Shock Bankruptcy Shows The Dark Side Of Tech SPACs

The stock market remains in a funk, yet the cause is not what most investors believe. A valuation bubble is bursting and sadly, this process is far from over.

Enjoy Technology (ENJY) announced Thursday that the retail startup will file for chapter 11 bankruptcy, only nine months after shares were listed via a special purpose acquisition company merger.

Another SPAC bites the dust. More to follow.

During the height of the pandemic two years ago SPACs were all the rage. The entire global economy was shuttered and so-called blank check companies seemed to offer exciting growth prospects. Sadly, the promise was never real.

Traditionally, companies have earned public listings years after toiling in venture capital hell. Startups are forced to raise several rounds of funding to stem the tide of red ink as executives grow the business toward profitability. The initial public offering is the reward for management success. It also a sign that Wall Street investment bankers are willing to vouch for the credibility of the underlying enterprise.

The opposite is true for most SPACs.

The structure of SPACs circumvents vetting. A stock promoter/financier files for a public listing on a major exchange. The goal is to side-step Securities and Exchange Commission filings requirements by holding only cash. A direct listing occurs when this blank check company merges with an ongoing concern. There is no underwriter. Nobody at all is performing due diligence on behalf of investors.

During 2020 and 2021 there were 248 and 613 SPAC deals, respectively. Many immature companies were being rushed to the public market with little more than an idea and a sales pitch. Investors should not be surprised the process ended poorly. It was all a scam.

Speaking with Bloomberg Technology one year ago, Ron Johnson, chief executive at Enjoy, told a different story. The former Apple (AAPL) executive claimed that Enjoy had clear visibility to profitability. And documents filed with the SEC projected net earnings by 2023, and $1 billion in sales two years later.

It was always a tough ask.

The business of Palo Alto, Calif.-based company was delivering mobile phones on behalf of AT&T (T), British Telecom, Rogers Communications (RCI), and Apple, then having Enjoy agents upsell additional products or services. The model was never profitable. Through the end of 2021 gross margins settled in the red at -34.5%, with losses of $158 million.

Still, Enjoy managed in October 2021 to raise $250 million through its SPAC merger with Marquee Raine Acquisition Corp. The transaction valued the money-losing company at $1.2 billion. Nine months later the company is filing for bankruptcy.

Sadly, many other SPACs are headed down a similar path. Bloomberg noted in June that 65 of these companies will need to raise more capital within the next year simply to keep the lights on. Of the 613 SPACs listed in 2021, 78 now trade at $2 per share or less. Twenty-five of these are trading at less than $1, the threshold to maintain a listing on the Nasdaq stock exchange.

Collaborative Investment Series Trust (DSPC) is an exchange traded fund that tracks SPACs. The ETF is down 67.7% year-to-date, and 78% over the past 12 months.

The valuation bubble has burst.

Wall Street investment dealers and TV talking heads blame the SEC for investor losses, however that is like blaming the cops for crime. It’s smarter to follow the money. Many SPACs never should have become publicly listed firms. Wall Street, financiers and greedy executives exploited a loophole to push these stocks to unwary investors. The financial press breathed life into SPACs with breathless stories about surging prices.

The story of Enjoy Technology is a tough, yet vitally important lesson for investors. Valuations matter, especially with unprofitable businesses. Many SPACs are never coming back.

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