Rocket Lab SPAC

Vector Acquisition Corporation (VACQ) is a SPAC that has an agreement to merge with Rocket Lab.

Rocket Lab is SpaceX’s number one private competitor, but it has several competitive disadvantages. One is that Rocket Lab’s product offerings do not include heavy launches. The other is that their rockets do not land by themselves (although they are reusable to a certain extent).

As such they are receiving a valuation of much less than SpaceX’s private placement valuation (SpaceX was estimated to be around $70 billion). Rocket Lab’s enterprise value was estimated to be around $4 billion.

The revenues scale accordingly – Rocket Lab estimates around $70 million in 2021, while SpaceX is reported to be around $2 billion in 2019.

Just like most SPACs, they promise a quadratic increase in revenues:

If I had a nickel for every SPAC that promised such a revenue trajectory… I’d be richer than had I invested in these SPACs!

Space launch systems are very capital intensive and there is a certain economy of scale that is required to do this successfully. Blue Origin (Jeff Bezos’ firm) is another competitive in this domain (and of note, they have seemingly failed to get that point of scale). It could entirely be the case that the launch for small satellites (especially constellations of micro-satellites) is a competitive space where no firm will receive outsized profits – instead, the profitability will be through differentiation and also cost controls (SpaceX’s landable rockets would likely give them a cost edge over competitors at present). The differentiation will most certainly be with maximum launch capacity – there is only so much you can do with weight limitations on satellites.

The other component of competitive advantage in space is government relations. They are a significant source of revenue, especially in the military domain. Nobody is better in GR than Elon Musk.

I’ll be watching this one, but at the offering price I’m not interested. SpaceX receives a premium valuation for very good reasons.

Who falls for these types of offers?

Ag Growth (TSX: AFN) sold off heavily today as a result of overall market weakness coupled with the markets not liking the fact that their costs are going to be increasing in the upcoming quarters due to the surge in steel pricing, coupled with a likely re-valuation of their technology platform. It’s not great having your top holding taking a haircut like this, but that’s how markets work – things go up and down, and this is also buffered by other things in my portfolio which take advantage of inflation.

However, what really got my attention was a tender offer from a “Sustainable Agriculture & Wellness Dividend Fund“, which will soon by listed as AGR.UN on the TSX.

They want me to flip my AFN shares in exchange for yet-to-be listed units in their fund, based off of the average trading price on June 1-3, at a par value of $10/unit.

I can only assume it was also offered to other securities they plan on holding in their fund (they list the prospective holdings on a one-pager, including companies such as Beyond Meat, Farmers Edge, Goodfood Market, Rogers Sugar, etc.).

I have stronger wording which I will not type in, but will state that this offer is highly unattractive for a few reasons. I’ll list a couple.

One is that right away, such an offering will involve a 4.5% payment to the agents, so effectively your $10 ‘value’ will be reduced to $9.55 immediately, plus another $500k in expenses associated with the offering (it costs legal fees to process partial tender requests such as these).

Assuming you were silly enough to go with it, the MER of the fund in question is 125bps.

I just shut off the prospectus from my computer screen before I wasted more mental space on it. But it was worthy of a post – who actually falls for these types of offers?

Small portfolio note

The universe of Canadian convertible debentures is ever-shrinking – there are 92 issues remaining, and three of them (Atlantic Power, Great Canadian, Yellow Pages) will be going in a month, and there are a few more that are obviously slated for rollover/maturity in the coming months after.

I’ve recently unloaded my last convertible debenture today. It is a statement on this particular market that there isn’t much point in putting capital into this when returns are so weak in relation to the apparent riches available in the equity market (of course, this could be a sign that equities are topping out!).

Junk bond yields are also at lows (ETFs include JNK, HYG). An interesting hedge here is longing puts on these in anticipation of some credit action.

My only material debt instruments I currently own are the Gran Colombia Gold notes (TSX: GCM.NT.U) which continue to happily slide into maturity (and if the underlying corporation has any financial sense whatsoever, will be called out before July 31st).

The pivot out of garbage into value

The year 2000 to 2002 was a fairly good barometer of what I think is to come with respect to these high-flying companies that populate the SaaS, ‘alternate energy’ and SPAC domains (I know SPACs are a financial characterization and do not necessarily reflect the entities that emerge from SPACs, but most of these are complete garbage reminiscent of the dot-com era of 1999-2000). There is also the market for crypto-garbage which many people in their 20’s are enamored with.

The poster child for all of the equity froth is the ARKK ETF:

There will be ups and downs, but the prevailing trend will be down as valuation eventually has to settle into the equation. Even after a major period of volatility in the spring of 2000, it took a couple years for the Nasdaq to fall roughly 75% from peak to trough before it began to recover again. Think about this – a 75% drop over 30 months.

During this same time, companies that generated real cash flows and provided economically valuable goods and services did reasonably well. Berkshire was a great example of this. Warren Buffet prior to 2000 was criticized as being behind the times, just as he is today. Once again, he is going to get his revenge:

I think Warren wants to live to see the day when Berkshire Class A shares trade for US$1,000,000 a piece. He’s accelerating the process by buying back shares. Just imagine the headlines then.

In Canada, it’s actually not that bad in terms of the froth. When dredging up a list of winners over the past year, while there are a few obvious examples of “stinkers” which I will not mention here, there are many companies which are riding the resurgence of commodities and are well positioned to generate huge amounts of cash.

A good example of this is Teck, which exists in the sweet spots of being the leading metallurgical coal producer in Canada (also go look at a chart of Stelco for an idea of how the steel market is being treated currently), coupled with having a very large copper operation that will get even larger with the completion of the QB2 project in Chile – with current commodity pricing they will be minting billions in the upcoming years.

One might be fearful that a drop in the high-flying sectors of the stock market will translate into drops in valuations of “real economy” firms. While this might occur in the short term (as portfolios inevitably will de-leverage to some degree), past experience would suggest that sentiment will flow favorably to companies that can demonstrate profitability and valuations will receive a boost accordingly, especially since the alternate is much less attractive in our very low interest rate environment.

Enbridge Line 5 – Canadian oil and gas

There appears to be a win-win situation coming for Canadian oil and gas companies.

I normally avoid politics on this site except when it intersects the financial markets, and this is one of those cases.

While publicly pooh-poohing the construction of hydrocarbon pipelines to placate their environmentalist voter base, the current federal government took actions to effectively kill the “northern gateway” pipeline and “energy east”, both of which were to provide egress from the Alberta/Saskatchewan production areas. In particular, Energy East would have solved the problem of how Ontario and Quebec could source an energy supply strictly through Canadian territory (something they are not doing presently!). Bill C-69 of the previous parliament (the enactment of the “Impact Assessment Act”) was the spike into the heart of further development, which allows the federal government to drag any development through light-years of muskeg bureaucracy for approval – unless if such a project receives its royal blessing. Indeed, it had exactly this effect.

However, our current government has also displayed some very glaring inconsistencies in their approaches to many things. I’ll leave most of it for the opposition parties to pounce on, but one of them has been the acquisition and subsequent ongoing construction of the TMX pipeline from Kinder Morgan – an opportunity for graft that even the Liberals couldn’t give up. Most people associate the TMX purchase with the expansion of the pipeline, but many less are aware there is a fully functional pipeline already in place (which, if you read Kinder Morgan Canada’s prior financial statements, generated a ton of cash flow).

To the present day, the biggest piece of hypocrisy has been the reaction to the governor of Michigan threatening to shut down Enbridge Line 5. Instead of cheering on the Michigan governor for her bold stance on reducing evil carbon emissions associated with the transportation of fossil fuels, especially in a potentially destructive manner that would spill oil inside the Great Lakes, the current government has shown grave concern for the shutdown of Line 5. Since Line 5 supplies over half of the raw fossil fuel product for Ontario and Quebec, a shutdown of this pipeline would have catastrophic economic consequences for the region.

Because of the regional effects (Alberta and Saskatchewan are a political wasteland for the Liberals and hence they will never lift a pinky finger to do anything beneficial for the region that won’t also benefit their power base of Ontario or Quebec), this is why the Liberals are screaming foul and suddenly the continued operation of an oil pipeline becomes paramount.

Enbridge said it won’t stop the pipeline unless if ordered to by a judge.

However, on the backs of everybody’s minds (especially those in Alberta and even those in Enbridge itself), I think there is a significant segment that actually want the pipeline to be shut down, at least for a month or two when it will become glaringly obvious that there is indeed a connection between the smooth functioning of hydrocarbons and people’s everyday lives.

It is an interesting political calculation – while Enbridge would lose short-term cash flow if they shut down Line 5, the pain dished on everybody (on both sides of the border – Line 5 also services a good deal of the American side’s fossil fuel needs in that region) would be quite the marketing lesson. Canadian producers as well would have to scramble to deal with the storage and transport situation (and oil-on-rail would get a temporary kick).

So what is this win-win I’m talking about?

After this debacle, it will be really difficult for the Liberal government to talk trash oil pipelines. Only the NDP and Bloc can remain ‘ideologically pure’ on the matter and maintain an opposition to it.

If there is a disruption in Line 5, Canadian oil producers will take a short-term hit, but this would be transitory. If there is no disruption on Line 5, the message is still intact – even southern Ontario and Quebec need oil to function – it’s just a question of where they’re going to get it from.

The completion of the construction of Enbridge Line 3 in Minnesota (estimated Q4-2021) and TMX (est. Q4-2022), will bode well on this front for Canadian oil. There’s still a US$13 or so differential between West Texas Intermediate and Western Canadian Select, and Canadian producers (which are already very profitable at current WTIC levels) will be able to make even more – and so will the Albertan government, which makes a pretty penny out of the royalties coming out of the oil sands.