Christopher Raby, BridgeTower Media Newswires
The paltry yields in the bond market have left many investors clamoring for more yield—and searching in nooks and crannies of the securities market to find it. Fortunately, opportunities to generate compelling returns with minimal risk still exist, if an investor is willing to hunt for them.
While we have written about investing in SPAC common shares in the past, a new opportunity has become particularly attractive: Special Purpose Acquisition Company Initial Public Offerings (IPOs).
Special Purpose Acquisition Companies, or SPACs, emerged as popular investment vehicles in the 1990s. Simply stated, a SPAC is formed for the sole purpose of effecting an acquisition. At the IPO, a SPAC would typically have a target industry in mind, but any specific target company is unknown. Investors are essentially writing a blank check to the SPAC management team to generate an accretive acquisition. As the financial crisis of 2007-08 took hold, SPACs faded away, only to reemerge with a vengeance in recent years.
During the IPO, investment bankers, seeking to lure potential investors into new SPAC IPOs, have begun to design increasingly creative and valuable packages. Each SPAC IPO comes in a varying package consisting of common shares, warrants and rights called a “unit.” When the SPAC IPO occurs, a designated amount of cash is placed in a protected trust managed by a third party. The trust is invested in short-term securities. The amount of cash in trust also varies and can often be above the selling price of the IPO. This is especially important—all SPAC IPOs come with a free “put option”— to redeem your common shares back to the company at certain points during the SPAC’s life for their pro-rata portion of the trust. A few weeks after the IPO, the units will “separate” and their individual components will be freely tradable.
The value of a SPAC unit at IPO is often inversely related to the experience of the management team. Recently, experienced management teams have sold IPO units consisting of one common share, 1/3 of a warrant and a mere $10 cash in trust (IPOs are sold at $10 per share). This package does not imply much value on its face, but investors often bet this management team will be more likely to generate an accretive acquisition.
However, due to the recent influx of new SPAC IPOs, we have seen SPACs with unproven management teams be forced to sweeten the deal to sell the IPO. Just recently, we’ve seen units sold at IPO (for $10 per share) that consist of a common share, a full warrant and $10.20 deposited in trust. Because of the free put option that comes with every SPAC IPO, investors will be able to redeem their common shares at $10.20 during the course of the SPAC life. Further, once the warrants become freely tradable, they often command a value between $0.30 and $0.80 per warrant. In the above example, the SPAC IPO selling for $10 could have an implicit package value of over $10.50 per unit.
We have seen SPAC unit’s trade 2-3% above the IPO offering price just a few weeks after the IPO. Once units separate into their individual components, we have sold the units and purchased the common at a significant discount to the cash value in trust. By doing this, we’ve generated 2%+ gains on the IPO units while locking in another 2%+ future return on the SPAC common shares. While these returns may seem paltry, keep in mind that SPAC trusts are essentially cash—and we’re buying that cash at a discount that rivals the yield on the 10-year U.S. Treasury.
While every SPAC IPO is different, careful diligence can uncover hidden value. Careful diligence and professional management can help produce compelling returns with minimal risk.
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Christopher Raby, CFA is a senior taxable fixed income portfolio manager for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully’s Trail, Pittsford, NY 14534, (585) 586-4680.
