Modern Speculation with SPAC Warrants

Most investors in SPACs (Special Purpose Acquisition Companies) have experienced a series of body blows since late February. While the exact catalyst could be argued, none were larger than missed expectations from an overly anticipated deal with Churchill Capital IV. The subsequent freefall of most warrants was extreme, even for those of us that hold and have held many warrants for great lengths of time there were few if any left untouched and experience provided very little protection to the downside.

If that were the only event then we would likely have returned to speculative pricing of the past, but it was not, it was followed by hundreds of articles that were exceptionally “anti spac.” It was followed by the largest financial networks CNBC and Bloomberg including regular negative commentary on SPACs while disproportionately giving credence to IPOs with an arguably worse outlook for the future performance. It was followed by SEC employees commenting on a specific asset and postulating the changes they thought were important, necessary or overdue but given in such an editorial and anecdotal context that leads any of those changes down a path of opinion and conjecture. The commentary on those same networks was regularly condescending, dismissive and by almost every litmus would lead a savvy SPAC management team to never agree to an interview again.

So, what does it all mean? Who is right? Who deserves to have your ear in these times?

This article will not be a fluff piece for SPACs, nor will it be anti spac or anti warrant. The intention is to put an HONEST reflection that will examine the details that pundits with no skin in the game will likely never understand without the inherent psychology that accompanies trading in speculation. The 1+1=2 scenario is a myth with speculation and that extends into commodities, warrants, SPACs and anything that would be classified as HIGH RISK. That is after all what we invest in with SPACs, HIGH RISK, SPECULATION.

If one were to read most SPAC related articles, they would draw an inference to an investment in an Airline or FORD, by most accounts, a relatively normal investment in the past that fits into one’s portfolio like a cold body in a warm blanket, familiar and typical price action would be common, and returns would be somewhat predictable and arguably unimpressive. The inherent difference is that investing in SPACs like other forms of speculation is a different type of investment, it is rarely discussed in those same articles that portfolio allocation in speculation is never the entirety but rather just a piece of the pyramid of diversity. The goal in these investments is not for nominal gains, the goal for this group of investors is outsized gains of 100’s if not 1000’s of percent returns that can accompany the outsized risk. Much like seed and VC rounds, the investors that participate in these opportunities expect the outsized returns; we have little to no desire to take high risk positions on normal opportunities. We look for potential, the teams that are pursuing these targets for acquisition are not looking for “normal”, the underwriters and PIPE investors are not taking the risk without an adequate reward on the table. With that in mind, lets unpack what a SPAC is and then really try to expand that into the famous or infamous (depending on your perspective) warrants that are associated with those investments.

SPACs or Special Purpose Acquisition Companies have actually been classified as Blank Checks since the mid 90’s when they were allowed to utilize exceptions to bring a company to public markets that in most conditions would not be eligible for listing in a normal capacity due to a myriad of factors or time constraints. In a truncated explanation, they offer X amount of UNITS in an IPO for X amount of dollars based on the speculation that the UNIT will have exposure to the deal they ultimately complete. These UNITS that are offered are rarely just a common share and arguably are far less attractive when incentives are omitted. The UNITs dominantly contain a Common SHARE, fractional to full Stock Warrants, and/or 1/10 to 1/20 of a Stock Right. The only investor fully exposed to this scenario is the unit investor prior to the units splitting (between 45 and 52 days on average after the closing of the offering). When the unit splits then the market has access to trade the Common Shares, Warrants and/or Rights on the open markets. Each of these components can come with a variety of conditions that should be explored and understood by any investor and while those with experience would view most of this as relatively straightforward in an environment where the SEC blogs rather than regulates, some of these component’s pieces will need to be explained.

The Unit:

Consists of the Common Share + The Warrant + The Right and is the IPO offering

The Common Share:

A share of the SPAC post unit split. This share has the ability to be redeemed in almost all cases at the time of a vote for a business combination and while considered a sound strategy can also carry a less articulated opportunity cost as the redemption ability can be 12-24 months out to exit with modest gains if any. Some investors find this is an ideal place to deploy margin and have been very successful.

The Rights:

Love or hate is the best way to describe this security. If acquired for a reasonable price after the unit splits or given as an additional kicker to the UNIT offering; the rights have a built-in share allocation upon completion of the business combination. While varieties of terms exist in the broader market for rights, the SPAC Rights at this time of writing are either a 1/20 of a share e.g. (NYSE: GIX.RT) or 1/10 of a share (NSDQ: MCACR) and with nothing further required will convert in your brokerage account to the proportional Common Shares upon that completion and symbol change. The rights will cease to exist, and you will see the new companies shares in your account. Generally, the rights are seen as an incentive above and beyond the warrant rather than any form of adequate replacement. For me, I have seen success when acquiring rights in the open market for discounted prices under .30 cents and holding them with a sell order for my intended exit from day 1. Again, many strategies exist, and none should be seen as a panacea, everyone believes they are right until they aren’t, nothing should replace due diligence.

The Warrant:

I will admit a degree of bias on this topic prior to writing as my twitter handle should easily attest to @SpacWarrants. The warrant is the true kicker or incentive in the UNIT offering in my opinion. A warrant is very similar to a long-term call option and should immediately indicate a level of risk and speculation that should not encompass the bulk of any investor’s portfolio just like every other speculative asset they carry a larger degree of risk. The warrant as offered in the unit can be given in fractional quantities ranging wildly from No warrants, No Warrants and 1 Right, 1/9 of a Warrant, 1/3, 1/4, …., 1 full warrant; This allocation upon unit split is NOT the terms of the warrant but the terms of the UNIT and the incentive being offered. Warrants that are trading in the market do not exist at the time of the offering and do not trade in fractions, upon that unit split, complete warrants begin to trade, and warrants are sold. If a Unit offers 1/3 of a warrant, then for every 3 units an investor splits they will have 1 whole warrant in the market. These publicly traded warrants have independent conditions that determine their value but one of the most common and potentially confusing for new investors is that the warrant terms are independent of the unit terms and when bought are considered to be a full warrant. Ratios required to “Exercise the Warrant” are of equal import when evaluating investment potential. As of this writing the terms of SPAC warrants are 1 Warrant for 1 Share (1wt:1sh), 2wt:1sh, 3wt:1sh (only one example with these terms currently). These terms relate to the potential moment of exercise as it relates to the number of warrants required and conditions set by the company regarding the Exercise Price. When the company reaches a common share price that equals or exceeds the Exercise price of the warrant then the warrant can be exercised through your brokerage for the common shares provided the other conditions for exercise have been met. With few exceptions such as tax implications, at Common Stock Warrants we don’t see many reasons for investors to exercise rather than sell the warrants into a liquid market.

The warrant provides an upside leverage vehicle to the SPAC Common Shares, as such, it also carries a few key elements that should be understood. The volatility is part of the game, with less warrants offered than common shares and less volume to accompany that; the ability for wild price fluctuations should come as no surprise. Perhaps more importantly is the lack of the NAV floor which provides a built-in stop loss for those participating in the Common Shares at the point they can redeem. The warrants can go to 0 dollars if the SPAC does not complete a deal, or if the common share never reaches exercise price. While this is a HUGE caution the scenarios are uncommon thus far, additionally the expiration of a SPAC warrant is somewhat deceptive; The expiration from most SPAC warrants at the brokerages will denote 5-7 years into the future which is woefully inadequate. The warrant does not start a 5-year timer for expiration until the business combination is complete. The price action and risk potential of the 6-24 months that the SPAC has stated as its deadline for completion is the only expiration date that exists until there is a combination. While we observe this as a formality, in the event there is no deal it is a valid expiration, in the event there is a pending deadline or required extension then it is a valid expiration as it pertains to the price action seen in the warrants during those events.  One could argue that the warrant has a 7 year or a 5-year life but the potential within hundreds of offerings this year alone to test that is uncanny. The fact is they need a combination to be granted those terms. No sensationalism, no fluff. Contracts are not speculative; they are simple and in your face. What the company is going to do is speculative, what they acquire, revenue multiples; all are relatively speculative. What is written in the description of securities about a warrant are not speculative but rather black and white. Much like science it does not care for opinions. Know what you own.

With those specifics in mind: a journey through the last year can begin to make far more sense as it relates to price action, speculation, fear. As every industry, relationship and business can attest: the last year has been transformative and not with a scalpel, but rather the likes of a jack hammer. Major changes that were a decade away were thrust into the current environment with little regard for opinions but rather the necessity for which those changes were required. A year ago, the equity markets were just taking the first real breaths after a near killing blow upon the news of global quarantines.

The people who at the worst moments had the vision to enter such SPACs as: $DKNG, $OPES, $NKLA and make a speculation on the future for each of those companies, well aware that uncertainty was the driver in those markets, these people took that risk. Their very risky speculation at a time when the global uncertainty was at highs and the future was in the literal toilet at best was richly rewarded.

With several major business combinations taking place in the previously ignored blank checks at the end of the summer of 2020 there was a new influx of interest. Names of potential companies flooded social media and the Reddit forums giving a population secluded at home this amazing list of opportunities when all else seemed dire. Very little was a bright spot in history around September of 2020, but #Fintwit would argue the opposite as hundreds of thousands of retail traders found something with a future. That future potential normally reserved for only the most informed was right here at your fingertips, a chance to be in the earliest phase of what you see to be the future. Most if not all of those investors were well rewarded by the end of 2020. While the ensuing and relentless issuance of new SPACs grew in the early days of 2021 it was inevitable that the liquidity would not be instantly shared and was going to take a bit of time to gather the steam required for each of these to have the potential performance. The next catalysts are likely already in the works or waiting for completion much like an old (NYSE: KCAC) in a depressed environment prior to the completion to behemoth QuantumScape (NYSE:QS), I see CCIV as being one among many that are going to have the speculative world on the edge of their seats as we enter a period where Lucid Motors and many others will complete their mergers and be turned loose on the broader markets.

Let’s be clear, those that argue AGAINST potential growth, disruptive tech, the intended globalization of a product or service; those people are the same that said Google and Amazon were overvalued when they had no revenue. The investors that succeeded in these times were not given a glorious reception but rather the scorn of traditional commentators who missed the boat and still can’t seem to find their way to the docks all this time later. Its your “post dot com” pundits that never owned a tech stock. The real question is not what these people believe to be the future but what you do. As a modern speculator in future growth opportunities do you see that the recent chip shortage means that it is because the world wants less? Do you believe that a strong management team can identify a better business than one currently dominating market share? Do you see a technology that can thrive given the capital? What about a regional food business that is successful and could benefit from near immediate globalization?

Notice they are all questions because it is all based on the speculation of the investor, your vision of the future or mine. Only hindsight will reveal which of those speculations are valid. Only hindsight will decide whether you were that person stepping into the uncertainty of the moment because of your belief of what will happen in the next moments.

You can’t play the game when it’s over.

Speculation is very risky and should be treated as such regardless of anyone’s opinions. The investor can lose part or ALL of their investment and should seek competent advice prior to participating.

Where do we go from here? The future, for me, is explosive growth and unexpected opportunities. I see an emerging market with more opportunities for SPACs than can be counted, I see a robust return to hospitality and leisure that provides great SPAC opportunities in countries that saw less government assistance for great businesses. I see cutting edge ideas and technology being packaged through SPACs that are superior to debt ridden lumbering whales of the past. The catalysts for growth for me have all aligned to a decade that will surpass expectations not seen for generations. I see a retail class eager to invest in decarbonization, the environment, plant-based alternatives and the like. The market is ready for far more Quantum, AI, and machine learning driven products and services than even the recent deluge of SPAC IPOs are capable of absorbing. Augmented Reality, Surgical Tech and the potential of larger conglomerates being formed via SPAC, as well as the potential of smaller SPACs to find a target to be great for the overall SPAC environment. Some of the recently completed deals are to me still very undervalued in the marketplace and will show exceptional returns when supported by rising markets.

The future is in the SPACs.

However one chooses to invest is up to them, as previously mentioned there are many very adequate strategies that exist to capitalize on the market conditions for SPACs at the time. I sing the praises of the SPAC warrants for the potential leverage on the unknown and favorable conditions that are unique to SPACs. As it relates to warrants, I feel the entry price is more important than the flexibility allowed in most other investments but if acquired at fair market value or below then the returns are hard to beat even when comparing to those utilizing margin on the common shares. I will wrap my specific warrant strategy into a subsequent article since this one has gotten a bit lengthy but sufficed it to say, this should be a clear indication that I fall in the Bullish long-term camp and any reference to the speculation of SPAC warrants from me will reflect that. You can find me on twitter @SpacWarrants or at Common Stock Warrants.