‘Blank-Check’ Companies Are Hot on Wall Street. Investors Can’t Ignore Them.

By convention, a SPAC will go public at $10 per unit, which consists of a common share and a fraction of a warrant—as low as one quarter—generally exercisable at $11.50. Once the securities begin trading, the units split and the stock and warrants can be bought and sold separately.

The cash raised in a SPAC IPO goes into a trust, where it earns interest until the merger with the target company is completed. At the time of the transaction, common stock can also be redeemed for a proportionate share of the cash in a SPAC’s trust.

“That means that an investor who sees the deal and doesn’t like it can ask for their money back,” says Douglas Ellenoff, a partner at the law firm Ellenoff Grossman & Schole, which has advised more than 65 SPACs since 2017. “But they’ll almost always still vote in favor of the deal because it hurts their warrants if it fails.”

And redemptions can be significant—nearly 100% in some cases.

The redemption option means that SPACs can be left without enough cash to complete approved deals. Many need to rely on committed funding from their sponsors or new institutional investors when the deal closes. In a private investment in public equity, or PIPE, deal, backers will receive a new allocation of shares, warrants, or both—potentially diluting existing shareholders. Some SPACs have also raised debt coinciding with their merger.

It is another sign for investors to watch. If new shareholders in a PIPE deal are coming in at $7 a share, existing shareholders get diluted and the stock will tend to trade down to that price after the transaction closes and the option to redeem has passed.

Alternatively, a PIPE deal at or very close to $10 a share can be a positive sign for a SPAC’s long-term prospects after the transaction—at least in the minds of the investors willing to put in a significant amount of new money at that level, assuming the company is worth more.

If a SPAC can’t consummate a merger within its specified term, its trust is liquidated and returned to stockholders, while warrants expire worthless. That gives sponsors an incentive to get a deal done – but also means investors should be warier of transactions announced right before the deadline, when the pressure to find one is highest.

After the SPAC has identified its target company, “the decision on whether to hold the stock or warrant really boils down to fundamental analysis,” says Erik Falk, head of strategy at Magnetar Capital. “You have to think of the target company like any other stock investment and do your homework to understand its probability of providing a return on your investment.” Magnetar has about $13 billion in assets under management, which includes SPAC shares and warrants.

Of recent SPACs, one to keep an eye on is Mosaic Acquisition (MOSC), which raised $345 million in a 2017 IPO and struck a deal to acquire Vivint Smart Home from its majority owner Blackstone last fall. Vivint bills itself as “smart home as a service,” with 95% of its revenue recurring. Its 1.6 million subscribers pay an average of $63 a month for smart-home devices and services including smart locks, cameras, thermostats, and security monitoring. “Smart-home adoption is in the very, very early stages at this point,” says Vivint CEO Todd Pederson, who founded the business in 1999.

Mosaic is sponsored by Fortress Investment Group and David Maura, who assembled a collection of consumer brands into Spectrum Brands Holdings (SPB).

Vivint had $848 million in revenue for the first nine months of 2019, up 10% from the same period a year earlier, while earnings before interest, taxes, depreciation, and amortization, or Ebitda, rose 19%, to $474 million. Vivint expects to maintain 14% top line growth and 23% Ebitda growth through 2021 as it signs up new users and sells existing ones on new products and services.

The deal terms look attractive. At an enterprise value of about $4.2 billion, Vivint will go public at less than eight times its estimated 2020 adjusted Ebitda. Alarm.com Holdings (ALRM) trades for over 20 times EV/Ebitda, and is less profitable.

As with many private equity-backed companies, Vivint’s debt load is high—but deal proceeds will be entirely used to reduce it. And Vivint and Mosaic’s backers are in for the long term. Blackstone is rolling over its entire ownership of Vivint into the newly public company, and is putting in an additional $100 million in cash at a price of $10 per share. All PIPE commitments from Blackstone, Fortress, and others total $475 million.

Shareholders approved the deal on Friday. Shares will begin trading on the New York Stock Exchange (ticker: VVNT) on Tuesday.

There are more conservative ways to play in SPACs. Because the common shares will be redeemable for their share of the cash in the SPAC’s trust, a nearly risk-free arbitrage opportunity exists.

“We view SPACs in a similar way that we view closed-end funds,” says Chris Raby, a portfolio manager at Karpus Investment Management. “It is a vehicle that can trade at a discount to its intrinsic value. We primarily buy SPACs after they’ve split, and we just buy the common shares when they’re trading at a discount to the cash in trust.”

Karpus, based in Pittsford, N.Y., with $3.6 billion in assets under management, uses SPACs to offset some of its longer-duration strategies. By getting in below the guaranteed value it can redeem its shares for, investors can lock in a minimum—although modest—return, with the potential for greater gains if the stock trades up.

“Instead of just being in T-bills, this gives us the opportunity to earn a higher yield,” Raby says. “From our perspective, these investments can earn a conservative return with the potential for upside if one of the deals is well-received by the market.”

Spartan Energy Acquisition (SPAQ) could present such an opportunity. Sponsored by private equity firm Apollo Global Management, Spartan raised $552 million in an August 2018 IPO to seek targets in the North American energy industry. Shares recently traded for $10.19, a 1.4% discount to their estimated $10.31 at their liquidation date this coming August, according to SPACInsider.

Should investors hold for about seven months through that deadline and redeem for cash, they can receive a risk-free annualized 2.36% yield. A U.S. six-month Treasury bill yields 1.57%. And if Spartan finds an attractive target before its deadline and the common shares trade higher than $10.31, investors can pocket those gains instead.

As with any new area of the markets, investors should approach with caution, and go with the best track records. But as the SPAC industry matures, the opportunities will continue to grow. •

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com