Understanding SPACs Better

Understanding SPACs Better

Understanding SPACs Better

We inspect in detail how SPACs work, how has been the performance of SPACs in the past, and whether it is a fad that would fade away soon or meant to stay on.

SPACs are a major movement in the IPO world right now. Over the past few years, firms such as Nikola, Draft King, and Virgin Galactic have all joined the market through SPAC (Special Purpose Acquisition Companies). This has been a record year for SPACs with nearly $34.6 Billion in SPAC gross proceeds so far in 2020. That’s 3-4 times higher than the $12.1 Billion in gross proceeds in 2019 and the $9.7 Billion in 2018, as per Dealogic.

These structures, also known as blank check companies give private firms an alternative to an otherwise costly and time-consuming IPO process, making them hugely successful these days. Some investors see strong potential in SPACs and claim them to be a more effective way for firms to go public, but serious critics suggest they encourage backdoor transactions that are not worth the risk and promote opacity.

How do SPACs work?

SPAC mergers are very similar to a reverse merger. They are generally formed by investors with expertise in a particular industry or business sector to pursue deals in that area. While forming a SPAC, the founders sometimes have at least one acquisition target in mind, but they explicitly don’t identify that target to avoid disclosure requirements needed during IPOs. Hence, the name blank check companies. Many have argued that companies like Nikola and DraftKings wouldn’t have made been able to go through the normal IPO process because of the strict due diligence involved in a typical IPO.

Investors who buy stocks in the IPO have no idea what company they are ultimately going to invest in. They are effectively buying the target company’s IPO in advance (say Virgin Galactic) without knowing the essence of what the target company does and the price that will be paid by the acquiring company (say Social Capital Hedosophia Holdings Corp). It is important to note that these deals will be usually structured in such a way that if the investors don’t like the target company they can get their money back by just backing out of the deal before the merger closes.

Unlike normal belief, SPACs don’t seem to be cheaper than traditional IPOs. They pay underwriters and institutional investors a fee of around 5-6% of the sum raised and gives the founder up to 20% of the shares for free. Even after accounting for the additional cash brought in by SPAC’s sponsors and other friends and family, SPACs aren’t any less expensive than IPOs today.

With a conventional IPO, promoters and directors, and officers sign a lock-in for 180 days from the IPO date. For a SPAC IPO, the standard lock-in period ranges up to one year after the close of the closed merger or De-SPAC deal, subject to early termination of the common stock sell at a fixed price (generally $12 or above) for 20 out of 30 trading days beginning 150 days after the closure of the De-SPAC transaction.

The money earned by the SPAC is deposited into an interest-bearing trust account. The funds are only used to make an acquisition or to refund the capital to stakeholders when the SPAC is liquidated. SPACs normally have two years for getting completed or winding-up. Some instances include the SPAC’s working capital being funded by the interest received from the trust. Following the acquisition completion, a SPAC is listed on one of the prominent stock exchanges.

In our opinion, the fees and structure for SPACs would continue to whittle down and can become better than IPOs where bankers have created high-cost structures. Our primary concern is all-around compliance, investor rights’ protection, initial and ongoing disclosures, and scrutiny that make it safer for the general public to invest through an IPO. Unless SPACs can match IPOs in terms of transparency and reporting and third-party scrutiny (analysts industry experts), they will continue to be the domain of a small bunch of fund managers and institutions engaged in dodgy financial engineering. As the overall crypto industry has realized that being regulated has its benefits, SPACs will need to evolve to have the same or better standards than IPOs.

The biggest SPAC deals made thus far

Pershing Square Tontine made waves in the rapidly growing SPAC space with its July debut. The firm raised $4 Billion with its IPO, a record for such investment vehicles and a new sign of Wall Street’s obsession with SPACs. The stock is currently trading at a share price of $23.90.

Churchill Capital Corp III, and MultiPlan Inc. entered into an agreement to merge in a deal worth $11 Billion that will take the U.S. healthcare services firm public. The deal will expand MultiPlan’s data analytics platform and is the largest SPAC merger ever. The merged company will be listed on NYSE and will operate under the name MultiPlan.

MultiPlan will receive up to $3.7 Billion of new equity that will reduce the firm’s debt. The transaction includes $1.3 Billion worth of common stock at $10 a share and $1.3 Billion in convertible debt that will be convertible at $13 per share.

Blackstone-owned Vivint is also one of the biggest corporations to enter into a SPAC arrangement since the IPO. Blackstone had explored an IPO or sale of the technology company and ended up merging with a SPAC raised by SoftBank’s Fortress Investment Group, in a deal valued at $5.6 Billion including debt.

The SPAC and PE camaraderie

The SPAC burst is taking place at a time when trillions of dollars are sitting in private equity and venture capital funds. For institutional buyers, SPACs serve as an incentive to buy into glittering businesses that would otherwise stay private. Analysts claim that these cash shell structures remain a lousy gamble for average investors. The majority trades at less than $10-$12 per share, the regular price at which SPACs first sell their stock to the public.

For private equity funds, they have a strong economic interest in the company due to less upfront spending. A private equity fund financing a SPAC typically purchases between 2% and 3% of the shares on the public listing, more often by buying businesses via SPACs to pay down their obligations more efficiently.

For 21% of the founders of SPACs, an institution is either linked to a private equity fund or one of the managers is operating a private equity portfolio simultaneously.

Why are SPACs so popular now when they have been around since the 1980s?

In the 1980s, SPACs acquired a shady reputation tied to penny stock frauds. In the past two decades, new laws and regulations helped add credibility to bolster investor confidence. SPACs have an appeal to private companies that wish to go public in this volatile environment because SPACs guarantee the transaction at a certain valuation as opposed to the IPO which are seen as riskier and may or may not go through once documents are publicly filed. For example, WeWork’s IPO got scuttled once it published its details and intense scrutiny of the company led investors to back out.

  • It can take months for companies to negotiate pricing, file documents, get necessary approvals and then finally list on stock exchanges SPACs have an edge here where companies can work with stakeholders that understand them well and can conclude transactions quickly. Given the long timelines associated with an IPO, the valuation of the underlying company can also take a nosedive.
  • IPOs require significant private information to be made available to the general public for scrutiny. A large number of companies, especially tech companies are uncomfortable disclosing such details and may instead want to go through the SPAC structure which has lower disclosure requirements.
  • Businesses going public through SPACs in 2020 have had higher valuation and share price growth than traditional IPOs; in September, United Wholesale Mortgage went public in the latest SPAC transaction with a valuation of over $16 Billion.
  • With the quality of management teams improving, SPACs are gaining traction and more institutional investors and HNIs are buying in. With SPAC funds getting bigger, the scale of blank check deals is also expected to increase.

A lot needs to be done before SPACs go mainstream

  • One of the biggest issues is that firms going public via SPACs can afford to bypass critical oversight and intense scrutiny, unlike conventional IPOs. For example – Nikola, who went public via the SPAC a few months ago has turned out to be the focus on multiple allegations lately. Federal authorities have since begun to pose questions and the SEC is also investigating how SPACs report their ownership and how compensation is related to the purchase.
  • Investors are at greater risk compared to IPOs as they do not know the target investee company at the time of investment.
  • SPACs may prove to be quite expensive. In certain blank-check transactions, the founders of SPAC have the right to purchase 20% of the resulting public business at rock-bottom valuation. For example, initial shareholders of Social Capital got 20% of the Company at $0.002 per founder per share while the public shareholders got the remaining 80% at $10 per share.
  • Target firms also give up more power as they sell to a SPAC that has its operating staff in place. They are therefore subject to a vote and control by the owners of the SPAC. This can lead to deal cancelations even after the announcement.

Analyzing the performance of previous SPACs

We analyzed 50 SPAC merger deals that happened between 2015-2019 and how they are faring now. Are they profitable, what share price are they at now and how does the valuation look like? Look at the table attached in Annexure I for the detailed analysis.

While Nikola Corporation has been the biggest loser after its SPAC merger closed, its valuation has dropped by more than 50%, and currently stands at $7.14 Billion. The biggest gainers have been in the healthcare segment, financial services, analytics, and consumer goods. For Immunovant and AdaptHealth in the healthcare segment, the valuations have soared by more than 85%. For SaaS firms like Clarivate Plc, the valuation leap has been a colossal $5.7 Billion. Open Lending Corp which focuses on lending now has a share price of $26.12 with a valuation higher by 80% than its SPAC price.

The underlying fact is although some good names get benefitted from the SPAC route, total losses outnumber profitable SPACs. The majority of companies have not been able to perform well. Talking about the 50 deals that we analyzed, 37 of them (74% of total) now have current share price trading at less than $10 per share with a current average market capitalization of less than $250 Million. The number further disappoints as 40% of those firms end up with share prices trading at less than $5 in the stock market.

Upcoming SPACs

On 7th October, Momentus Inc. reported its intent to sign a merger agreement with Stable Road Acquisition Corp Momentus offers a “last mile delivery” service for spacecraft, with a transfer vehicle that helps deliver satellites from a rocket to a specific orbit. The merging business entity will be named Momentus Inc. after termination of the deal and its shares are to be listed under the ticker symbol “MNTS” on Nasdaq.

This merger will create the first publicly traded space infrastructure company. Strategic partners and clients include Lockheed Martin and veterans like SpaceX and NASA. The combined company will have an estimated valuation of approximately $1.2 Billion following transaction close in January 2021.

Post-merger Momentus will have approximately $310 Million in cash on the balance sheet, to be funded by Stable Road’s $172.5 Million of cash held in trust (assuming no redemptions) and $175 Million from a fully committed common stock PIPE at $10 per share, including investments from private equity growth investors, family offices and niche top-tier public institutional investors.

Will SPACs fare in the long run?

Bill Ackman’s SPAC which recently raised $4 Billion for his Pershing Square Tontine Holdings is by far the largest SPAC ever raised. There will be no founder’s stake in the company saving up on huge SPAC fees. If the SPAC succeeds in taking a large private company public – this will be the best proof of concept for the SPAC structure.

The premise of SPACs relies heavily on the reputation of the SPAC founder – their ability to raise funds from a broad group of shareholders. A blank check company is a testament to the faith that the investors have in that person’s ability to find and execute a good deal. We believe that the future of blank check companies remains doubtful. Investors find SPAC deals as a better way to go public, while critics argue that the SPAC boom is just a trend that isn’t destined to last in the long run.

Related Posts

Will the DJI Drone IPO finally take off in 2021?

Will the DJI Drone IPO finally take off in 2021?

Will the DJI Drone IPO finally take off in 2021?

DJI Innovations is evaluating an IPO in mainland China and Hong Kong in early 2021. In this article, we evaluate the merits of the world’s large drone manufacturing company and what investors can expect from its IPO.

DJI Innovations is a Chinese company that produces commercial and recreational unmanned aerial vehicles (UAVs). Its product line covers the high-end UAV flight control system and ground control system, professional film and TV aerial photography platform, top commercial gimbal system, high-definition long-range digital video transmission system, professional-level wireless remote control and imaging terminal as well as intelligent model aircraft products and high-precision control module which are widely applied to flying toys.

Overview

DJI is the market leader with a 74% market share in the global drone market which is growing at 19.41% CAGR. DJI is currently offered at a valuation of 18Bn and expected to IPO in 2021 at 24 Bn USD (current discount 25%). DJI’s core business is strongly poised with an excellent value proposition to its clients – ranging from photography, agriculture, risk detection, racing to hobbyists. It has a market holding strategy of low price and high volume to keep competition at bay. However, it faces headwinds in the form of high risk from government regulations including a potential ban in the USA due to data hijacking risks. Another major risk is the development of open-source flight control platforms, which might ignite a fierce price war in the drone industry. 

Snapshot 

Founded: 2006
Notable Investors: Accel Partners and Sequoia Capital
Headquarters: Shenzhen, China
Total Funding: $155 Mn
Chief Executive Officer: Frank Wang
General Manager, SF; Director, Aerial Imaging: Eric Cheng

The Secret of Success?

  • Market Share: China’s DJI possesses a 74% market share of the global consumer drone market. It was valued at $15 Bn in 2018 during its last fundraising round, ranking it among the top tech unicorns worldwide. The drone market itself is growing at an exponential CAGR of 19.4%.
  • Value Proposition: DJI offers drones with a wide variety of features, and at various price points to capture as much of the consumer market as possible. They have also vertically integrated drone manufacturing and own stakes in various key component suppliers, such as a majority stake in their drone camera supplier Hasselblad. This helps keep costs lower than any other player in the industry.
  • Continued R&D: In 2016, DJI internally incubated the team Livox that focuses on R&D of LiDAR sensors for high-speed self-driving and industrial robotics. As the range and image sensors are essential for drones as well, DJI has been working on similar technologies for years, thereby helping easy technology migration for the vehicle LiDAR. Besides, due to differentiated design, Livox LiDAR is tens of times cheaper than the ones manufactured by the US-based company Velodyne. DJI is known for continuous and relentless innovation and most of the competition is quite behind when it comes to drone technology.
  • High Volume and Low Price Point Strategy: the firm aims for profit margins in the low single digits to ensure competitors cannot offer a similar drone at a lower price point. The fruit of the company’s early start and commitment to cost control show in their manufacturing prowess. DJI consumer-level quadcopters have been outperforming their competitors in terms of drone size, stability, image quality, and battery life since the release of its Mavic pro series in 2016.
  • Strategic Partnerships: DJI has collaborated and created distribution agreements with many companies worldwide, including the Apple store since 2015 for its Phantom series and later the Mavic series making its products accessible to all consumers. These moves have improved brand awareness and allowed DJI to reach more consumers than the competition.
  • Industrial integrations: DJI has enhanced its integration capabilities by partnering with industry giants for niche capabilities:
    • Microsoft has integrated Azure IoT Edge and Azure Cloud with DJI drones to streamline the secure deployment of DJI drone squads. Also, DJI Manifold 2 has now been approved for Azure IoT Edge, making it easier for companies to deploy AI frameworks on computers.
    • FLIR Systems has launched the MUVE C360, the first multi-gas detector completely integrated with the DJI Matrice 210 drone, which will change the way emergency response teams treat toxic, industrial, and environmental accidents by offering a new level of protection, significantly minimizing time to action.
  • Future-ready product stack: DJI Drone technology helps companies and organizations around the world save time and money and increase the safety of employees in myriad industries. DJI focused on providing easy-to-use drones to farmers, agronomists, and stewards to help maintain their land in a more productive and environmentally sustainable manner, while also ensuring that emergency responders need assistance to respond effectively and save lives during natural disasters.
    • P4 Multispectral drone: the world’s first fully-integrated multispectral imaging drone designed to power next-generation agriculture and allow more effective land-use environmental management.
    • Agras T16 drone: The global launch of DJI’s leading spray drone for agricultural applications that makes it easy to apply liquids such as fertilizers and pesticides specifically to field crops and orchards.
    • DJI Disaster Relief Program: A new initiative to rapidly equip first responders with DJI drone technology and support during natural disaster response and recovery missions for wildfires, hurricanes, floods, tornadoes, and earthquakes.
  • Diverse client base: Caters to a diverse clientele in the industry from government to agri-businesses. Easily accessible to varied users such including hobbyists and professional photographers. They have expanded into racing drones for the gamers and even drones that carry people.

Key Risks

  • The US government may blacklist DJI for potential data threats. USA is DJI’s second-largest market. With rising geopolitical tensions, the situation might get worse, endangering approx. 40% of total revenues.
  • The American Drone Security Act is just around the corner, if passed it would mean that all federal agencies using Chinese drones, such as the Department of Justice and the Department of the Interior, would have 180 days to avoid using and purchase them. In other words, the police, fire departments, traffic controllers, and several others could lose their drone fleets and have to find other suppliers or give up using drones.
  • Big firms such as Intel and Qualcomm are making significant investments and waiting for opportunities to replace DJI as the top drone player. Competitive intensity is likely to increase going forward, especially in niche areas.
  • The development of open-source flight control platforms might ignite a fierce price war in the drone industry.
  • The CEO of DJI Frank Wang predicted that the company’s revenue would hit a ceiling of USD 3 billion as it already dominates the overall drone market.
  • The most problematic factor for the consumer drone market in it is the local market is evolving government regulations around the use of drones. As per Chinese regulations, only UAVs that weigh under 250 grams is not required to be filed with the local government. The current government regulation on consumer drones limits the functions of miniature drones and likely to restrict sales going forward.
  • The US Army has raised security issues as it believes that DJI can capture location, audio, and even visual data from consumer flights. The US Army is worried about the widespread exposure to data hijacking as drones might end up disclosing comprehensive knowledge about military activities, given that DJI is a Chinese business.

How justified are the current valuations?

The last reported market valuation for DJI drones was $15 Bn as per the latest round of funding in April 2018.  Based on current market news, DJI is likely to launch its IPO with a minimum valuation of $24 – $27 Bn. Taking EV/Revenue multiple into account and weighted average calculation of the comparable companies, we arrive at an NTM multiple of 4.77x – 6.15x which gives us an intrinsic valuation range of $9.54 Bn to $12.3 Bn.

Due to its colossal size and market share, it’s difficult to compare it with any other drone company which has a similar size or business growth potential, however, we have compared it to publically traded companies GoPro, Parrot Drones, and Plantronics.

     Table: Financial performance of DJI compared to its competitors

Metric DJI GoPro Parrot Drones Plantronics
Projected Revenue 2000 Mn 1194 Mn 128 Mn 1762 Mn
Revenue Growth 60% – 8% – 37% 24%
Fund Raised 155 Mn 288.2 Mn 1.2 Bn
Gross Margin 33% 37% 44%
Net Income – 67 Mn – 170 Mn – 71 Mn
 Valuation 12.3 Bn 1.2 Bn 723.1 Mn 2.7 Bn
EV/Revenue 6.15x 1.01x 5.65x 1.53x
Employees 14000 926 551 6584
NYSE GPRO PARRO PLT

 

Financial Highlights

Revenue: DJI has experienced very strong revenue growth in the past years and trends continue to remain very robust. With two product launches in the past six weeks and over 70% market share, revenues were up by 60% year-to-year growth at $2,000.6 Million and a profit margin of 26.17%. 

Fraud: Back in 2018, some of the employees had been inflating the cost of parts and materials for financial gain. DJI dismissed several employees, alerted law enforcement, and immediately set-up renewed internal channels for whistleblowers to report fraud. The amount of losses from the fraud is approximately around 1 Bn Yuan i.e. $150 Mn USD.

Competitors

GoPro: GoPro is an American company that is engaged in designing and providing cameras, mounts, drones, and appliances. The company outsources a part of manufacturing to third parties in China. GoPro has a global presence, including Europe, the Middle East, Africa, and Asia-Pacific, with the Americas contributing over half of the total revenue. It raised $427 Mn in its initial public offering on the NASDAQ stock exchange under the ticker symbol of GPRO in 2014.

Parrot Drones: Parrot is a European leader based in Paris that creates, develops, and markets consumer technology products for smartphones and tablets worldwide. It offers consumer drones, including mini, AR, and bebop drones; commercial drones; handsfree kits, plug and plays, and infotainment products; Bluetooth, digital music, and infotainment solutions; and audio products and connected devices.

Yuneec: Major Chinese competitor and manufacturer of remote-controlled electric aviation designed for model making applications and to conduct aerial photography. The company’s aviation range from manned aircraft, electric drones, and audio controlled helicopters to micro-copters and camera supported quadcopters and hexacopters, enabling people to capture a broader picture and see live video of places from above.

UVify: Developer and manufacturer of autonomous unmanned drones based in San Francisco CA, designed to create amazing experiences with drones. The company’s drones can be used in drone racing, videography, freestyle flying, and research, enabling customers with intelligently designed, high-performance drones to fly farther and faster.

Autel Robotics: American developer of flying camera drones designed for aerial photography systems. The company’s flying camera drones utilize aerial engineering and camera drone technologies and develop quadcopters and flying remote control GoPro camera systems, enabling users with superior aerial imaging, filming, and photography.

Excellent business model and differentiated technology getting marred by trade tensions and emerging regulations

Market Saturation and growing competitive pressure growing headwinds: Unless DJI finds more markets for its products or meaningfully expands its product suite, its growth is likely to stagnate. Also, several other competitors are spending a lot more attention and money on this segment, and we expect higher competition going forward. At the current stage, DJI’s popularity is caused by a temporary situation where the flight systems powered by the above companies are not competitive enough in terms of stability, maximum flight time, and human interaction. However, as DJI’s technology in consumer drones reaches a ceiling, it is only a matter of time for other system providers to catch up with DJI.

Trade Tensions in the Global Markets can impact both supply and demand: The last two years have witnessed various cases of deglobalization, which is considered especially harmful for the development of tech firms. In DJI’s case, the risks aroused by the trend of deglobalization involves every step from production to sales of DJI’s business. On the production side, the company heavily relies on overseas hardware suppliers. The core components such as motion sensors, CMOS sensors, and GPS modules are mostly provided by the US and European companies. If DJI is blacklisted by the United States, it will lose access to motion tracking sensors that are supplied by InvenSense, Phantom series chips provided by Atmel, visual processors from Intel, and the WiFi SoC from Qualcomm. Not to mention the loss of almost 50% market share. This uncertainty is going to act as a glass ceiling to DJI’s IPO valuations and further share appreciation.

Dependency on non-domestic markets: The company has around 80% of total revenue from outside China and around 40% from the US market. Any change in regulations in the USA and EU can lead to significant disruptions to the business. In China as well, the company is now facing changing regulations that restrict the easy sale of more sophisticated drones

In a nutshell, DJI is likely to continue its pole position in the drone market for the near future with better technology, a large product stack, and a competitive manufacturing setup. However, there is a regulatory overhang over the company that stops it from commanding the kind of valuation a profitable company with $ 2 Bn+ revenue should command in current market conditions. We are sanguine about the prospects of DJI in the near term.

 

 

Related Posts

The Pre-IPO Startup Equity Market

The Pre-IPO Startup Equity Market

The Pre-IPO Startup Equity Market

IPO market geared up for the busiest week

In a low-yield world, is Pre-IPO investing the hidden secret to higher yields?

  • Pre-IPO secondary transactions are growing, and over past few years have consistently generated higher returns over other traditional asset classes
  • Startups are remaining private longer. The average age of technology companies going public has gone from 4 years in 1999 to 11+ years now. As a result, several broker networks and pre-IPO marketplaces have emerged to provide liquidity to early stage investors and employees
  • Our analysis shows that secondary investments in mature startups 2-3 years prior to a liquidation event have yielded between 40%-70% annualized returns with fairly high success rates. That’s not a typo!
  • Case in point – Slack went public with IPO priced at $38.5 per share, earning around 200% above the last private funding round 10 months prior to the IPO.

However, investing in Pre-IPO is no silver bullet. Just like all other forms of investing, you can go wrong and will go wrong. Imagine investing in AirBnB in 2017, or in Bytedance in Dec 2019. AirBnB’s valuation has halved since, while Bytedance has taken a nosedive.

Is Pre-IPO investing the hidden secret to higher yields? Is it a promising asset class that can consistently deliver returns for private investors looking to invest in high quality high growth unicorns headed for a liquidity event in 12-24 months? What are the key risks investors should be aware of?
We did an in-depth analysis of the past performance of this market in order to quantify potential returns, as well as look for potential pitfalls. This report provides a complete analysis and our point of view of the Pre-IPO secondary market, its intricacies and future prospects.

    Related Posts

    Busting the 60:40 myth

    Busting the 60:40 myth

    Busting the 60:40 myth

    Why private assets are emerging as an alternative for HNI investors

    • Private Equity returns have beaten public market returns over the last 10, 15 and 20 year period
    • A 30-year investment of 10,000$ in S&P 500 would amount to 76,312$, whereas the same amount in a private equity fund would become a whopping 211,071$ – a 20x return
    • Individual investors allocated less than 5% of their investments to alternatives, compared to 26% by pension funds and 57% by endowment funds. America’s largest public pension plan, CalPERS put $7 billion into private equity during the 2018-2019 fiscal year. “We need private equity, we need more of it, and we need it now,” chief investment officer Ben Meng said in early 2019
    • The case for alternatives is well understood by HNW (High Net-Worth) investors: for instance, 67.5% of the registered investment advisors surveyed said their HNW clients are interested in private equity. And yet, on average only 10% of their client base is investing in private equity funds
    • In view of worldwide rising volatility and disruption, alternatives are well suited to create value through selection and a record 1.7 trillion dry powder ready to invest
    • Disruptive technologies, such as artificial intelligence, are helping fund managers to improve operational efficiencies while creating new opportunities for investment

    Over the past 20 years, alternative investments have surged tenfold from a trillion dollars to 10 trillion USD compounding roughly at 12% per annum and slated to grow to 14 trillion USD by the year 2023. 

    You may ask what are alternative investments? Alternative investment is a financial asset that does not fall into traditional investment categories like stocks, bonds or mutual funds. These include, but are not limited to private equity, private debt, hedge funds, real estate, infrastructure and natural resources.

    Over the last few decades private markets have grown significantly in scale and complexity and are rife with opportunities. Quite simply put, alternative investments provide higher returns and lesser volatility as compared to private markets as we can see from the data of the last two decades.

     Source – Committee on Capital Markets Regulation and Voya Investment Management (October 2017)

    By investing in alternatives, an investor can easily diversify their portfolio and control risks. According to a study published on PlanAdviser.com, more than half (53%) of millennials favor alternative investments over ‘traditional diversification’. People all over the world are realizing the potential of such investments and the train is about to leave the station. Googling “liquid alternatives” yields 119 million results in half a second.

    The pandemic has ruined businesses and all over the world, companies in certain sectors are being sold for cents on the dollar. Private equity companies are sitting on a cash pile of 1.7 trillion USD and are ready to take advantage of these distress opportunities and primed to push for higher deal-making. According to a PwC report, PE firms are looking to increase investments across TMT – technology, media, and telecom in the coming months as the sector has shown more recession resiliency relative to other industry groups.

    Further reasons why seasoned or ‘accredited investors’ should make the shift towards alternatives are:

    Public Markets are overcrowded and expensive – Over the last 10 years, stock market valuations have kept on increasing year on year and as of September 11, 2020, the P/E ratio of S&P 500 has reached 28.72 compared against the historical average between 13 and 15. Overcrowding in the public markets has led to such high valuations and earnings are simply not matching up to these crazy valuations. For example, TESLA trades as 970 times its earnings, and Hilton Hotels trades at 728 times its earnings. There are fewer public companies (number of listed companies have decreased 39% in the last 25 years) and companies are waiting much longer in their life cycle to go public (average age of US tech cos which went public was 4 years in 1999, which had risen to 11 years by 2014).

    Private Markets Opportunities Growing – There are around 400 unicorn startups (private companies that are valued above $1 bn). With large companies and funds willing to back these companies, they don’t have a huge incentive to go public to raise funds. These companies are remaining private longer because it allows them to think and act more strategically, which means that equity investors have less access to the market as a whole. Alternative investments allow individual investors to gain access to this asset class which is designed to take advantage of volatility, dispersion, and dislocations are particularly well suited and may provide returns that have low correlations to traditional betas. The industry has crossed the 10 trillion barrier and with over 12,000 active alternative asset management institutions, the numbers are just going to grow. Furthermore, more and more fund managers are deploying artificial intelligence & machine learning (AIML) technologies to stay ahead of the curve.

    More sources of information available to investors – Individuals have much higher access to information regarding private markets. There are hundreds of financial research software that can help an investor conduct proper due diligence on private companies as well as private equity funds. Some of the most used databases are Pitchbook, CB Insights, Mattermark, Tracxn, S&P Capital IQ, Eikon, and the Bloomberg Terminal. Apart from providing investors with quality data, some of these platforms also allow for making models and risk analysis. The free internet also has huge coverage of private companies and markets which enable an investor to make a rational decision.

    Change in regulations paving way for easier access to private markets – The Securities and Exchange Commission in the USA is changing the way alternative investments are going to be regulated. Chairman Jay Clayton has said he’s eyeing an overhaul of all regulations around private placements, with the intent of making them more accessible to individual investors. It appears the democratization of alternatives is an SEC priority. In fact, its December press release recognizes the key role that pooled investment vehicles, including private and regulated funds, can play in providing a more level playing field for individual investors and allow them to gain from excess or uncorrelated returns from participation in the private markets. The European Commission has issued its much-awaited report on the Alternative Investment Fund Managers Directive (AIFMD). The report is short – only six pages of substance – but gives a clear sense of the direction of travel.

    Asset owners’ evolving needs – Asset owners are looking for ways to optimize their alternatives allocations, with goals that extend beyond performance and diversification. In many instances, investors are seeking strategic relationships with alternatives managers that have the potential to create value on several levels. Investors want to invest in causes or technologies they are personally interested in. The new-age investor also wants to invest in companies following ESG (Environmental, Social, and Corporate Governance) norms. According to consultancy firm Mercer, more than three-quarters of respondents (76 percent) incorporate ESG criteria when investing in alternative asset classes and that most believe ESG improves risk-adjusted returns and is an important aspect of risk and reputation management. New platforms are emerging which allows for customization in the alternatives. iCapital in the US, Moonfare in Europe, and Torre capital in Asia are changing the way people invest in alternatives.

    While we advocate for allocation to alternatives, we don’t want to wish away the inherent risks. Some of the risks while investing in private markets are:

    Illiquidity – While private markets are gaining higher liquidity over time with the deepening of the secondary market and lingering overhaul of regulations, certain assets in private markets are highly illiquid and an investor must be aware of the amount of time their capital may be locked for 5-10 years. Only dedicate that portion of your portfolio which you are comfortable investing for long term, and where a little bit of volatility would not unnerve you. 

    Smart Allocation: We at Torre Capital do not recommend investors to allocate more than 10% of their portfolio to alternatives across asset classes. It is always better to ask for advice and understand the role of alternatives in your portfolio given your current asset allocation and your financial goals before you make your first investment. Smart allocation that allows you to stick to your investing plan would always yield higher returns than investing just based on returns offered or relative “hotness” of an asset class. 

    Novice Effect – During the cryptocurrency mania in 2016, everyone wanted to jump on the bandwagon rather than regret missing out on a huge opportunity and a lot of amateur investors lapped up various cryptocurrencies only to suffer a major crash and lull for a long-time. Although interest in alternatives is heating up, novice investors should do proper due diligence of where their money is going and not bet on gambles promising enormous returns. 

    Manager Selection – Manager selection in alternatives matters. Unlike in public equities, where the difference between top- and bottom-quartile managers in any one-year averages about 2.5 percent, in private equities that spread approaches 20 percent. Picking the right or wrong manager matters hugely if an investor is looking for discretionary portfolio management.

    We at Torre Capital pride ourselves on our promise to always look out for our investor interests. Irrespective of incentives offered, we only bring investments that make sense for our investors. Our motto is principal preservation over principal protection, and we conduct multiple levels of due diligence before offering an investment on our platform. We request you to always do your homework before investing, and reach out to us in case of any queries! 

     

    Related Posts

    What is the motivation behind Torre Capital?

    What is the motivation behind Torre Capital?

    What is the motivation behind Torre Capital?

    Here we take a look at why we see a need to start an investment platform and why we are on a path to revolutionize access to alternative investments

    In my erstwhile career as a Digital Consultant with first Accenture Digital and then Mckinsey, I have had the privilege of building Digital Banks and Fintech platforms from scratch. There were two key takeaways I had from all these experiences put together:

    • Digital channels, if used efficiently, could transform the customer experience by offering better products at a much lower price point by eliminating useless intermediaries.
    • By the time any financial instrument reaches retail hands, a large portion of the profit pool has already been siphoned off. It is a rather simplistic but fairly accurate argument that institutions benefit from early access to investments, which at a later stage gets distributed to unsuspecting retail investors.

    I went looking for a white space in the finance industry armed with these two hypotheses, and soon found one.

    Over a period of six months from January 2019 – June 2020, I personally spoke to over 200 High networth investors and about 50 family offices across 5 APAC countries. The entire group had a few complaints and requirements:

    Issues with current wealth managers:

    • If they didn’t offer their entire portfolio to one private bank, they wouldn’t take them seriously. Anything short of double digits, and you won’t get the advisory or access you need
    • Mostly unsure on how much trust to place on their Relationship Managers.
    • High and opaque fee structure which made returns look ordinary.

    What do they really want:

    • Institutional Access to exclusive products that helped enhance portfolio returns but without the potential of steep drawdowns. Not equity baskets or mutual funds that everyone else is offering under the garb of managed AUM or roboadvisory.
    • Clear and unambiguous understanding of products on offer. No opaque language or unnecessary jargon
    • Clear and transparent pricing that doesn’t try to fleece at the cost of returns. No kickbacks to funds or investment managers
    • An easy self-directed process to invest using digital channels rather than being chased by Relationship managers
    • Support who is readily available and knowledgeable to answer queries, handhold during the investment process. But no hard sell or repeated follow-ups

    Ergo! Torre Capital

    We built Torre Capital with the sole intent of providing a platform that looks out for investor interests before anything else.

    We bring our investors access to asset classes at low minimums so that they can invest even with modest portfolios. We do with only the top decile of funds and startups and other assets that have an excellent track record of protecting and growing investing principal. And we do this at AUM fees that are 5x lower than traditional players.

    We currently bring you access high quality Private Equity Funds, Venture Capital Funds, and Pre-IPO startups. Create a login in 2 minutes to check out the available opportunities.

    Why should you care as an investor for private markets?

    Better Returns and lower volatility

    In multiple articles that follow on this blog as well as my LinkedIn profile, I will demonstrate how returns in PE/VC/Pre-IPO opportunities are calculated and why they make sense. For now, I will borrow from Bloomberg and Goldman Sachs to illustrate the point. They looked at overlapping data for hedge funds, private equity and real estate 1990 to September 2017. A traditional 60/40 portfolio of U.S. stocks and bonds — as measured by the S&P 500 Index and the Bloomberg Barclays U.S. Aggregate Bond Index — returned 8.2 percent annually during that period, including dividends.

    Adding a 10 percent allocation to each of the three alternative investments — as represented by the HFRI Fund Weighted Composite Index, the Cambridge Associates US Private Equity Index and NCREIF Fund Index Open-End Diversified Core Equity, respectively — would have added 0.7 percentage points a year. And thanks to hedge funds’ ability to short stocks and the fact that private assets aren’t subject to the whims of public markets, adding alternatives would also have resulted in smaller declines during each of the last two bear markets.

    Check out our upcoming article on Pre-IPO funds and their past returns. Some of the numbers surprised even us.

    Our promise

    We built this platform to create a differentiated experience, and that is what we are going to provide. As investors, you can be assured of:

    • We will never recommend an investment that we would not put our own money in. None of our team members have a revenue or fee income target, the only target they have is to make sure that we protect our investors’ faith at all costs
    • We will not push products, we will put the facts in front of you as transparently possible, and answer your queries as needed. But ultimate investments decision remains with you.
    • Because of point (2) above, unlike every other fund out there we do not charge any fees on committed capital. You pay when you invest and start earning. Or else you pay nothing.
    • We will not build hidden fees in asset prices. All fees are transparent and upfront. We would rather see you walk away than feel cheated at any point of our interaction

    And it begins!

    The word Torre means tower, or watchtower in Spanish. While you progress in your careers, we will make sure your money works as hard as you do, and that is always protected in the best manner possible.

    Reach out to me at [email protected] 24*7 and I guarantee a response within 24 hours (not working hours!). As we work to expand and better our offering for your investing pleasure, please feel free to send across your feedback and comments.

     

    Related Posts

    Right Menu Icon
    Cancle

    Login to your Account

    Sed ut perspiciatis unde omnis iste natus error sit voluptatem

    Forgot Password?
    cross

    Select Country