2023-04-28 09:30:00 ET
Summary
- I sorted through over 400 SPACs that completed mergers (de-SPAC'd).
- While many SPAC deals were garbage, a handful are real businesses with real profits and sustainable balance sheets.
- The warrants can gain 100-500% if these better de-SPAC'd businesses are acquired under certain circumstances.
- I essentially view these securities as very cheap, long-dated lottery tickets.
- More ideas like this will be in my new Investment Group, Catalyst Hedge Investing, which just launched yesterday!
The Basic Thesis on de-SPAC Warrants
For those who hate SPAC's and maybe lost money on them in the past, let me start by saying I am with you. My general view on SPACs is that the sponsors got paid egregious fees to consummate deals that did not always make wonderful business sense. Therefore, sponsor incentives were not aligned with shareholders until they become shareholders themselves. Even then, sponsors' cost basis is often so far below that of original SPAC investors, their economic decisions going forward can still be very different.
Because of this view, I sat out the entire SPAC boom. I also thought most companies SPACs bought were garbage. That said, out of the over 400 SPACs that successfully merged with companies (de-SPAC'd), there were bound to be a handful (and I mean only a handful) of decent enterprises. I believe I found a few of them. Their deals were all consummated at prices that were way too high, but that is immaterial now. Many of these stocks have fallen 90% or more. Lower prices create some opportunities.
In some cases, de-SPACs are trading at low multiples of EBITDA. Where there isn't EBITDA, in some cases the companies command very small premiums above their net cash value. These low valuations make some companies takeover targets.
Many of these stocks trade around $1 or below, essentially making them options themselves. If one thinks they are buyout candidates, playing the stocks could lead to gains of 50-100% if not higher. However, a quirk in the structure of de-SPAC warrants makes those securities extremely cheap long-term options that can pay off even more on a buyout of the underlying company.
How Do De-SPAC Warrants Work?
SPACs issue warrants during their IPO's as incentives for participating shareholders. SPACs usually IPO at $10. The warrants' strike price is usually $11.50. That means the warrants have no intrinsic value until the shares rise above $11.50. That does not mean, however, they have no value at all. Warrants are long-term call options issued by companies. Their value is determined by the underlying share price and volatility and the amount of time until expiry. There is also a mechanism if the SPAC is acquired. This mechanism is where stuff gets interesting.
Many de-SPAC warrants have provisions to protect holders if the company is acquired far below the strike price. The standard language says that if a de-SPAC'd company is acquired for 30% cash or more, the warrant must be redeemed. The formula used to value the warrants for redemption is what leads to large potential gains even if the stock is acquired well below the warrants' strike price. Let's look at an example.
Innovid ( CTV ) trades at ~$1/share as of this writing (April 26th). It has:
Market Cap (@ $1/share) | $137 million |
Debt | $22 million |
Cash | $47.5 million |
Enterprise Value | $111.6 million |
The company provides Nielsen-like ratings for streaming services. It should be profitable this year and growing from there. I can easily see this company as an acquisition target. The warrants ( CTV.WS ) trade at $.08.
Below is the warrant valuation as of today. Notice the red circles around the underlying stock price, the warrants and the volatility used (the volatility of the warrants).
CTV Current Warrant Valuation (Bloomberg)
Here's where it gets interesting. Let's say CTV gets acquired for $1.50/share. You would use the higher underlying stock price, but instead of using the warrant's volatility, you plug in the 90-day volatility of the underlying stock . In this case, it 106% instead of 68%.
Using those numbers, the warrants gain nearly 400% to $.38.
CTV Warrant Valuation in a Buyout (Bloomberg)
So while the stock is nice win at 50%, it pales in comparison to gains available on the warrants. The gains grow the higher the stock take out price is.
CTV is just one example of the gains that are possible from this strategy. I have over ten others. I do not expect every one of them to pay off. To be clear, I have no idea if any of them will be acquired. But I think a portfolio of these types of warrants stands a decent chance of paying off handsomely. If one or two of a portfolio hit, it's probably enough to get you even. They give a holder plenty to time to wait as well. The warrants I have chosen are all fairly long-dated. These CTV warrants don't expire until 12/31/27; that's over 4.5 years.
Risk
The main risk is that nothing happens with this company and the warrants expire worthless. The good news is that you have a lot of time before that happens. Of course, there is also risk that this company deteriorates operationally and eventually goes bankrupt. Like I said, CTV should be profitable this year and is net cash.
There is also risk that the company gets acquired for stock rather than cash, in which case your warrants are convertible into the new stock. That is likely to be a positive even for the warrants but not a guarantee.
Conclusion
I think a portfolio of warrants such as these is a low risk/high reward strategy. The trick is finding companies with real businesses and capital structures as well as valuations that make them potential buyout candidates. CTV is a good example.
Write ups on more warrants with more detail on the issuing companies are available now in my investment group Catalyst Hedge Investing. I will be adding more there in the coming days.
Join Catalyst Hedge Investing
My new investment group, Catalyst Hedge Investing , launched yesterday. Most of my best ideas including more of these de-SPAC'd warrants will remain private for my subscribers as will live portfolio of longs and shorts, an active chat board and direct access to me. There are generous introductory prices for early subscribers that will continue for the life of your subscription. I hope to see you as a subscriber and thank you for following my work.
For further details see:
De-SPAC Warrants Primer: Digging Through The Wreckage, Unearthing Gems Like Innovid