Description

DMS warrants currently trade at 20c with upside to 75c if the non-binding LOI received ultimately results in a transaction.

We posted a similar trade idea back in June on GTYH / GTYHW.  While this idea is similar, the key distinction is that a transaction has yet to be announced.  That remains the primary risk to this thesis.

While overall there has been carnage in SPACs/DeSPACs there have been some opportunities if investors embrace a little complexity.  Most recently we have seen these opportunities manifest in DeSPAC warrants, primarily as it pertains to ratio adjustments; exercise price adjustments and M&A adjustments.  Today’s idea takes advantage of the M&A adjustment.

Situation Overview

On August 16, 2021, DMS commenced a process to evaluate potential strategic alternatives to maximize shareholder value, and as part of that process, have been evaluating a full range of strategic, operational and financial alternatives.

On September 8, 2022, the board of directors received an offer from Prism Data, LLC, an investment vehicle affiliated with the CEO Joseph Marinucci and COO Fernando Borghese, to acquire the company for $2.50 per share

The offer letter is below, however, I would call out a few dynamics:

1. The offer is being made by CEO and COO, which should theoretically indicate they see value above current levels (or they think they can kick off a sale process)
2. It is clear that management is attempting to convince the other large investors to roll into this take private.  They specifically call out Clairvest Group and Lion Capital
3. Assuming the participation of other significant stockholders, cash outlay is expected to be $35-40mm
4. B. Riley has provided a “highly confident” letter to raise up to $50mm

Shares were trading at $1.18 prior to the offer.  They quickly traded up to $2.22 before declining to $1.70.  Warrants were trading at 9c prior to offer, increasing to 46c and currently trade at 20c

Pursuant to the warrant agreement  https://www.sec.gov/Archives/edgar/data/1725134/000119312520118284/d920540dex21.htm  (section 4.5) in the case of a cash acquisition the warrants will be valued at Black-Scholes.  The agreement goes on to spell out the key assumptions:

Warrant treatment in a chance of control

Price: 10-day VWAP into close

Volatility: 90 day volatility obtained from the HVT function on Bloomberg determined the day prior to announcement – we’ll use the current for now

Risk free interest rate shall correspond to the US treasury rate equal to the remaining term of the warrant

Note: the SPAC transaction closed on 7/15/20 and the warrants have a 5 year life.  We assume the transaction closes on 3/31/23 which implies 837 days remaining which you can see in the calculation below

Risks

• No deal is ultimately consummated – potential to hedge some of this risk by shorting common
• Decreases to the 90 day volatility. Volatility Is a key input to the Black Scholes model and elevated volatility is one reason why the warrant upside is so compelling
  • The volatility input is set on the day of a merger announcement
    • Currently stands at 161, but it was 177 prior to the offer and peaked at 197
  • Conversely if volatility increased it would add upside

Catalyst

• Official deal announcement