Anyone have suggestions on how to go about valuing SPAC warrants? Features: Always ITM Not exercisable for some 12-18 month period During that period, vol of underlying is nearly 0. When they become exercisable, vol of underlying is usually a more equity like vol Some non-zero risk of never becoming exercisable and going to 0. Can I think of it like a european option with the present value of an american option attached at some point in the future?
HoldSideAnalyst Wrote: ------------------------------------------------------- > Anyone have suggestions on how to go about valuing > SPAC warrants? Features: > > Always ITM Right up to the point where the expire worthless. > Not exercisable for some 12-18 month period Because there is nothing to the company except a pile of cash for something > During that period, vol of underlying is nearly > 0. Cause there is no underlier except a pile of cash that you have no claim on. > When they become exercisable, vol of underlying is > usually a more equity like vol It’s absolutely equity like, but you don’t have any idea what it’s going to be. > Some non-zero risk of never becoming exercisable > and going to 0. > And as SPAC’s become more common this ought to become more likely as more people are going after the same things. > Can I think of it like a european option with the > present value of an american option attached at > some point in the future? Suppose that was exactly true (it’s not), how would you value it then? You would do the usual asset vol/dilution warrant valuation thing. The problem here is that the vol comes from something completely unknown and it includes all the vol associated with actually getting a target and having the equity holders think it’s a good idea. I can’t imagine what would ever cause me to invest in SPAC equity right now. I think it’s like paying $10 for a grab bag gift and offends me in all kinds of ways (like I just don’t think it’s responsible investing and we’ve lived through this about 6 times before and it always comes out badly). If I wouldn’t invest in SPAC equity, I certainly wouldn’t invest in SPAC warrants. Valuing them is sort of interesting, btw, because it doesn’t fit into the usual framework for risk-neutral type derivative valuation.
"Cause there is no underlier except a pile of cash that you have no claim on. " You do have a claim on it - at the time a deal is announced you can vote against the deal and get your cash back. If no deal is announced, it liquidates and you get your cash back. SPAC common shares trade at a discount to the liquidation value, so buying the common shares essentially gives you a guaranteed return with upside if a good deal is announced. However, I agree that I have no desire to hold the warrants, but getting a read on the value is still important. You’re telling me you wouldn’t pay $9 to bet Tom Hicks will find a decent deal, with the downside being you get $10 in 2 years or sooner?
HoldSideAnalyst Wrote: ------------------------------------------------------- > "Cause there is no underlier except a pile of cash > that you have no claim on. " > > You do have a claim on it - at the time a deal is > announced you can vote against the deal and get > your cash back. If no deal is announced, it > liquidates and you get your cash back. Not with warrants and you don’t get all your cash back. Somewhere between say 80 -95%. > SPAC > common shares trade at a discount to the > liquidation value, so buying the common shares > essentially gives you a guaranteed return with > upside if a good deal is announced. “Guaranteed return if [blah]” is an oxymoron >However, I > agree that I have no desire to hold the warrants, > but getting a read on the value is still > important. > > You’re telling me you wouldn’t pay $9 to bet Tom > Hicks will find a decent deal, with the downside > being you get $10 in 2 years or sooner? If that was the deal, I probably still wouldn’t do it, but that’s not the deal. It’s also not sound investing, not what CFA is supposed to teach you, calls portfolio management irrelevant, suggests that you take stock in some grab bag company with no due diligence yourself, etc. etc. If you put a client into one of these and then they asked what was the reasonable basis, what would you say? I trust Tom Hicks to find you something good?
Most recent SPACs deposit north of 97% of IPO proceeds into the trust, which then earns interest. Most recent deals also have interest clawbacks, where management can access some of the interest earned (generally equal to about 1% of trust assets). So sticking with my Tom Hicks example (although it’s a poor example because he did a sh1tty SPAC) for a $10 IPO, they put $9.71 in the trust. After 2 years at 3.5% after tax this will be worth $10.40, although management can access about 1%, so we’ll call it $10.30. This indicates the SPAC will make money even in liquidation. More importantly, I can do one of two things - buy the units, strip out the warrants and sell them, or just buy the common alone, and hold them until liquidation. Yeah, “guaranteed return” always sounds shady, but I think 200-300 bps above treasuries in an asset backed by a trust account is a pretty good deal. Also, we clearly know your views on the subject, but how is buying a portfolio of SPACs different from investing in a PE fund, except that the SPACs allow for liquidity and the chance to opt out of deals you don’t like?
HoldSideAnalyst Wrote: ------------------------------------------------------- > Also, we clearly know your views on the subject, > but how is buying a portfolio of SPACs different > from investing in a PE fund, except that the SPACs > allow for liquidity and the chance to opt out of > deals you don’t like? OK - that’s a fair point. I suppose that a portfolio of SPAC’s is similar to a PE fund with the exception that your money isn’t doing anything for sure and for certain in a SPAC for a little while and it is in a PE fund (presumably your investment in a PE fund can both fund existing investments and be used for new investments). Perhaps that’s my objection - money sitting in a trust fund waiting to make a risky investment a year down the road is a pretty inefficient use of capital and an unusual portfolio choice. I have a bigger issue with the warrants than the stock because all those nice advantages you point out don’t accrue to warrant owners. I don’t see where you get the 200-300 bp above treasuries. If they don’t find a deal, they liquidate the trust minus expenses. The warrant holders go hungry and the stockholders get whats left which is likely less than they put in 2 years prior. If they find something good, obviously, you win.
After the IPO, the common and warrants trade separately. The common will usually trade for about $9/share. Buy that, and hold it 18 months until you get the $10.30 (or better) I described above. That’s 9.4% annualized. Now lever it 3X…
Your numbers just don’t make sense. A liquidation of a SPAC is bad news for a SPAC investor. Management has taken its cut and the rest has been put in a trust fund. At liquidation you get your share of what’s left. There is no way that your money - 5% (which seems low to me but maybe recent SPAC’s are taking 3%) growing in a trust fund gives you a 9.4% return. You get rf - (5% amortized over 18 months)
Management usually gets 20% of the SPAC, but no liquidation rights. They also put up 2-5% of the deal in Warrants, which also goes into the trust - and they have no liquidation rights on that. And the underwriters usually put half their fee in the trust as well, to be returned in the event of liquidation or conversion.
Show me a SPAC in which the trust fund is larger than the amount put in by equity holders not including interest.
There have been some SPACs which have 100% of IPO proceeds put into trust, but these SPACs carry 100% interest clawbacks.
OK - so you’re not making your 200 bp over treasuries on those…
If I buy something at 9 and sell it at 10.30 18 months later what sort of annualized return have I achieved?