SPACs – $1B RAISED IN RESTAURANT SPACE, $5B OF BUYING POWER, A NO LOSE PROPOSITION FOR INVESTORS ? WHAT CAN GO WRONG?
It should be no surprise to anyone that SPACs, or “blank check” companies, have become very popular. About $80B was raised in 2020 for use by these investment vehicles, and just about the same amount in only two months this year.
There are five SPACs, formed by Sponsors that have a background in the restaurant industry, in total raising about $1B, which can support a cool $5B or more in acquisition activity. BurgerFi has been brought public, FAST Acquisition Corp (FST) is working to merge with Tilman Fertitta’s hospitality empire, Tastemaker (TMKRU) and Union Square Hospitality (HUGSU) have raised funds and are conducting their search. Cliff Hudson (ex-CEO of Sonic) is planning a $125M offering.
THE REDEMPTION BACKSTOP
We’ve written before how Sponsors can make anywhere from 10x to 50x their investment over perhaps five years (hopefully less) with minimal risk if the SPAC funds are raised and if they have reasonable success managing the Business Combination (BC).
Public investors, typically at $10/unit, which consists of a share and some portion of a warrant, have an apparent “no lose” proposition because they can redeem their share for approximately $10 if they don’t approve of the BC. The Sponsor is given up to 24 months to complete a BC. Investors feel, therefore that they can “always” get their money back and they have substantial upside in the meantime because the SPAC Units often trade at a substantial premium to the $10 offering price well before the BC is completed. Before the BC comes to a vote, therefore, and redemption becomes an active option, the SPAC investor has the opportunity to sell their shares into the marketplace, hopefully at a premium to the $10 issue price, and the warrant can be retained as well.
THE PROBLEM
We’ve said “always” and investors in may feel “always” because nobody in a bull market worries about technicalities, but that does not mean “any time”. The redemption right is only effective at the time of the shareholder vote, 24 months down the road. Between now and then, the SPAC Unit trades like a closed end fund, at a premium or a discount to the issue price. While it is true that most SPACs are currently trading at a premium to the $10 issue price, there is something like $100 billion worth of SPACs that have not formally proposed their BC and therefore could trade at a discount rather than the premium most prevalent today. When we consider that, with the hundreds of billions of dollars chasing deals, at least $5B (with leverage) in the restaurant industry alone, lots of SPAC Sponsors will propose an obviously high price to complete a deal before time runs out. If the marketplace doesn’t like the appearance of the proposal, the SPAC shares could quickly go to a discount and investors would have to wait for the formal vote before redemption could be requested.
We can provide a couple of examples of this phenomenon.
AUCTION RATE SECURITIES
Fifteen years ago, prior to the ’08 –’09 financial crisis, a popular investment vehicle, Auction Rate Securities (ARS), became popular. Something like $200 billion of these securities were sold by underwriters, whereby investors could get a higher yield than was possible in money market funds. The ARS were invested in a variety of fixed income securities, including money market funds (who were guaranteeing $1.00/share) and a variety of other fixed income investments. There was an “auction” of each ARS portfolio every 7 to 35 days, whereby a new interest rate would be fixed. The underwriters “guaranteed” that an investor could “always” sell their ARS shares at $1.00/share, largely based on the fact that the ARS included (but was not limited to) money market funds.
In Feb’08, money market funds allowed their shares to “break the buck” because their portfolios were not liquid enough to meet redemptions, and the ARS market froze as well. Investors (including this writer) had their funds literally frozen, not redeemable at any price. There was an obscure technicality, under certain conditions, that allowed the ARS Sponsors to do this. As it turned out, the US Government guaranteed the hundreds of billions that had been invested in money market funds, which allowed the ARS Sponsors to redeem those shares, close to par value, as well. This process took about eighteen months. No harm, no foul, but it took a while.
THE GRAYSCALE BITCOIN TRUST (GBTC)
More recently, on December 22nd, we wrote about the Grayscale Bitcoin Trust (GBTC, a closed end fund owning Bitcoin). GBTC was, on 12/22/20, trading at a 40% premium to the Bitcoins that were held. GBTC today trades at a 12% discount. Bitcoin has gone from $22.3k to $48.2K (up 116%) and GBTC has gone from about $30/share to $41/share (up only 28%). Investors obviously haven’t participated anywhere as much as they anticipated in the Bitcoin “play”.
THE BOTTOM LINE
A prospectus for a SPAC typically runs 200 pages, and contains a great deal of legal jargon. Just as was the case with Auction Rate Securities fifteen years ago, there could be some basis by which redemption might not be as easy as it seems. (It’s always easier to get someone to take your money than to get it back.) Setting that possibility aside: redemption of shares, anticipated in the prospectus to be close to the $10 issuance price of the Unit, is typically offered along with the shareholder right to approve the proposed Business Combination.
Between now and then, however, the investor funds are “at risk”. They can sell at a premium to the $10 redemption price (which has so far most often been the case), but discounts are possible as well. Investors in SPACs should not risk any funds that cannot stay in place until the Business Combination is proposed and the redemption provision becomes effective.
Roger Lipton