Thinking About Investing in the SPAC Attack? Important Valuation Considerations.
Posted by Richard Wagner on May 28, 2021 5:12:00 PM
When investing in a SPAC, at the IPO or after, you are not investing in an actual company with fundamentals.
A Special Purpose Acquisition Company (“SPAC”) is a blank check shell company formed by investors with the sole purpose of raising money through an IPO to acquire another company. When investing in a SPAC, you are investing in a management team and their ability to find and negotiate with a private company to take that entity public through a business combination. When a SPAC is trading on an exchange, it can be very volatile because it is not trading based on its fundamentals. For example, the market price of the SPAC may have little or no correlation to the economic success of the SPAC.
There are many ways to gain exposure to SPACs, but when investing in SPACS, there are important considerations related to the purchase and subsequent valuation of the security, for example the following:
Public Shares – Public shares are the shares that are traded under a ticker symbol on an exchange after the SPAC IPO. $10 per share is a common IPO price for a SPAC. The proceeds from selling these shares are used to pay for an acquisition of a private company, and to take that company public through a business combination. The SPAC has approximately two years to find and complete the acquisition, although an extension is possible if the SPAC is in the process of negotiating an acquisition at the two-year deadline. If the acquisition is not completed in the allotted time, and the SPAC is liquidated, the shareholders at liquidation will be entitled to receive their pro-rata share of the proceeds from the IPO that were not utilized. At the announcement of an acquisition by a SPAC, the public shares are entitled to vote and have the option to tender their shares back to the SPAC for approximately the price paid at the SPAC initial public offering. As long as there is activity on the exchange, the public shares are easily priced at the last traded price.
Public Warrants – Whole or fractions of warrants (typically one-third or one-half ) are sold with the public shares at the IPO and are included in the IPO price as an incentive. After the IPO, the whole warrants can trade on a public exchange under their own ticker symbol. The public warrants typically have a strike price at a 15% premium. These warrants generally are cash settled when the price of the underlying stock reaches a specific amount for a period of time as defined in the prospectus. If the SPAC does not acquire a company in the allotted period, the warrants will expire worthless. As long as there is activity on the exchange, the public warrants are easily priced at the last traded price. If not, Black-Scholes may be used to model a price.
Public Units – Public units can be purchased from a broker after the IPO, before the public shares are available for trading on an exchange. Public shares and public warrants are typically available for trading on an exchange about 52 days after the IPO or final prospectus. A benefit to purchasing a public unit is that you can own the stock before it is available for trading. A public unit is comprised of common stock and a warrant or fraction of a warrant. After the SPAC starts trading on an exchange, the public unit can be separated by a broker into common stock and warrants that will trade on the public exchange on their own ticker symbol. A SPAC can be traded as a unit if you choose not to split the common stock and warrant. After the SPAC common shares and warrants start trading on an exchange, value of the units can be determined by the traded prices of the separate securities. Prior to the trading of the separate securities, the value of the units may be determined with broker quotes or other methodologies.
Founder Shares – Founder shares are shares purchased by the sponsor (sponsors can include business executives, companies, PE funds, and individual investors) prior to the IPO at a significant discount to the IPO price. The founder shares automatically convert to public shares at the completion of the acquisition of the SPAC on a one-for-one basis. Founder shares can also be purchased as founders units and would have whole or fractions of warrants attached. Prior to the conversion into public shares, there are some items to consider from a valuation standpoint.
- Founder shares are not eligible to be sold during the time the SPAC is looking for an acquisition target and for a specified time period after the acquisition.
- While public shares can be tendered for cash back to the SPAC if an acquisition is not completed, founder shares expire worthless if an acquisition is not completed timely.
- If the sponsor does not participate in the acquisition, a larger percentage of the founder shares can be forfeited.
- The founder shares are more complicated to value. Aspects that should be considered include liquidity discounts for lockups, adjustments for likelihood of an acquisition completion and share forfeiture. A detailed valuation approach or valuation specialist should be considered for this type of share.
Forward Purchase – A forward purchase of a SPAC consists of an agreement with the SPAC by affiliates of the sponsor or other institutional investors to commit to a purchase of stock or units in connection with an acquisition by the SPAC, if additional funds are required to complete the transaction. The consideration would be when the contingent investment should be included in the books and records and if it should be shown as a gross up of the asset/liability or netted showing only the asset. The valuation would be straightforward, as the SPAC would be trading the exchange.
On a final note, when investing in a SPAC, the prospectus should be reviewed in detail to determine the risks involved and possible dilution by the warrants, founder shares and forward purchase agreements. The SEC website should be reviewed periodically to look for form 8-K filings notifying shareholders of any changes. The SPAC website should also be reviewed periodically to identify news, press releases, or investor resources that may enhance your understanding of the SPAC.. If changes in the SPAC are not addressed timely, an opportunity may pass, or the SPAC shares may expire worthless.
We welcome your questions regarding investments in SPACs and possible impacts on your Funds.