people who think that they should be long China for that reason, the risk that you get is overnight, without warning, the government pulls the rug out from underneath the companies in which you're invested. And we saw that a decent bit last year.

And that's the nature of the system. That is a system that encourages fraud on a widespread basis. But that system in which there's really very little rule of law and there's no accountability to US regulators effectively, that system can just blindside you all of a sudden.

So that's what I would say, is, go in eyes wide open and maybe it works for the next however many years. But you have to understand that there's a risk. You're going to wake up and you're going to be in tears over these stocks that you're still owning. So if you can live with that and you think that there are going to be flows of funds into China equities, then maybe you should go along.

BRIAN SOZZI: Well said. Muddy Waters Research founder Carson Block, always nice to get some time with you. Yahoo Finance's Akiko Fujita, good to see you as well.