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Idea Brunch with Raj Shah of Stoic Point Capital
Everything you want to know about De-SPACs
Welcome to Sunday’s Idea Brunch, your weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Raj Shah!
Raj is currently the Co-PM at Stoic Point Capital Management, a Palo Alto-based equities fund he co-founded in July 2018. Before launching Stoic Point, Raj was a managing director and partner at Stillwater Investment Management, a partner at Light Street Capital, and an analyst at Highline Capital Management. Today, Stoic Point manages two long/short funds, one of which is devoted exclusively to de-SPACs. Raj recently started tweeting @stoic_point on Twitter.
Raj, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Stoic Point Capital?
Thanks for having me, Edwin! I’ve been long/short investing for over 13 years and have had the good fortune to work at large well-established funds, sector-focused funds, and startup funds. I really think this is the best job on the planet. I get paid to research a company or situation with an unbiased view and ascertain whether value is likely to be created or destroyed. I also get to interact with some of the smartest people I’ve ever met, including my partner with whom I started Stoic Point four years ago.
I started out my career at Highline Capital in New York where I cut my teeth covering a variety of sectors but ended up gravitating towards technology. That eventually brought me to join Light Street Capital, a TMT-focused growth manager in Palo Alto. While in Palo Alto I was introduced to Adam Weiss as he was un-retiring after managing Scout Capital, a $7bn concentrated fund. I joined Adam and a truly fantastic team to launch Stillwater Investment Management in 2015. This was a big learning moment for me. Building an investment approach from scratch, including the systems and processes to scale, and seeing how important culture matters at the outset is an education I’m thankful to have gotten firsthand. Perhaps equally as important, I shared coverage of Stillwater’s portfolio with Cullen Rose, an investor whose acumen I came to greatly respect and whose style complemented mine. Cullen and I shared a commitment to process-oriented investing and balanced each other out—my growth orientation versus Cullen’s background in value and activism.
Cullen and I launched Stoic Point together in mid-2018, leveraging the guiding principles (Quality, Misunderstanding, Self-Knowledge) from our prior firm. We also migrated our investment committee process, including a 30+ factor investment scorecard by which we grade every idea across those three principles. The best way to summarize our values system is to think of Quality as how we grade the business, Misunderstanding as how we grade the opportunity, and Self-Knowledge as how we grade ourselves. Quality and Misunderstanding exist across a spectrum—of course, we’d love to own the highest-quality businesses that are most misunderstood, but those circles are rarely completely concentric. Self-Knowledge is an inward-looking measure of how comfortable we are with what we don’t (and can’t) know about an investment, and what our reactions will be to some likely scenarios that may come to bear (some call this a “pre-mortem”). The numeric grading output from the scorecard across these three vectors determines our position sizing and feeds into risk management. Everything I laid out applies on the short side as well.
We also took something else important with us: the experience of building an investment management business from the ground up. It’s easy to overlook that running a hedge fund isn’t about just investing, it’s also about managing a business. We specifically engineered Stoic Point to give ourselves the longest possible runway. The race to put up numbers and scale is incredibly distracting to an already incredibly difficult task of investing. Fortunately, we took some lessons learned with us when starting Stoic Point.
What we did not take with us is AUM. Stoic Point didn’t take seed capital and launched with something like $2mm on Day 1. As if that wasn’t enough, we made it even harder for ourselves by being Co-PMs, a structure we were told repeatedly that allocators hate—something that never quite made sense to us. We consider two decision makers married to the same investment process and principles to be a real asset, not an impediment. It also never made sense to us to misrepresent our investment committee process by making one of us “Portfolio Manager” and the other “Director of Research.” I’ve worked for PMs who were prone to emotional decision-making. As process-oriented investors we seek to remove as much emotion out of the decision-making process as possible…hence the name Stoic Point. Stoics knew that you can’t do anything to control what happens around you (the market), only what your reactions will be. Having a partner and process in place to remind you of the scoring that went into a decision in the first place—when your emotions are telling you something different—is extremely valuable.
How’d you come to get involved in the SPAC universe?
I’m not prone to hyperbole, but this is the single best hunting ground for SMID-cap longs and shorts I’ve ever seen. We’ve long paid attention to SPACs given the potential for Misunderstandings, but there was relatively limited activity every year, and it was never a universe known for quality. But one of our early investments at Stoic Point was APi Group (NYSE: APG), a high-quality business services company that came public via a UK-listed SPAC in 2019. The deal was priced at a substantial discount to any other public comp, had great anchor investors, and the sponsor, who has been very actively involved in company strategy, had a great track record of value creation. The stock only traded OTC in the U.S. prior to the deal close which became our opportunity to buy at an attractive valuation.
As the SPAC fervor took over in late 2020, we increasingly focused on the opportunity set.
I don’t need to convince you that it’s been a phenomenal source of shorts, which was our original attraction to the universe. We kept seeing SPAC mergers with cash-hemorrhaging, pre-product companies (like companies that roll non-functional trucks down hills) double or triple at deal announcement. This was also around the time of the retail/Reddit meme stock mania. People were calling for the end of shorting... which is usually around the time you should be pressing all your shorts. But it’s incredibly hard in the moment, and if you are reckless, it can cost you your business.
But SPACs provided an incredibly useful tool for risk managing shorts—the five-year warrant. As the SPAC boom gained momentum there were numerous opportunities to short the stock and buy warrants trading below intrinsic value. All you needed to do was wait for exercisability of the warrant and you had locked in a nice arbitrage profit. At the time, the arb spreads were so wide that people assumed there was a catch. And the kicker was your stock short position was much bigger and the warrant was so cheap relative to the stock that if the stock blew up (and basically all of them did) you’d make even more money than the arb spread.
That observation about a very wide arb spread led us down the path of further exploring the warrant market. Our general takeaway was that the instrument was very hard to price and prone to inefficiencies given some of the market dynamics, namely liquidity and varying market participants (yield funds, arbs, fundamental investors, retail traders, etc.). The warrants tended to significantly underprice volatility relative to the stock, yet SPAC stocks tended to be highly volatile. We ultimately constructed a portfolio of long warrants and short stocks of various hedging ratios to take advantage of the volatility mispricing.
What are you doing now in the SPAC space?
Over the past two years, about 300 companies have gone public via a SPAC. With the help of an analyst, we have processed nearly all of these deals to quickly ascertain if they are potentially actionable, long or short. Spoiler alert: the vast majority seem like shorts, certainly at $10. The current pipeline of announced and unclosed deals also contains many short ideas. And now that we are at the bottom of the barrel of SPACs still desperate to find a target, any target, before they expire, we suspect many of the deals announced for foreseeable future are potential shorts.
Yet amidst all the carnage, there are at least 15 names we think could be multi-baggers over the next few years. So, while we are still actively shorting in this universe, we have considerably increased our long exposure to De-SPACs.
As negative and pessimistic as we sound about the universe, there are many reasons to believe there could be a handful of great long opportunities. As mentioned earlier, part of our investment framework and process is identifying Misunderstandings. We will highlight a few likely at play here. First, there is the baby with the bathwater effect—the good companies being tossed out with bad just because of the go-public structure. The De-SPAC index is down nearly 80% since the beginning of 2021. Many of these situations are now almost orphaned securities—too small or illiquid to care about. The original sellers are no longer liquidity providers at the current price and the market caps have been chopped, so it is very difficult for any large long-only funds to build a meaningful position. There is also a healthy amount of investor distraction and fatigue. There are at least 100 broken regular-way IPOs from the last two years—so who is going to put a broken De-SPAC at the top of their due diligence list given all the pessimism? While some of these companies picked up decent sell-side coverage, many still suffer from a lack of interest and coverage. These stocks generally have much less passive support than their comparable more liquid peers that have been public for longer. These companies also have spotty and often wildly inaccurate data in financial databases like Bloomberg and FactSet. They often show up incorrectly or not at all in screens. Then there is just the typical stock chart feedback loop—the charts on some of these names look horrible. Clearly, something must be wrong, some have cut their original guidance. That’s fair. But many of them raised a considerable amount of cash (especially relative to their current market caps) and the risk/reward looks very different at $5 or below than it did at $10. There is also considerable secondary “overhang”, potential new investors could be worried about big secondaries as soon as the stock moves up. We think secondaries leading to increased liquidity will contribute to multiples re-rating upwards over time. We have an opportunity at our size to participate earlier in the potential upside.
Finally, we continue to think the end game for many of these companies is to just go private again. The costs of being public are significant (and rising)—many of these companies talk about $5-10mm per year. For some of these companies, EBITDA would increase significantly just by eliminating these costs. Why stay public? Just so you can report quarterly earnings to the seven people who might actually care about the stock and conduct an annual carbon emissions study? Not to mention we just went through an epic private equity fund-raising cycle resulting in a LOT of dry powder waiting to be deployed.
Long way of saying our bias in the SPAC world has always and continues to be on the short side. But due to the epic carnage this “asset class” has experienced, we have uncovered a meaningful number of long opportunities.
What are some of the common red flags and positive signs you are looking for when researching a de-SPAC? And which de-SPAC sectors have the best opportunities for shorts and longs in your view?
This sounds glib but going public via SPAC is a red flag. The incentives are perverse. The fees are high. The opportunity to mislead people is too great. So, let’s start with that. A company should have a good answer for 1) why it is coming public this way, 2) why it is partnering with this sponsor, and 3) why this financing structure makes sense.
A year ago, an example of a good answer to these questions would have been that the business was deeply impacted by COVID (travel, discretionary etc.) and would face difficulty from a regular-way IPO process in which management could not forecast a recovery. SPACs can talk about the future (for now) and enable investors to understand what management forecasts (yes, this is frequently abused). Another good answer is that the SPAC sponsor truly does offer value, not just helping the company do a PIPE roadshow or get sell-side coverage. There are sponsors with real operational expertise, M&A, and growth guidance that can add value in the board room.
A bad answer is something like, “SPACs allow us to pick our investors,” or “the merger offers us price certainty,” or “this lets us come to market faster.” SPAC shareholders redeem or sell stock faster than hedge funds getting IPO allocations from Morgan Stanley, a dynamic that has led to companies coming public with as little as $5mm in capital raised (before fees!). There’s no price certainty when you’re back in the market issuing equity again three months later at $5. The De-SPAC process is also taking far longer now, leading to stale valuations compared to IPOs that price the same week they start trading.
Other red flags: serial sponsors with a poor track record; a sponsor merging with a business that has nothing to do with its stated objective or just before SPAC expiration; creative and complex financing; using FPAs (forward purchase agreements) that buy redeemed stock to get a deal over the finish line with a put back to the company at $10 shortly after deal close; absurd projections; and/or nonsensical comparable valuations (many SPACs raise all of these red flags, and more).
It’s also important to look at the other parties involved. SPACs can advertise large PIPEs with a strategic investor in the press release, but the S-1 later discloses a PIPE filed with arb and credit funds, or random “strategic” investors like Palantir. Hedge funds will be gone as soon as the PIPE unlocks and can crush the stock on their way out.
The best areas for short opportunities probably won’t surprise you: electric car companies with no actual product (internally we call those “a drawing and a dream”), charging companies (horrible businesses with terrible unit economics/moat), compute hardware (e.g. quantum computing, bitcoin mining), and fintech (to name a few). I’d also add that any company with less than three years of revenues usually has no business being public.
The best areas for longs are harder to generalize, but I would say we’ve found some great software and consumer businesses that are well established. It’s easier to underwrite historical financials and do real customer/competitor diligence on businesses that have been around for many years. Software exhibits nice recurring revenue streams and generally these businesses are not cash burning and the unit economics are easier to discern. Consumer businesses are generally more tangible and easier to understand.
Raj, many de-SPAC companies have a reputation for promotional, dishonest, and money-oriented management. Are there any management teams that stand out as honest and exceptional in your view?
“Exceptional” is a very high bar. In fact, honesty is even a high bar for most SPAC management teams. It may be too early to say who’s truly exceptional. But there are a handful that appear to have the right ingredients and that we already hold in high regard (and are honest): CCC Intelligent Solutions Holdings (NYSE: CCCS), AvePoint (NASDAQ: AVPT), Cvent (NASDAQ: CVT), Janus International Group (NYSE: JBI) and Nextdoor (NYSE: KIND).
First, they’ve aligned themselves with reputable sponsors. Most SPAC deals are bake-offs where management/owners have their pick of who to go public with. Choosing a reputable sponsor, not just the one who tweets great one-pagers or bids the highest valuation, is a good sign. All our longs have partnered with good sponsors.
I tend to gravitate towards founder-led management teams (CVT, AVPT). Founders have real skin in the game and feel a deep obligation not just to investors, but to employees and customers as well. They live and breathe their business and I love that. Relatedly, we look for management teams that are customer obsessed and have reinvested profits back into widening their moats (CCCS, JBI, KIND).
The best management teams are also long-term focused and opportunistic. They aren’t panicked that the stock is down because they are focused on the business trajectory and capital allocation, with the knowledge and confidence that the stock price will figure itself out. I mention opportunistic because they are also smart capital allocators. A few have done smart deals (JBI bought its only real competitor within a few months of coming public), bought back stock at severely depressed valuations (AVPT, KIND), or redeemed warrants at a discount to future fair value (CCCS and JBI).
Being a public company offers a whole new set of challenges and not all these stocks have fared well since their debut (in fact the best are still about $10). These are new public companies in a very crowded (and extremely volatile) field. We very frequently speak with De-SPAC management teams, and it doesn’t take long to figure out the ones that “get it.” They must improve communication, build credibility, and continue to garner investor attention. We are optimistic because communication can always be improved, but they already possess the above characteristics, which are significantly harder to develop. And one additional commonality among these teams is their interest in and openness to investor feedback.
What are some of your favorite de-SPAC ideas on your radar now?
I think about our long SPAC exposure as being in two buckets: 1) good/great businesses trading at deep discounts to peers and/or intrinsic values, and 2) companies with massive option value and/or massive asymmetry.
In the category of good/great businesses that are cheap, I’ll highlight two software businesses. Both are deeply discounted, have strong unit economics, and are run by longtime founders.
The first is AvePoint (NASDAQ: AVPT — $920 million). It checks a lot of boxes I mentioned earlier. The company has been around for over 20 years. Today it’s the largest data management company in the Microsoft ecosystem and rides on top of Office 365, doing over $200mm in annual revenues and growing 30% annually. The SPAC sponsor, Jeff Epstein (not that one) was CFO of Doubleclick and ORCL and sits on the boards of OKTA, TWLO, POSH, Couchbase and Kaiser (and formerly BKNG). He understands software and isn’t living off his SPAC sponsor money. AVPT’s CEO co-founded the business and much of the management team has been there from the start. What they do is boring. There is nothing exciting about securing and managing corporate data in the MSFT ecosystem, but their products are mission-critical in regulated industries. The company is sustainably growing 30% annually, with gross margins in the 70%s but trading for <3x revenues compared to similarly growing peers trading at 7x or higher. It’s a prime example of a good company that’s been sold off amidst a bloodbath in De-SPACs. Management isn’t sitting still – they’re buying back 15% of their shares at depressed prices. We think the stock will compound at 30%+ but can more than double if/when it trades more in line with peer SaaS businesses.
We also like Cvent (NASDAQ: CVT — $3.00 billion), which was taken public by Dragoneer’s 2nd SPAC. We owned Dragoneer’s first SPAC, CCCS, possibly the highest quality business to go public via a SPAC in 2021 (and is priced accordingly). CVT on the other hand was priced richly to begin with, but shares have gotten crushed. The stock wasn’t interesting at $10 but now a year later with numbers higher than what they originally forecast, and shares down ~50% to less than 4x revenues, it’s a different story. CVT’s software provides end-to-end technology for finding, booking, hosting, registering, and managing events as large as Dreamforce and as small as a local trade show. The company was public from 2013 to 2016 until Vista Equity bought it and merged it with Lanyon, another portfolio company, and created a behemoth in the events management industry. CVT has a good answer for taking the SPAC route…the business powers in-person meetings so COVID was a significant impact. Amazingly, revenues were only down 12% in 2020 and the company is already close to surpassing 2019 revenues. Part of the reason behind its successful navigation of COVID is that the founding management team is still running the business over 20 years later, not something you’d expect at a once LBOed/twice public company. Today, they’re coming off a large investment cycle (building a virtual meetings platform) and we expect EBITDA margins to climb into the mid-20s (where they have been in the past) from the mid-teens where it has been in the last year or so. Why does the stock trade at only 4x revenues despite 20%+ growth and profitability? Liquidity. CVT is a $3bn market cap that often trades less than $2mm per day, as Vista still owns over 80%. Over time as legacy owners sell and the float is increased, we anticipate more liquidity will benefit the share price. In the meantime, the company will compound topline at 20% and bottom-line much faster thanks to margin expansion.
Our second bucket of “option value” names may not be the highest quality businesses, but a number of these companies came to market at the right time and raised a ton of capital. With their stocks down 80%+, they are sitting on a lot of cash (in a few cases cash in excess of their market cap).
One such company is Evolv Technology (NASDAQ: EVLV — $386 million). The company sells next-gen weapons detection systems aimed at preventing mass-casualty events at large venues like schools, arenas, and courthouses. What sets it apart technologically is that the IP behind Evolv’s devices allow for 10x higher throughput than metal detectors, so patrons don’t have to stand still and venues don’t have to worry about long queues. I don’t have to tell you the market for tools to stop mass shootings is large and growing. Unit growth is triple-digits for the foreseeable future, and we had been watching the company because it was backed by some Tier 1 VCs and had scored some major customer wins like the NFL and MLB. Two weeks after being installed at a high school in North Carolina, they stopped a student with a loaded handgun. Last month they were installed at the AO arena in London, where a few years ago a suicide bomber detonated at an Ariana Grande concert. It’s great tech, but this is a venture business that came public far too early. The stock has been crushed in part due to supply chain issues and in part due to changes in revenue recognition accounting which reduced estimates. If anything (sadly) the demand outlook has only gotten better.
We started buying EVLV when the company’s enterprise value went negative (its cash balance exceeded its market cap). In a vacuum that’s interesting, but a high-growth business like EVLV can easily burn through its entire cash balance. In this case, we don’t think that will happen. EVLV sells much of its product under a SaaS model where hardware and software are bundled together (PTON is experimenting with this now). At present, the company is financing this on its own balance sheet. Optically this paints a picture of high cash burn (what would be COGS recognized ratably over time is instead CapEx recognized all at once). Our math suggests at its present valuation the company’s EV is less than the NPV of cash flows from its current install base alone. There is no value ascribed for future growth. Ultimately, we think shares will rerate substantially as higher cash flow waterfalls in from a rapidly expanding customer base (growing triple digits), but if I had to guess I don’t think the company remains public much longer. Motorola Solutions was one of the first venture checks into the business, the largest investor in the PIPE, and recently became one of its largest resellers. At present, EVLV has 73% of its market cap in cash, and substantial synergy can be generated as part of a larger business that can provide financing and channel resources. We also note that the company’s founding team has started and sold multiple businesses before.
We own shares in PartsID (NYSE: ID — $39 million), a microcap company with one of the highest asymmetries we have come across. ID operates CarID.com, a leading aftermarket auto parts e-tailer in one of the few remaining categories that is still underpenetrated by e-commerce. Over many years the company has built a moat around its business by investing in “fitment” data. There are literally hundreds of thousands of SKUs for aftermarket auto parts and small variations lead to increased complexity (there are seven different versions of the Ford F-150). Getting the right part is critical. ID’s fitment database is so good that the company has a low 5% return rate. Thanks to its broad assortment and high NPS score, ID punches well above its weight class on SEO and organic search. (Try it for yourself and Google a spoiler or seat covers for your own car – you’ll likely see CarID.com as one of the first organic results along with AAP and ORLY.
The business has compounded revenue and gross profit growth in the teens since 2017. COVID, stimulus checks, and a strong used car market added further fuel, pushing growth to more than 50% at one point. The company is inventory-light via a drop-ship model, resulting in high cash conversion. Management has re-invested profits into new verticals like RVs, boats, and motorcycles as well as replacement parts, but like many COVID beneficiaries, trends are mean reverting. Execution has been strong but we think high insider/founder ownership is why shares now trade at just 2x EBITDA, with 1/3 of the market cap in cash (the co-founders and chairman own over 70% combined). The stock is very cheap: cumulative FCF generated since 2017 is equivalent to its current enterprise value. Undoubtedly, COVID trends are reversing and topline trends will decelerate substantially, if not go negative in the near term, but the mismatch between valuation, business quality, and longer-term growth potential is substantial. Over time we predict liquidity will increase as co-founders sell stock, or the company is likely to go private. EBITDA could nearly double just from eliminating public company costs.
In other cases, the disconnect versus similar companies or take-out values is extremely compelling. LiveVox (NASDAQ: LVOX — $164 million) provides communication software for customer call center reps. The company is still controlled by a PE firm (Golden Gate Capital), which bought more stock after the deal closed at around $5 late last year (it’s now <$2). It’s growing 15-20% which should accelerate to >25% as it laps COVID impacts. It trades for ~1.7x annualized GAAP gross profit. The most relevant public comp is Five9 (FIVN). It’s growing a bit faster (~30%) but trading for 20x annualized GAAP gross profit (I use GAAP here because FIVN is an epic abuser of stock comp adjustments at >20% of sales). Also, recurring revenue software businesses tend to get acquired well north of 3x gross profit. Tremendous valuation disconnects like this don’t tend to persist in perpetuity.
These are just a select few of our favorite opportunities, but it hopefully gives you a sense of how substantial the asymmetry can be and why it makes sense to us to be shopping for longs in this part of the market.
What are some of the first things you do when researching a potential investment? What does that first hour of research look like for you? Do you do anything that few others do?
I’ll split my answer into two parts because the way we approach a De-SPAC is perhaps a bit different from the way we approach most of the companies we invest in. I’ll start with where I generally begin with any business.
Our process covers underwriting through the lenses of Quality, Misunderstanding, and Self-Knowledge, in that order. A big reason for starting with Quality is that 1) it’s one of the easiest things to fail an idea on quickly, and 2) without meeting our Quality thresholds, scoring along the other two principles is irrelevant. Move on.
People are a big input into the Quality score and I often spend much of the first hour there. I want to know who’s running the business, what their backgrounds are, and what their incentives look like. Another reason to start with people is that Stoic Point has a large professional network we can leverage—often we may be able to get some interesting intel on a stakeholder this way.
From a fundamentals standpoint, I often hear investors say they start with the 10-K. I always read the 10-K, but it’s not necessarily the starting place. Maybe it’s because I spend most of my time in TMT, but I usually start with the website, or a slide deck if it is available. It should be easy to glean what a company does from those things and often the segment reporting in filings doesn’t represent the way a business is actually operated. By the time I get to the 10-K I’d like to already have that idea, and then compare that to my understanding of how the economics work. Also, I’m a slow reader.
Valuation generally comes last. It matters, but it matters less than the aforementioned. Valuation can be shorthand for Misunderstanding, but by the time we get to Misunderstanding we’re usually well past the first hour of research.
The first hour of looking at a De-SPAC is a little different. The first place to start has little to do with the fundamentals. Deal dynamics matter much more in the medium term. SPACs don’t have underwriter banks smoothing out trading and the De-SPACing process entails a months-long rotation of the shareholder base from arb and PIPE investors to more fundamental long-term investors. That transition can be messy. So I’ll begin by understanding what the pro-forma ownership structure looks like and who are the parties that are involved. A poorly constructed deal with a great company can trade terribly for a year or more no matter how cheap a stock is or how well a business is doing.
What would you like Stoic Point Capital to look like 10 years from now?
I’d like us to have sponsored at least ten SPACs. Just kidding!
We pride ourselves on focus and maximizing our “return on time.” I expect in 10 years we’ll be back to managing one fund. The SPAC opportunity is a unique point in time, and we always want to be ready to take advantage of opportunities that arise. But at our core we are Quality-focused, concentrated investors. We think our investment principles enable us to know exactly what we’re supposed to be looking for. We know we aren’t going to be competitive in healthcare or energy so we don’t spend any time there. We won’t have a private fund because we will literally be the last people here in Silicon Valley to get a look on a great deal. We love shorting, so I expect that we’ll continue to deliver differentiated returns on the short side while compounding healthy returns in our long book. And I expect the team to grow somewhat, but we intend to remain small.
Raj, thank you for the great interview! What is the best way for readers to follow or connect with you?
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