The “S” in SPAC Stands for Special
EXIT ROUTE ALTERNATIVES IN EARLY STAGE CPG — ACQUISITION, IPO OR SPAC?
By Rachel League
Historically, venture-backed consumer brands seeking a path to exit had one reliable option: sale to a legacy conglomerate looking to boost its brand portfolio. However, with several high-profile, failed M&A attempts (such as P&G’s takeover of Billies and Edgewell Personal Care Co.’s acquisition of Harry’s) and public valuations at an all-time high, attention shifted to alternative exit paths. Harbinger has watched with genuine curiosity over the past two years as an unprecedented number of relatively young VC-backed consumer companies went public through IPOs or SPACs seeking to access super-premium, tech-like multiples on tech-upgraded but relatively analog consumer concepts. This was either out of necessity (an attempt to outgrow multiple rounds of inflated equity financings) or to access what looked like material private to public valuation arbitrage. We are familiar with both concepts: for years in the private market, Harbinger has operated under the philosophy that applying tech principals and underwriting to consumer product companies leads to over-capitalization, over-valuation, reduction in optionality and ultimately, depressed risk-adjusted returns. We’ve also been the beneficiary of market inefficiency in our opportunity set that allows us to buy at slightly below market multiples and sell at a premium after we’ve scaled and professionalized our investments. It’s a valuable upside driver.
As we watched SPACs launch with celebrity endorsements and consumer product companies try to reposition themselves as tech-enabled to drive up valuations, it felt familiar. As we saw later stage investors chase multiple expansion that existed in the private to public spread, we recognized that strategy. We couldn’t help but wonder — how will this play out? Will investor enthusiasm for growth sustain what increasingly looked like private to public market arbitrage, perhaps giving us even more upside? Would this make an IPO an increasingly probable and rational outcome — even for our relatively small companies?
The short answer is no — on an absolute and risk-adjusted basis, the thesis did not hold up under sustained public scrutiny.
For more detail, read on.
INITIAL PUBLIC OFFERINGS
This last year was a monumental period for public offerings volume, with +1,000 IPOs raising +$316bn, beating the 1994 dot.com boom record. It was also a record year for consumer. Some of the most recognizable and relevant venture-backed consumer brands that made their public debut in 2021 include Winc, Warby Parker, Oatly, The Honest Company, Sweetgreen, FIGS, Rent The Runway, and Allbirds. The record number of exits last year reflect the cyclical nature of venture capital, the appetite of VCs to take advantage of strong valuations, and — in Harbinger’s opinion — potentially the lack of other alternatives.
Of this list, the names that initially fared best often shared two common threads. First, they emphasized their tech-related aspects, filling their S-1’s with buzzwords like “DTC,” “tech-enabled,” and “digitally native” guiding investors towards more premium multiples. And second, they created their own profitability metrics designed to distract from the fact the businesses were not generating actual earnings. Sweetgreen noted in their S-1:
“We are one of a select few restaurants designed with technology as the basis for all elements of our operations. Many restaurants were built on antiquated technology, and while they have tried to slowly adapt, we believe they are at a fundamental disadvantage given their large legacy footprints and historical underinvestment…. To date, we have not achieved profitability in any fiscal period, in large part because we have consciously invested in our operating and technology foundation. We believe this foundation has positioned us to achieve the above growth strategies, while also implementing restaurant-level efficiencies (such as enhanced labor management, automation and optimal store layouts) and economies of scale in our supply chain. We expect strategic investments in these key areas to result in strong AUV growth and an expansion of our Restaurant-Level Profit Margin.”
Through one lens, we suppose the strategy worked — if you only measure success based on initial list price and capital raised. However, after several quarters of public scrutiny, euphoric public investor sentiment sobered up and valuations corrected to better reflect these brands fundamentals and true comps. This has resulted in some less than successful outcomes for consumer IPOs measured over 12 months, or shorter.
We are not surprised. With smaller TAMs and relatively asset-intensive business models, consumer brands will always ultimately be held accountable to the standard of earnings growth in addition to revenue growth of consumer peers. This is hard for a relatively small company without the sponsorship or benefit of strategic resources. As these young brands seek additional growth — beyond early adopters or US markets — the relative benefit of their initial proprietary advantage often becomes less pronounced while the relative disadvantage of lack of scale or infrastructure becomes more pronounced. To tie back to the above quote — Sweetgreen’s integrated digital backbone offers diminishing returns as the complexity of optimizing for “restaurant level efficiencies” like labor management and store layout become more complex, more urgent, and analog. Retail is detail. As further evidence — companies struggling with profitability (The Honest Company, Allbirds, and Rent the Runway, to name a few), have seen meaningful declines in their valuations.
Finally, it’s worth noting worst case outcomes, such as Casper, which listed on the NYSE exchange in February 2020 at a $575mm valuation, and after +70% decrease in share price value, delisted via an acquisition 18 months later.
When does a public offering make sense for a consumer brand? To our young brands, we often warn of underestimating legacy competitors who may lag on innovation and look sluggish on growth but are excellent operators. It may not be a winning strategy, but it’s a resilient one. Our belief, therefore, is that a consumer brand is a quality IPO candidate when it has the scale, commercial model, and leadership team to deliver both above average growth and quality earnings consistently. This likely occurs beyond our base-case underwriting where we expect to steward a brand to $50–75M in net revenue, supporting terminal values of $150–200M. As a result, an IPO will remain an outlier in our investment thesis and underwriting. Furthermore, should we seek an IPO, we must be prepared and able to absorb substantial downside volatility as the market determines an efficient price during our lock up period.
SPECIAL PURPOSE ACQUISITION CORPS (SPACs)
We also followed closely the acronym on everyone’s lips: SPACs. Part of what potentially made SPACs appealing to earlier stage businesses is that they provide the same ability to raise meaningful capital and increase brand exposure as IPOs, but they are faster, cheaper, and require less disclosures and scrutiny around forward-looking projections.
The sheer number of SPACs that came to market in 2021 was staggering — over 600 new blank check companies. To increase visibility, differentiation, and access, SPAC sponsors turned to marketing tactics we at Harbinger know well — partnerships and celebrity endorsements. The performance outcome of SPACs with and without a celebrity and / or with and without an experienced sponsor is a picture-perfect illustration of a Harbinger philosophy. The best outcomes are built off a strong, balanced, cross-functional platform where great marketing is supported by great operations and grounded in great culture. The SEC took the words out of our mouths: “It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.” Further reinforcing our view that investors with value-add insights (such as Harbinger) are more likely to steward their portfolios to success, Wolfe Research published data that the key ingredient to a successful SPAC is having a sponsor with experience in the target company’s industry.
Our key SPAC takeaways include:
(1) Generally, this is a very low probability outcome in consumer based on volume alone — there were only 15 consumer products & services De-SPACs in 2021.
(2) The incentive structure can create deep misalignment resulting in hidden risks and costs. The sponsor’s bias for execution versus precision, combined with a bloated SPAC share price pre-merger, can create material downside volatility that is most damaging to early shareholders. This risk must be priced in when considering a SPAC.
(3) While a SPAC is seductively pitched as a short cut to IPO — which it may be — it is not a short cut for long term value creation. As one expert notes, “you can go public through SPAC, but then the real work starts…managing the business to the expectation of your new stakeholders is very important.” What has become clear is that most SPAC targets were not mature enough to be in the public eye.
(4) As a result, despite 600+ SPACs raised, SPACs — as memorialized in the name — are ‘special’ purpose vehicles that unlock value only in rare circumstances where the company is mature enough to be a public company but also benefits substantially (net of the dilution) from an accelerated process. In our opinion, it is not a viable or attractive path to liquidity for the vast majority of our consumer companies for the same reasons listed above in the IPO discussion.
To sum up our review, IPOs or SPACs do represent exit opportunities for our companies in rare circumstances where (a) the management team and company are mature enough to set and then deliver against expectations that create long-term shareholder value, (b) the experience and commitment from stakeholders and shareholders around the table result in a fair price for a premium asset, and (c ) the almost inevitable downside volatility is priced into Harbinger’s returns expectations and timelines. While we’ll never say never, neither of these outcomes are represented in our base case underwriting. We value and capitalize our businesses to preserve multiple paths to exit, protecting our investments against a need-driven IPO of last resort and instead reserving this avenue for outlier or upside cases. Which brings us to our final thoughts.
THE CONCLUSION: BACK TO THE TRIED-AND-TRUE M&A
Although less glamorized than public market offerings, we still believe M&A remains the most likely path to a successful exit for earlier stage consumer brands, particularly those in Harbinger’s portfolio. Legacy brands continue to seek to acquire innovation rather than invest in R&D, supporting our confident view of the strength of the buyer universe for consumer companies.
As it relates to valuation, multiples have remained largely consistent with some upside favorability. What has changed is the correlation between quality and valuation. Strategics are getting smarter and more selective in underwriting challenger brand acquisitions — scrutinizing losses, demanding greater scale, not overpaying for digital capabilities, etc. — and as a result, auction processes are receiving lower volume but better qualified participation from strategics. This has implications on preparation prior to an exit — an area we consider critical in our value-add partnership model.
What could have been an unfavorable shift in auction dynamics seems to be offset by significantly greater participation from financials sponsors. Sponsor to sponsor trades — at our stage and in our opportunity set — even 5 years ago likely represented a discounted value relative to a strategic exit. Today, financial sponsors are increasingly competitive. They have substantial capital to deploy, increasingly appreciate and value the stability consumer may offer and have the appetite to steward a young brand to maturity before IPOing or selling to a strategic themselves. This later stage capital overhang has been valuable in protecting our favored and favorable path to exit through M&A.
In sum, Harbinger strives to partner with consumer companies capable of rapid, but capital efficient growth in categories that are significant and relevant to multiple potential buyers. We invest early at valuations that protect alignment and multiple paths to exit. As a firm that has a strong operational bias, we collaborate with our teams to create a balanced growth strategy that builds a durable business, supported by a powerful brand, and led by an entrepreneurial but professional team. If we accomplish that, we have choices at exit that allow us to maximize shareholder value and long-term business outcomes without exposing ourselves to substantial risk at exit.
 Piper Sandler.
 Sample index includes Oatly, Honest, Laird Superfoods, and Sweetgreen. Sweetgreen reflects multiple at IPO (11/18/21) and 2/22/22 for H1’21 and H2’21, respectively.
 Sample index includes Bark and Vintage Wine Estates.
 Compared to true consumer tech or FANG stocks.
 Google Finance.
 Retail Dive: on average, executed on a 2–4-month shorter timeline than IPOs; on average fees are ~150bps lower than an IPO.
 White & Case.
 Matthew Katz, managing partner at SSA & Company.