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SPACs, IPOs, Direct Listings, O My!
We’ve all been tracking the absolute mayhem going on in the banking world through the slick new mechanics of all these different methods to “go public.”
The cute guy at the dance this year has been Special Purpose Acquisition Companies (SPACs). In 2021, there have already been gross proceeds of $105B raised through SPACs, and we’re only halfway through the year.
I broke down SPACs in a previous newsletter that you can find here.
When it comes to IPOs, outspoken critic, Bill Gurley, had this to post on Twitter:
It’s hard to read so I have re-written here:
The hot deals are obviously a currency, which can be used to please institutions, please high net worth individuals, acquire new customers (perhaps for GS.com), help ECM as per the memo, etc. How should we allocate between the various firm businesses to maximize value to GS (Goldman Sachs)?
How much “say” do the issuers have? They have an obvious trade-off between a big “pop” (great media coverage and morale boost) versus more cash proceeds. Could we offer a “dial” to issuers and let them (and perhaps their ad agencies) decide?
For GS.com, EXCLUSIVE access to GS hot deals might be a critical competitive tool to keep customer acquisition costs low and encourage larger clients to move to our site from a competitor’s.
Companies have also recently found success in doing a direct listing:
The end goal of going public SHOULD BE to allow the average Joe to invest in the company while providing growth capital for the business.
But this is rarely the full picture and there are a lot of different strings being pulled to incentivize the different actors in the system.
In tonight’s newsletter, we focus specifically on the younger little brother in the go-public world - the Reverse Takeover (RTO), as made popular by the Canadian Stock Exchanges. In America, the VC’s make all the money but up in Canada it’s the seed and founder round investors where the 10-20x bagger action is and you can become one easier than you might think!
This week, in <5 minutes, we’ll break down RTOs:
Overview 👉 Definition, Structure
Actors in the transaction👉 shell shareholders, brokers, institutions
Early-stage funding 👉 VC in the US vs. RTO in Canada
Case Study 👉 Recent success story
How GRIT’s Playing it 👉 Checklist that I use when looking at deals
Let’s get started!
1. Overview 👉 Definition, Structure
Why is a psychedelics company merging with a mining company? WTF?
A Reverse Takeover (RTO) is an effective shortcut to going public. A private company looking to go public will merge with a public company in order to bypass the lengthy and expensive process of an initial public offering (IPO).
The objective is to search for a public company that is an operational failure and now has little to no recent activity (essentially a skeleton) - known as a shell company.
This shell company could have been a junior mining company that is now defunct, and only maintains the bare minimum, like filing financial statements in order to remain a public company.
The private company buys enough shares in the shell to gain effective control.
The private company's shareholder then exchanges its shares in the private company for shares in the public company, effectively becoming a publicly traded company.
There is also usually (not always) a concurrent financing round done with the RTO that provides the necessary growth capital to the new entity - all at an implied valuation.
The end result is an RTO being a couple hundred thousand dollars cheaper, AND a couple of months faster as a path to go public.
The reason why so many happen to be mining companies in Canada, is due to the boom and bust nature of the industry, with a recent cycle for a lot of mining juniors ending around 2013.
It’s almost poetic that a lot of psychedelics and cannabis companies are being born out of old-industry shells to make way for the new.
Like a caterpillar becoming a butterfly.
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2. Actors in the transaction 👉 Shell shareholders, brokers, institutions
The shell companies I mentioned above have become a booming industry of their own. If you are an individual in control of a shell, it is a valuable proposition to sell.
These shell companies will typically have a cash balance on hand, which when combined into the new partner can be viewed as the shell’s “investment” in the new entity.
That is why the sponsor of the shell is important - to know that they will back the story, and not sell off shares in the early days, putting downward pressure on the illiquid stock.
In addition to having the majority ownership of the shell, there will also be fringe minority owners of the shell company. Someone who used to hold a junior mining company may not be interested in a psychedelics company and could add to this selling pressure.
However, it is the responsibility of the brokers to inform and educate individuals and institutions on both the progress and potential of the company to provide aftermarket buying support.
Brokers are the piece of the puzzle that help tell the story and connect the dots in getting the deal done. It is what is commonly referred to as “the sell side.” These firms have three distinct divisions: Sales & Trading, Research, and Investment Banking.
The Investment Banking division underwrites the deal and performs the logistical functions, the Sales & Trading team help facilitate transactions to “build the book” of orders on the deal, and the Research team writes reports once the company is public, to help institutions better understand the value proposition of the company.
Brokers also have in-house retail networks which are large individual investment advisors (IAs in Canada, RIAs in the United States) that can champion a deal. Especially in the small-cap space, there are many IAs that are as big as entire funds when it comes to firepower for writing big cheques.
This is how I picture the average big-book IA, total gunslingers:
Large funds/institutions are vital to the early-stage success of these companies. Since the company has a small amount of free-floating shares available, it is important for these large institutions to continue to support the stock in the public market by either holding for the longer term, or better - continuing to buy the stock.
Institutions also provide a very important role in this fundraising process - the validation of a company. If you have a reputable institution in on a deal, they can be displayed as the “lead order,” showing that someone with a big old business degree or a CFA has done the due diligence on the deal. This HEAVILY brings on the FOMO effect - almost as much as when a deal is described as “oversubscribed.”
More active institutions can sometimes place members of their investment teams on the advisory board of the company, although this can run into some insider information complications in trading positions down the line.
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3. Early-stage funding 👉 VC in the US vs. RTO in Canada
The Canadian RTO mechanism is sort of the anti-Silicon Valley. If you look at private companies in the US, they are now more than ever staying private for longer.
This is largely due to the much more robust venture capital network built out in SV vs. up here in the great white north. Companies don’t go public earlier because they don’t need to.
They find the capital somewhere else with longer grace periods on providing the early investors a liquidity event.
Not so in Canada.
By nature - we apologize a bit too much, pay a bit too much in mutual fund management fees, and are a bit too conservative.
Which is kind of ironic - because these RTO structures were largely the children of junior mining exploration companies.
I guess we only like shooting from the hip when it comes to having a random chance at pulling something out of the ground (precious metals or oil). But I digress…
HOWEVER, what this structure does, when done properly, is allow returns for public investors to hit absolute multi-baggers.
Amazon didn’t have some massive IPO where Goldman’s highest fee-paying hedgies were the only ones to get allocation to that sweet sweet day one pop.
Your grandma could’ve (and probably should have - DAMMIT GRAN GRAN) bought Amazon back in 1997 at $5/share (now ~$3,300/share). The bag of all bags. For those keeping score at home - that’s a 660x bagger!
4. Case Study 👉 Recent success story
Let’s walk through a recent example - one that I also own in my portfolio: Abaxx Technologies (ABXXF-US). Let’s start with looking at the bullet form headlines that came out. And the first one is what I’m talking about when I say two unusual companies are merging:
If you were to ask yourself “what does an iron ore company have to do with an ESG company,” then “absolutely nothing” would be the correct answer.
The other point to note is that New Millennium (NML) shareholders will still own 17.8% of the combined company. So you have to find a sponsor that loves the new story. And the bonus in this deal was that NML actually had +$10MM in cash so it could effectively jumpstart the capital formation stage for ABXX.
Let’s look at the 5-year chart, and see if you can guess when NML was relevant, when it died and became a “shell,” then when the RTO was announced.
That’s right - September 20, 2020 was the RTO press release above. If you want to dig through the filings in the process, in the US you use EDGAR, in Canada you use SEDAR.
Going through the directory for ABAXX, we end up on this landing page. Here we can comb through the company’s filing from shell to OpCo to see what associated liability holdings will/ will not come with the shell, who the equity owners are as well as in-depth financial information.
Over the coming weeks, subscribers of my paid newsletter will see some of the same deals that I see, and exactly how I think about them (and how I got in on ABAXX at $0.15/share and made a +20x bagger!)
Now, let’s check in with our Outrageous Chartered FinMEME Analyst Dr. Patel and see what he thinks about getting in on PRE-IPO DEALS!
5. How GRIT’s playing it 👉 My checklist
Whenever I look at these deals, I always find it helpful to use a mental framework in the original approach to both the deal structure and the company itself.
Tight share structure
Not overly aggressive promote
Solid brokers banking the deal
WATCH activity around lockup expiry periods - need support
Great management team that has had success before
Incredibly good at a one specific thing
Potential to increase total addressable market
Try to get in as early as possible … seed & founders round being the best time of course ; )
The RTO market in Canada is baptism by blood for a lot of junior bankers. You can hit home runs but it can also turn into an absolute wreck. But by having a checklist, sizing your bets, and getting good “at bats,” it is a non-linear way of using your investing chops to make some FU money.
I look at these deals extensively through my proprietary deal flow, and I talk about it all in my paid version of this newsletter that you can sign up for HERE !
Let’s hit more home runs, like Abaxx together ; )
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
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What else we Grittin’ On?
Inflation Nation. Prices rose 0.6% in May, above the 0.4% Wall Street was predicting. The YoY numbers were no better with prices surging 5.0%. Next big FED meeting is Jackson Hole in August. I expect volatility on the 10-year yield as we get closer to the meeting,
Margin Call! Stock market leverage has increased for 13 months in a row (since March 2020) and is now nearing $850B. Compare this to Dot.com at $300B and the 2008 Financial Crisis at $400B and it looks a little scary!
Comeback Kid? Big bets being placed that oil is going back to $100/barrel! I have been buying a new oil name this week.
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