Why the 'trillion-dollar' markets touted by SPAC startups don't always add up

• The booming SPAC market has been spooked by the acting SEC director's recent hints that new rules could be on the way.
• The financial forecasts used by companies going public through SPACs could come under scrutiny.
• A close look at the so-called Total Addressable Market estimates used by companies involved in SPACs shows why caution is advised.

Last week John Coates, the Harvard academic who is acting director of the Securities and Exchange Commission's division of corporate finance, caused a kerfuffle in the world of SPACs.

In a highly readable (really!) treatise on blank-check companies, as special-purpose acquisition companies are also known, Coates issued a warning to the investment bankers, lawyers, entrepreneurs, part-time board members, and other charlatans exploiting the trend. Plenty could go wrong, he said, when those who raise SPAC funds then buy a company. He ticked off a list of concerns from conflicts of interest to celebrity involvement to the potential ordinary investors being lured by "baseless hype."

Coates focused on the use of financial projections in SPAC deals. Because a SPAC buying a target technically is a merger, not an IPO, most have assumed it's okay to ignore IPO rules, which prohibit financial projections that could be used to bamboozle investors. Coates cautioned SPAC sponsors against becoming too comfortable with this loophole-and suggested the SEC might make rules to clarify matters.

The SEC official didn't give specific examples of "baseless hype," but he might have mentioned the way companies describe the market opportunity in front of them. SPAC after SPAC, in presentations to investors, describe the "total addressable market" they are attacking. The implication is that even if they have little or no business today their potential is huge.

Like the financial projections that worry the SEC, these market-size estimates - nearly always rosy and often far out into the future - ought to give pause to investors. SPACs tend to buy unproven companies, like flying car manufacturers and space "infrastructure" companies. (If they were proven, the companies likely would go the more respectable IPO route.) Because investors can't possibly know what these startups might become, the potential market size estimates are important for making an investment decision.

Flying car companies are particularly good at this cheerful prognostication. Three have announced plans to become SPACs so far. Two, Archer Aviation and Lilium, say their market could be as big as $3 trillion by 2040. Both based their guesstimate on the same 2018 Morgan Stanley research report by analyst Adam Jonas. The far-into-the-future estimate applies a kitchen-sink approach to market sizing by including revenue projections for several industries, including airlines, cargo, ride-hailing, and "key accelerants" like batteries, communications equipment, and software.

I asked Morgan Stanley for a copy of the Dec., 2018, Jonas report, "Flying Cars: Investment Implications of Autonomous Urban Air Mobility," so I could dig into the assumptions Archer and Lilium are relying on. A Morgan Stanley spokeswoman said "we decline at this time, due to this report being outdated." Good point, though one wonders why it's good enough for companies about to include average investors as their shareholders.

Joby Aviation, another flying car company has a more modest, but also aggressive estimate of its potential market. It told investors it saw a $500 billion addressable market in the US alone and a global market of "north of $1 trillion." Joby didn't cite a date by which this market will appear. But it did source its estimate to another 2018 study, this one by tech consultant Booz, Allen, Hamilton.

That study, prepared for NASA, is available online. A summary notes that the US prognostication is "for a fully unconstrained scenario" and that factors like weather, certification, regulatory hurdles, and public perception could reduce its near-term estimate to 0.5% of the total, or $2.5 billion. As it happens, the BoozAllen consultant who wrote the report, Rohit Goyal, now works in "product intelligence" for Joby, according to his LinkedIn profile. Investors might do well to ask him about the report's assumptions.

Let's be clear about something: Making a guess at the total size of a potential market is a valuable exercise for investors. The late Don Valentine, a founder of Sequoia Capital, was famous for paying attention to the size of the market opportunity to the exclusion of all else. But he was making risky venture-capital bets. Lise Buyer, an advisor to companies that go public, and a fund manager, research analyst and VC at various stages of her career, told me it's "totally legit for investors to ask what's the biggest the market could be if everything goes right. But I think they will roll their eyes when the numbers get too big."

Or at least they ought to.

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In other news:

While I have you, I'd like to recommend a fine book that reflects badly on big business. It's called "Death in Mud Lick: A Coal Country Fight against the Drug Companies that Delivered Opioid Epidemic", by the Pulitzer-prize winning West Virginia investigative journalist Eric Eyre.

There are plenty of good books about the opioid scourge, including Beth Macy's "Dopesick" and the just-out and rapturously reviewed Sackler family takedown "Empires of Pain" by Patrick Radden Keefe. Eyre's book focuses on the role of the big drug distributors - Cardinal Health, McKesson, and AmerisourceBergen - in pushing pills for years that led to an overdose epidemic. Each of these companies is locked in multi-state litigation to resolve the type of allegations Eyre details. CEOs of each, for what it's worth, signed the Business Roundtable's 2019 statement of purpose, which, among other things, promises to "respect the people in our communities and protect the environment by embracing sustainable practices across our businesses." After reading this book you'll be hard pressed to judge their actions respectful or sustainable.

I planned to write an entire column on hollow corporate statements and how they relate to the current climate of corporate activism and political awareness. But the lead editorial in the current issue of The Economist published a perfect distillation of what I wanted to say. So instead, I'll link to it here.

Adam Lashinsky is a Business Insider contributor and former executive editor at Fortune magazine, where he spent 19 years. He is the author of two books: "Inside Apple" (about Apple) and "Wild Ride" (about Uber).