While the rest of the world has been staying at home, special purpose acquisition corporations (”SPACs”) have been going out hunting for clean energy and transportation startups.
A SPAC is a publicly-traded shell company set up to acquire another company and thus take it public, while short-cutting much of the regular IPO process. They’re sometimes called “blank check companies”. So far in 2020 around two dozen such cleantech SPAC transactions have taken place. The companies that have completed or announced that they are using this approach to go public have ranged from clean transportation startups like Nikola Corporation and XLFleet, to battery companies like Stem and Eos Energy Storage.
The SPAC model (and the high valuations it drives for companies that sometimes have very little if any revenue) has been a lightning rod for debate and criticism among investors. In speaking with some of the SPAC management teams, it’s become clear to me that even among these proponents of the model, there is healthy skepticism of the long-term prospects for some of these now “publicly-traded startups”.
However, there are two compelling reasons why this wave of sustainability SPACs is going to continue for at least a little while longer.
The first is that there is clearly a lot of pent-up demand for sustainability and climate-related stories in the public markets. Not only among the Robinhood-enabled individual investors out there, but also among the largest institutional investors who are now seeking ways to gain more exposure to clean energy and the sustainability megatrend. It’s these latter investors who are capitalizing the blank check companies up front; it’s the former that have been driving the prices of most of these SPACs higher after their debuts. And that will just generate even more SPAC-creation activity.
But the second reason is because for SPACs, clean energy and sustainability is a target-rich environment. There are a lot of venture-backed startups out there in these markets that should have been acquired by now by the incumbent players, but weren’t. And why haven’t they been? Because for decades now, the biggest players in the automotive, industrial controls, lighting, HVAC and related sectors have been highly unmotivated buyers.
In the world of Big Tech, we’re used to seeing big splashy acquisitions of very young companies all the time. Google, Microsoft MSFT , Facebook et al are aggressive acquirers. They are used to operating within a winner-take-all market, where a failure to jump into the “next big thing” on time is potentially deadly. It’s therefore worth it to these big players to protect themselves by going and finding the promising new platforms and teams, and paying high valuations for those acquisitions. Valuations justified not by the revenues or EBITDA of the targets themselves, but by the potential strategic value for the acquirers.
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That has simply not been the case for most of the energy and industrial market. Instead, the big players haven’t felt any urgency to adopt new innovations. Instead, they sit around waiting for bargains. When they do finally make an offer, it’s typical for it to be something around 2x trailing twelve-months revenues. Which, for a fast-growing startup, adds up to low numbers.
And until recently, that’s been a winning strategy for these big incumbents.
The startups they are interested in often don’t get more valuable over time, they actually get cheaper. Why? Small, fast-growing startups burn cash. So over time, their investors get “tired” and don’t want to keep funding by themselves. Some startups obviously continue to raise capital round after round from new investors. Others back away from aggressive growth plans and make themselves achieve cashflow breakeven, but then they look less attractive to potential acquirers since their revenues stall. And of course, far too many promising startups with compelling innovations flame out.
But for many startups and incumbents, it becomes a waiting game… The startups and their investors hanging around as long as possible, while the incumbent acquirers wait around to make lowball offers on the startups that run out of runway.
It’s one of the major reasons why venture returns in the “cleantech” market have been underwhelming. Let me point to two data points to help illustrate the problem:
- According to John Tough of Energize Ventures, the average Series C round of venture financing for energy and industrial startups in 2019 was $28M. These venture rounds rarely take a majority stake in a startup, so by rough approximation this suggests that the average Series C round post-money valuation was at least $56M. Probably higher.
- According to Mirus Capital Advisors, the median industrial technology M&A transaction size for years has been fairly consistent, ranging between $20-60M.
You don’t need to be a math wiz to see that these numbers don’t add up to a lot of good results. Of course, VCs don’t make their returns “on average”, they make most of their returns from a very few winners. But you can also see where the incumbents have been using their oligopsony (yes, it’s a real word) buying power to keep prices low by waiting until startups are vulnerable — whether on purpose or just because of their own inherent slowness.
I know of one startup from a few years back that was offering something truly industry-changing to one of these sleepy but huge markets. The solutions this startup was offering were beating the incumbents’ products in the market, and they grew their revenues up to tens of millions in annual revenues off of a handful of compelling product lines. But then the startup and their investors faced a crossroads: Either raise even more venture capital in order to multiply their product offerings ten-fold and attempt to become a new market giant themselves, or sell to one of the incumbents. The value to an incumbent should have been obvious: Whichever incumbent bought the startup would gain an innovative team, and a platform for rapid growth across a wide range of billion-dollar market segments — in other words, that kind of “strategic value” beyond the startup’s actual revenues that I mentioned above.
Instead of attempting a big venture raise, the company and their investors decided to sell. And so they talked with all of the likely acquirers. And those acquirers moved slowly. Months later, one finally put an attractive offer on the table, but then the champion for the deal got transferred to another part of the company, and the conversation got shelved. “Let’s revisit it in six months,” which of course is an eternity for a startup. Several other buyers didn’t even want to put even offers on the table, one CEO explaining that it was his policy to never pay more than $100m for an acquisition. This, for a solution that could have been worth billions for his own company, once rolled out at scale.
Eventually, the startup did get sold. But had the SPAC route been available to them back then, you have to expect that they would have gone that way instead. After all, the company was fast-growing, with significant revenues compared with many of 2020’s SPAC targets, in a very large market that is ripe for reinvention. I can only imagine what they would have been able to do in that market with hundreds of millions of capital suddenly available to them.
Hopefully this true but purposefully-vague anecdote illustrates why so many startups in the clean energy and transportation sectors are both available and interested in going public via SPAC right now. And it’s really the incumbents’ fault.
Well, this SPAC wave suddenly changes the game for them. Now these sleepy giants suddenly face challengers with deep balance sheets and a mandate to go directly at them.
The incumbents should be watching this wave with some serious concern. Even if these well-funded upstarts don’t end up taking over as new leaders in these industries, at very least the pace of change in these markets will be ramping up much more quickly. And the acquisition valuation conversations just became a LOT more difficult for them as well.
The SPAC wave shows no signs of going away soon. By slow-rolling innovators in their markets for so long, these big companies in the transportation, energy, industrial and lighting markets have now set the table for their own value destruction. Unless they start moving a lot more quickly as they see this all unfold.
So here now is the next waiting game: Which incumbents in these markets will start going on panicky buying sprees first?