Currently I’m short Nikola, Palantir, Plug Power, Virgin Galactic Holdings, Tesla and Zillow. If I were to break these companies into three groups, I would call them early stage ventures, pre-profitability, and Tesla. Tesla gets its own group because Tesla is actually profitable, and I’m only short Tesla because it’s valuation is ridiculous, not because I think it doesn’t have a bright future.
But the remaining positions are reminiscent of an early stage Venture Capital portfolio. Two have no revenues, and those with revenues aren’t even close to profitability, with the exception of Zillow. Public investors are buying these stocks as if they were VCs themselves, because they are banking on a team, a technology, or a high growth rate to get the businesses to profitability many years from now.
I once raised a lot of money from a Venture Capital fund and I always remember what the lead partner told me about his business. He said he only needed one out of every ten investments to hit a home run and to get his money back out of a couple more in that group of ten. Combined he could lose everything on seven of the investments, and still stay in the VC business by getting huge returns out of one and break even on the others.
Let’s do a thought experiment based on his math, but in reverse. Imagine if long lived put options were available on VC A round investments, with the strike at the round price and duration until the investment exited or failed. Theoretically you could pay a very high premium, say at 50% of the round price, and still show a profit with a good margin of safety. Bet $10M on a group of ten where three finish at or above the strike price and the remaining seven end at zero would return $14M, for a 40% gain. It would seem to be hard to lose money using even a purely mechanical approach, as only a tiny number of superstar VCs are going to have funds with greater than 50% winners.
The problems are:
a) Over a three year or longer period 40% would not be enough to make sense, the puts really need to pay at least 4x for us to earn reasonable returns.
b) These puts don’t exist except in this thought experiment, and if they did exist the prices would likely be too high.
SPACs don’t have those problems
Relatively long lived options exist for public companies, and occasionally can be cheap. So I'm trying build a “reverse VC” portfolio of bets against early stage SPACs, especially ones that my research shows have almost no chance of success (SPCE, I’m looking at you). I believe a large portfolio that can be very profitable with a good margin of safety and without extreme risk. The bets I’m making is for them to drop to 1x to 2x book value (all except Tesla), and pay out 5x to 20x when they do.
One big benefit is its a great hedge against the next market rout. My plan is to have these positions provide me with a flood of new dry powder to put to work at the same time the market puts good companies on sale.
What are the risks?
Duration: All SPACs are by definition well funded, and during this mania it’s not hard for them to load up with more cash. That book value can increase, and their runways can go out a half decade or more. Right now I’m buying one year options because they are so much cheaper than two year, so its likely I’m going to have to buy some replacement rounds in a year.
Timing: A double shotgun blast of $1.9 Trillion in stimulus appears headed our way, and is likely to re-inflate the bubble that seemed to be slowly leaking. I am actually looking forward to this possibility as I’ve kept plenty of dry power in hopes the market gets even sillier so I can add to positions at even better prices.
The final risk is additional future rounds of stimulus inflating the bubble past 2022. That is why I’m limiting the entire position to less than 10% of the portfolio, including reloads this spring and next year. I’m confident I can find enough special situations and workouts to pay for a loss of that magnitude this year.