The Economy

The Capital Note: SPACs & Stimulus

The front facade of the New York Stock Exchange (NYSE) in New York, N.Y., June 26, 2020. (Brendan McDermid/Reuters)

Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: a SPAC ETF, Congress debates another round of stimulus, and Donald Kendall, R.I.P.

SPAC ETF
I wrote earlier this week about the rise of SPACs, not the first time that we have touched on this topic, but the particular trigger was the news that “a team of blank-check company dealmakers is seeking to raise $100 million for a fund that will invest exclusively in special purpose acquisition companies.”

Without wanting to comment on any individual fund or, for that matter, SPAC (special-purpose investment company), the investment vehicle less flatteringly known as a blank-check company, I wondered whether the dramatic rise of SPACs (and now, it seems, of derivative products that feed off them) were not evidence of either irrational exuberance or (where else to invest?) desperation.

Now comes this (via Business Insider):

The first exchange-traded fund tracking so-called blank-check companies will begin trading on Thursday, marking the next stage in Wall Street’s infatuation with the new investment vehicles.

The Defiance Next Gen SPAC Derived ETF will debut on the New York Stock Exchange with the ticker SPAK, according to a Thursday press release. The fund includes a basket of firms taken public after merging with special-purpose acquisition companies, or SPACs.

Defiance’s ETF will also follow SPACs that have gone public but not yet identified a target.

“SPAK allows both financial advisors and retail investors to participate in an IPO private equity style of investing, which until now, was only available to large financial institutions,” Defiance said in its release.

Blank-check companies have surged in popularity this year. The firms raise capital through initial public offerings with the intention of merging with a private company and taking the combined entity public. SPACs typically have two years to find a company to merge with, and owners aren’t required to publicize a target before taking a SPAC public….

Again, I have no views on this particular fund one way or the other, but the growth of a SPAC “ecosystem” can be taken as evidence of a maturing industry, a bubble or both.

And speaking of ecosystems, now there is also this (via Bloomberg):

A different kind of clean-energy vehicle is emerging, and it isn’t made by Tesla. At least nine clean-energy companies, most of which have little to no revenue, are planning to go public between now and the end of the year via reverse mergers with “blank-check” financiers, also known as special purpose acquisition companies.

The deals are emerging at a time of increasing scrutiny of SPACs. U.S. Securities and Exchange Commission Chairman Jay Clayton said last week that regulators are examining whether investors are receiving appropriate disclosures from these vehicles about insiders’ lucrative pay structures.

His remarks followed a slump in the stock price of electric-vehicle maker Nikola Corp., which was taken public in June by blank-check company VectoIQ. Nikola shares plunged more than 60% in the past three weeks after short seller Hindenburg Research accused the company’s founder of overhyping its technology, prompting investigations by the Justice Department and the SEC.

Undaunted, Hyliion Inc., which makes electric propulsion systems for trucks, will start trading Thursday on the New York Stock Exchange, three months after agreeing to a merger transaction with a SPAC named Tortoise Acquisition Corp. Velodyne Lidar Inc., which develops lidar sensors for autonomous vehicles and drones, is set to go public in the next few days, and the other seven companies are scheduled to complete their deals with SPACs before the end of 2020….

Of these companies, only one has “meaningful commercial revenue,” and that’s Velodyne, which had $102 million in the 12-month period ended June 2020, said Shayle Kann, a San Francisco-based managing director at Energy Impact Partners, in an InterChange podcast entitled “The Cleantech SPAC Attack.” Five had no revenue and Hyliion has just $1 million or so this year, Kann said. (Hyliion has said it expects that figure to grow to $2 billion in 2024.)

Given this backdrop, it’s perhaps surprising that the average clean-energy SPAC has an anticipated enterprise value—a measure of a company’s potential takeover value—of $1.8 billion, he said.

Surprising? Well, yes and no, I’d say, in current market conditions. To a cynic, this looks a lot like two bubbles merging: SPACs and green investments.

Beyond their conventional investment merits (or otherwise), “clean energy” companies are an example of two other factors at play. The first is that with “socially responsible” investing (SRI) on the rise, asset managers are looking for investments that can help green their portfolio (whether they should be doing that, other than in funds specifically designated as socially responsible or green is an entirely different matter), and these SPACs will fit the bill nicely. Who will end up paying the bill in the end, well…

The second is that SRI has become, in the words of the great Arthur Daley (no apology is made for vintage British TV references in the Note) “a nice little earner,” spawning a flourishing ecosystem in which innumerable advisors, consultants, NGOs, financiers, sustainability officers, and so on can flourish, doing well by pretending (or, worse, even believing) that they are doing good. Nothing surprising in that either—acquisitiveness is one of the characteristics that has taken mankind a very long way. At the same time, however, this ecosystem is creating a powerful lobby that has a vested financial interest in keeping the pressure on for yet more SRI, stakeholder capitalism and all the rest. As part of that, this lobby will push for governments to adopt policies that will back up an agenda that is green in a rather older sense of the word. As always, follow the money.

— A.S.

Stimulus
All eyes are on Washington again as House speaker Nancy Pelosi negotiates a fresh round of economic stimulus with Treasury secretary Steve Mnuchin. Members of the House are scheduled to leave Washington today until after the election, which leaves little hope for a pre-election fiscal deal in the coming weeks.

The main sticking points are state-and-local assistance and funding for education. Politico’s Playbook gives a broad overview:

REPUBLICANS TELL US THE DEAL NEEDS TO BE LESS THAN $2 trillion for it to pass their muster, and Dems want a deal at $2 trillion plus — so that’s the first issue. Those aren’t firm demands, just the general feeling among the dozens of people we spoke to Wednesday. And even if it’s at $1.6 trillion — MNUCHIN’S offer — it faces an incredibly treacherous path in the GOP Senate, where insiders told us it may never make it to the floor.

The stimulus debate crystallizes the two paths the U.S. economy could take after the November election. While the GOP has deemphasized fiscal responsibility and shown an increasing willingness to use transfer payments to boost consumer spending, it sees funding for states, cities, and public-school systems as bailouts of profligate Democratic politicians.

A Republican victory in November would mean trouble for the major metropolitan areas that drive most of the nation’s economic growth. The repeal of the SALT deduction in 2017 already hit high earners in cities like New York and San Francisco. With massive fiscal deficits looming, New York, California, and Illinois could face full-fledged budget crises if the GOP holds onto the Senate.

Should the Democrats take the presidency and Senate, on the other hand, we can expect increased federal spending to contribute to GDP growth, but with an added drag of increased taxes and regulations. Goldman Sachs estimates a drop in corporate earnings by 12 percent under the Biden tax plan.

In any event, markets don’t seem particularly concerned. Stocks are up today, perhaps supported by encouraging data releases. Consumer-confidence numbers published this week were the highest since before the pandemic, while unemployment claims leveled off around 800,000. Consumer spending, too, has seen a modest increase despite the expiration of the CARES Act.

— D.T.

Around the Web
Scott Sumner on disaggregating interest rates and monetary policy:

This “masquerading problem” is sometimes called the identification problem; it’s what happens when people engage in reasoning from a price change.

After forty years, economists yet to develop a generally accepted VAR model of the monetary policy transmission mechanism.  Like fusion power, there’s a small chance that it may happen some day.  But there’s almost no chance I will live long enough to see this approach yield useful results.  The profession would be much better off switching to an approach that used NGDP growth expectations as the primary indicator of monetary policy shocks, and then develop models to estimate those expectations using real time data from asset markets.  Interest rates are not a useful variable when analyzing monetary policy.

Cambridge University divests from fossil fuels:

Cambridge university’s £3.5bn endowment fund has pledged to divest from fossil fuels over the next decade, in a landmark decision that follows a lengthy campaign involving protests, hunger strikes and petitions by students worried about climate change.

The move marks a symbolic step for the UK’s second-oldest university, which, despite being a leader on science and engineering research related to climate change, has faced sustained criticism over its links to polluting companies.

A new database of bond underwriters:

[T]he structure of the bond market in 2020 is largely the same as it was decades ago, with little transparency in its inner workings. Bonds and other fixed income securities still trade over-the-counter, meaning a dealer and an investor directly negotiate a price, whether online or over the phone…As a result, investors, dealers, and others have no central place to find bond prices and other crucial information on trading…

But now bond issuers can get comprehensive report cards on the dealers and data from BondCliQ, a centralized pricing system that aggregates pre-trade institutional quote data. BondCliQ made data available this month to corporate treasurers that are part of the NeuGroup, the largest corporate finance organization.

Random Walk
Donald Kendall, R.I.P.

The Economist:

The cola wars became a cultural phenomenon. Credit for that goes to Donald Kendall, PepsiCo’s legendary former boss, who died on September 19th aged 99. A gifted salesman, he rose quickly through the ranks from his start on the bottling line to become the firm’s top sales and marketing executive at the tender age of 35. Seven years later he was named CEO…

[His] masterstroke was the all-out marketing blitz against Coca-Cola, long the global market leader in non-alcoholic beverages. The two firms had competed for decades, but they mostly fought low-grade battles. Mr Kendall changed that, by forcing both companies into an advertising arms race. In 1975 Coca-Cola spent around $25m on advertising and PepsiCo some $18m. By 1985 those figures had shot up to $72m and $57m, respectively. In 1995 Pepsi outspent Coke by $112m to $82m.

This was a risky gambit for both cola rivals. But it paid off in two ways. First, it helped fizzy drinks win a greater “share of throat” (a term coined by Roberto Goizueta, a former boss of Coca-Cola, who died in 1997). They went from 12.4% of American beverage consumption in 1970 to 22.4% in 1985. And though Coca-Cola maintained its lead in that period, with over a third of the market, PepsiCo’s share shot up from 20% to a peak of over 30% in the 1990s. Last year carbonated-drinks sales totalled $77bn in America, and over $312bn globally. Coca-Cola and PepsiCo remain dominant.

The second way that the cola wars benefited both companies was by turning them into “the world’s best marketers”, observes Kaumil Gajrawala of Credit Suisse, a bank…

In many industries a cosy duopoly retards innovation and harms consumers. The happy outcome of the cola wars has been the exact opposite. As Mr Kendall himself observed, “If there wasn’t a Coca-Cola, we would have had to invent one, and they would have had to invent Pepsi.”

Competition works.

— A.S.

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