Podcast: What Are SPACs—And Why Are They Important To A&D?

Investors are putting billions into urban air mobility and space projects, hoping to strike the next Tesla. Listen in as Aviation Week editors discuss the trend.

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Below is a rush transcript of Aviation Week’s February 12, 2021, Check 6 podcast.

Joseph Anselmo:        What is a SPAC and why are they all the rage? Welcome to this week's Check 6 podcast. I'm Joe Anselmo, editorial director of the Aviation Week Network. If you're not in the business world, you're forgiven for not knowing the answer. SPAC stands for Special Purpose Acquisition Company, and they are the new rage on Wall Street, including in aviation and aerospace.

Urban air mobility startup Archer has agreed to merge with a SPAC in a deal to raise up to $1.1 billion to fund commercialization of the company's all-electric air taxi. The transaction includes orders from United Airlines. Smallsat startup Astra, fresh off finally achieving a successful test launch, is going public after a takeover by a SPAC backed by telecom veteran Craig McCaw. And former Boeing CEO Dennis Muilenburg is teaming up with Air Finance founder Kirsten Touw to launch a new SPAC that will focus on transformational technologies.

And those developments were all announced in just the last 10 days! More than a dozen SPACs have made acquisitions or are looking to do so, the most famous being the taking public Virgin Galactic in 2019. So how do SPACs work and why are investors putting billions of dollars into them? Here to explain is Aviation Week Senior Business editor Michael Bruno, who has been reporting on the trend. Also joining us is Executive Editor for Technology Graham Warwick, who closely follows the emerging UAM industry and reported on the Archer-United development two days ago. Michael, let's start with you. What's a Special Purpose Acquisition Company, and how does it work?

Michael Bruno:           Thanks Joe. It's no fun unless you say the word SPAC, you’ve got to say SPAC, and you’ve got to say it with enthusiasm because that's what's happening right now on Wall Street. So SPACs are sometimes referred to as blank check companies or shell companies or even holding companies. But what makes them so interesting is that they exist for one purpose, which is to buy other companies and immediately take those companies public if they weren't public already, but to take them public under the guise of the SPAC. And this is sometimes referred to as a reverse merger.

                                   SPACs have been around for decades, but they've become popular in the past couple of years, specifically since 2019 for a couple of macroeconomic reasons. One of which is just, there is a ton of cheap, easily available cash out there in the world. Investment bankers and retail investors alike have access to monies that they didn't have even just a few years ago because federal reserve banks are keeping rates low. And everybody with all this cash to spend is looking for some kind of return on that investment. So SPACs are just another way to go public.

                                   We're seeing a lot more interest in aerospace and defense specifically since the Virgin Galactic SPAC happened in late 2019 for a couple of really interesting reasons. One of which is everybody when they're looking for a long-term investment such as a public company, assuming that you're kind of a buy and hold investor, you're looking for something that has a pretty good chance of growing. And if you set COVID-19 aside for a moment, the long-term trends of aerospace and defense look solid. I was just listening to a couple of conferences this week, the Pacific Northwest Aviation Association. Everybody believes the long-term growth prospects in commercial aviation are solid, the rising middle classes around the world, they want to travel, when they have extra money they spend it on an airline ticket. Defense budgets very well may flatten in the next few years, but overall global threats are rising and governments worldwide, ones we're allied with and ones we're opposed with, everybody’s spending more money on their national defense and homeland security. So long story short, you've got rising budgets and rising growth trends expected across A&D.

                                    A couple of other things to keep in mind why A&D is gaining more attention. A&D is kind of what financial investors refer to as a barbell kind of an industry. You've got a small group of large players on one end, we call them the OEMs and the large defense primes. And then there's kind of a small group of middle tier players. And then on the other end of this barbell, this bulge of Tier Two, Tier Three, Tier Four, several small mom and pop operations. And when you're an investor, you see that barbell of the Tier Two, Tier Three, Tier Four and beyond, and you look at them as a very fragmented marketplace and fragmented means there isn't a very strong player there. And if you're able to buy up one or two or 10 of them, you can make a big player almost overnight if you put them together. And so SPACs get attracted to that possibility for building a company.

Finally, the last thing to say, that's really interesting going on these days and it's best exemplified by Dennis Mueilenburg. There's a plethora of A&D executives who are available to help out with a SPAC. I'm talking about the former chief executive of Boeing is now out there and able to help some other investors go decide what companies to buy and who to put together. So there's a couple of other reasons but those are the big ones, and those are why we're seeing a lot of SPAC activity now in A&D.

Joseph Anselmo:        Well speaking about a lot of activity, Graham Warwick, there seems to be a heck of a lot of SPACs in the UAM market, including this Archer deal that was just announced this week. Why is that?

Graham Warwick:       Well yeah, it's interesting because I had to ask the question when I started writing the Archer story, what is a SPAC? And the thing that got me about Archer was, for starters it gives them a lot of cash, $1.1 billion in cash, which is kind of around the figure that most people thinks it will take to develop and certify an eVTOL taxi. So this kind of gets them into the market in one go, if you're going to say. But what really interested me was Archer's only been around for a couple of years. They've built some subscale models, they have not built a full scale vehicle, they will do that this year. So you look at well, why would a company that hasn't actually done anything raise that amount of money and be valued at somewhere around about $2.7 billion?

                                    Well, it turns out when you start to dig into this is that as Michael explained, there's a lot of cash around and a lot of investors missed out when they missed out with Space X, they missed out with Tesla. They may even have missed out before that with Apple and Amazon and whatever, they just didn't get on to a transformational business model. So what I'm hearing is that a lot of people are looking at advanced air mobility, urban air mobility, advanced mobility as a potentially transformational technology. And a lot of these investors want to in early, because they do not want to miss the opportunity to like they did with Space X and Tesla. So what you've seen is that here the first one that was done in this area was BLADE, which is the helicopter operator in New York. And of course, BLADE wants to become an urban air mobility operator long-term flying these eVTOL air taxis. So it was the first to go.

                                    Now we have Archer and there are reports which are probably fairly reliable around Joby Aviation looking at a SPAC and Lilium in Germany looking at a SPAC. And there may be others as well as a lot of these eVTOL companies have got to a point where they need another big tranche of money to get to certification, production, so there's probably a lot of these talks going on. But fundamentally it appears to be as Michael says, with interest rates low people are looking for places to put their money, which will give them growth, but also give them that growth by being in on the ground floor of something they think is going to be transformational.

                                   And the example that was given to me was Tesla, because literally in the past year or two, we've seen this massive, massive shift in the automotive market where all the traditional automotive manufacturers have said, ‘We're getting out of internal combustion we're going to electric vehicles.’  So all of a sudden, if you were in Tesla at the beginning, you are way ahead of anybody else in a mega trend that is just going to transform transportation. So these folks look at urban air mobility, they look at the players, they look at who's sniffing around and they think, okay, this looks like it could be something let's jump on it.

Joseph Anselmo:        I'm old enough to remember the dot-com boom at the end of the '90s and Michael and I 20 years ago actually worked together covering that boom and bust. It seems to me that there's a lot of money being thrown at unproven things, there's going to be some people that get burned in this. No Michael?

Michael Bruno:           Yeah, there will be people who get burned in it, but you know, that's capitalism and that's how the system is supposed to work. One thing to remember about SPACs is the word may be new and the headlines may be eye-catching, but the model for investment is age old. This is private equity by another name, this is what private equity does. They are investors who have a lot of available cash who are looking for good ways to allocate that capital in the hopes that one or two of their big investment turns out to be a category killer, the Space X, the Tesla, the Apple, the Microsoft, or something of the future. And so SPACs as a model for doing this investment may be relatively new, but that method of trying to the next thing on the horizon that's big.

                                    Even though you individual investors may lose money, many of the big players, well I would say all of the big players when it comes to SPAC know this, because they're very familiar with that private equity like model. The thing to keep in mind is if you are a journalist who's investing on the weekends or a mom and pop retail investor using Reddit or something like that and you're putting some of your funds into these publicly traded SPACs. You may have less of an ability to waste that money than the big investors who are behind some of these companies like Archer and, and maybe Joby. So smaller people are going to get burned as smaller people always do, the larger investors they know they're taking a risk.

Graham Warwick:       Yeah. So I think the risk at the moment, that the thing that's concerning at the moment, is the valuations behind it,  they're rapidly rising. I mean you see Archer valued at, this values it at $2.7 billion. Joby's SPAC what they're talking about or what's been reported, the valuation is $5 billion. These are huge valuations, and I mean there's a general agreement that these are over-valued at the moment. But that's again, as Michael says, that's capitalism, that's how this market works. So there will be some sort of correction I suspect at some point. But one of the really interesting things that was explained to me was that the thing about SPACs is, as Michael said, it's the retail investor, but it's actually, the institutional investors are doing this as well.

                                   These are people who really know what they're doing, they're investing for the long term, but they're using this mechanism to get into these companies early on. And actually one really interesting point that was made to me, was it, and I have to go a little bit sideways here. So about a couple of years ago, we've all talked about Will Roper at the Air Force, who was this kind of disruptive acquisition guy at the Air Force. And he introduced this concept what they now call Agility Prime, which was an effort to early engagement with the advanced air mobility market. And Roper's stated intent was to avoid what happened with the drone market, which is where everybody in the U.S. ignored the drone market and it went overseas. So now the Chinese dominate the drone market.

                                   They started to look at the urban air mobility, advanced air mobility market and Roper and his folks said if we don't show early engagement, the same thing will happen. And the point that was made to me was if it wasn't for the SPACs, we might be in a situation where outside investors from outside the U.S. would be buying these properties up these sovereign funds from other countries that want to invest in these things. And the point that was made to me was actually SPACs are doing a really good thing for the U.S. industry because they are investing in U.S. companies. They're keeping the industry here and it, I mean, it's the same in Germany and other places like that. It's keeping the industries where they are and allowing that industry to grow domestically, rather than just wither on the vine, which we've done so many times in aerospace and it moves somewhere else.

Joseph Anselmo:        So Graham, I got to ask you about this Archer deal that you reported on this week, because someone asked me, ‘United is ordering air taxis, what's an airline doing buying air taxis?’

Michael Bruno:           Yeah. We'll see if those orders are real or not.

Graham Warwick:       Yes, yes, yes, yes. Anybody who's been in the aircraft industry for as long as we all have been, know that orders are orders are orders are orders, right. They come in so many different colors, so United, I went to United, I said, ‘Are these what we call orders?’ And they said, ‘You can think of them as orders, but they're contingent on Archer developing an airplane, getting certified that airplane meeting the goals.’ But as we get closer and closer to urban air mobility being a real thing, it does raise this issue of who's going to operate them, who's going to use them. And to be honest, the first markets that present themselves are the existing helicopter-style markets, which is airport shuttles. And so airport shuttles are going to probably be one of the first markets that do this.

                                   And so if you're an airport, which a lot of airports have already got engaged with the eVTOL makers. Or if you're an airline and you're taking a holistic view of transportation, which increasingly everybody is, then you probably want to have your foot in that because at some point or other your high-value customers, your business traveler, your frequent business traveler is going to use that mechanism to get to the airport or from the airport. He or she may even start to look at, as the technology develops, look at it as an alternative to hopping between airports or something like that.

                                    So I think if you're an airline, there comes a point where you've got to engage. Now, there's going to be all sorts of gates and milestones that have to be met before we see an airline operating these things. But I’ll bet you we will see the equivalent of code sharing, if you want to call it that. Between an eVTOL UAM operator and an airline, you'll go up to that air taxi in Manhattan and your ticket will say United or something like that. And it'll be a seamless service. So I think that's what's happening, they're just reaching out early.

Michael Bruno:           There's one other thing I want to add onto what Graham's saying, and in his coverage of the Archer story in the magazine Aviation Week & Space Technology, he points this out. But if you look at the SPAC deal for Archer, there's very much a great example of how SPACs are working in a way that typical investment, even venture capital investment in aerospace and defense hasn't before. And what I'm referring to is the fact that in the Archer SPAC, you've got United, you've got Stellantis, and you've got this billionaire investment banker Ken Moelis, all coming together to back this UAM project.

                                    And when it comes to typical investments before you'd get corporate venture capital from maybe Lockheed or Boeing, or you might get some venture capitalists from Silicon Valley to come together. Or of course you'd get other strategics in the A&D industry to buy up some other company. But what SPACs are doing are, pardon the pun, but they're democratizing the ability for these new aerospace and defense companies to get invested in a way that brings in new investment and new partnerships that are going to help them get started far quicker than companies typically have in the A&D industry.

Graham Warwick:       And I think that's another important part of this, and Michael, did talk to this when he said that a lot of these SPACs are trying to assemble multiple pieces, to create a new mid-tier defense player or something like that. One of the things about the UAM SPACs and that's really unique about UAM, is that most of the players in UAM, are looking at being manufacturers and operators. So you have two revenue streams, you have the revenue stream in building the vehicle and probably selling that to, this is specifically how Archer's going to do it. They're going to build the vehicle, they're going to sell it to outside customers, but they're also going to operate their own service. So you have two different revenue streams. And so the way it was explained to me is that SPACs are looking for what they call full stack businesses-

Michael Bruno:           They would also call it vertical integration.

Graham Warwick:       Right. So where you've got these different revenue streams that are complimentary. So, and actually Archer in their presentation, the guy used the example of SpaceX. He said, SpaceX wants to go to Mars, but what will pay for SpaceX to go to Mars? Is it satellites? It's satellite network, I forget what it's called now, but it's broadband satellite, that's right, will generate the revenues that allow SpaceX to spend the money to go to Mars. And it's that kind of integration that UAM offers. If you're looking to put money in it, they're saying I will build vehicles, but I'm also going to operate this. I may ultimately also own the system that allows it to happen, or the air space. They're all these pieces you could bring together specifically in UAM, because it is creating a new market that you can actually own all the pieces or a large number of those pieces. Unlike a traditional aerospace market where somebody already got that piece over there and somebody already got that piece over there.

Joseph Anselmo:        So unfortunately, we're going to have to wrap things up, but I want, thank you two guys. It's so nice not to be talking about COVID and instead talking about a bright future and some really cool stuff that's going on. I'm sure you guys are going to keep writing about this. We'll be back to talk about it again on a future podcast as well. But for now that's a wrap for this week's Check 6, now available for download on iTunes, Stitcher, Google Play, and Spotify. Special thanks to our producer in Washington, D.C., Donna Thomas. And in three days, on February the 15th, we'll be posting a special podcast on the new Air Force One, moderated by Aviation Week Defense Editor, Steve Trimble. Be sure to be on the lookout for it. Have a great weekend and stay safe.