Description

East Resources (ERESW) - $0.25 per warrant

Disclaimer: Note that this is highly speculative and most suited for PAs. 

Introduction:

This is a fairly straightforward idea of a good risk-reward in the SPAC carnage. East Resources Acquisition is an oil and gas SPAC that closed its public offering with fairly traditional terms on July 27, 2020. ERES is headed by Bills owner Terry Pegula and is pursuing an energy deal with a $345M trust.

So with about 100 days left to complete a deal, why are we recommending this trade? For one, base rates on SPAC completions can provide some context. Very few SPACs ultimately liquidate, as seen in the chart below (credit spacresearch.com)

However, we do have to handicap the fact that ERES is running out of time. We approached this trade by calculating the implied probability the market assigns a deal not being completed, as this is the main variant position taken on this trade. 

We picked ERES in particular since we believe that they are best suited to complete a LNG / natural gas deal in this environment and have the best terms with only a half warrant per unit (less dilution) and no rights. In traditional upstream energy, there are only a few SPACs competing - namely ERES ($345M), BMAC ($240M), CENQ ($175M), and ROC ($180M). This totals about $1B in trust. There are over 75 SPACs searching for "energy transition" deals. 

Calculating Implied Probability of Deal Closure:

First, we will use the median costs in SPAC deals in the below chart to assume that a deal is done at a fair price with a 15% IRR. This results in a $8.5 stock after deal closure.

https://corpgov.law.harvard.edu/2020/11/19/a-sober-look-at-spacs/

ERESW have 5 years until expiration upon deal completion, and let's say that Terry's deal can get a 15% IRR. That takes us to a $17 stock sometime out in 2027 / 2028. At an exercise price of $11.5 that leads us to a $5.5 intrinsic value. Backtracking the implied warrant value at the same discount rate (15%) would result in a $2.7 warrant value - which isn't off from the base rates. A 10% IRR and discount rate leads to a $1.35 warrant.

 A 20% IRR leads to a almost $10 warrant which is a 40x return the $0.25 warrant price today.

Valuing on comps, we can just pick a confidence interval on historical warrant prices (which trade similar to LEAPs). From our metrics, 95% of completed deals at $8-10 trade with warrants around $1-$2. 

That being said, we believe ERESW should trade somewhere around the ballpark of $2 on deal completion. Thus the market is implying a ⅛ chance that Terry and his team can find and complete a deal before the deadline with a $0.25 warrant price today. We believe this should be higher around 25% of completion or a $0.5 price based on the base rates and strong energy deal flow environment.

Potential Target: 

In terms of potential targets, I think this is where ERES may have stumbled and not completed a deal quickly. For one, the team doesn't have significant deal flow without a major private equity or investment bank backing them. Wells Fargo is the sole bookrunner and they may be able to help them out, but with a $345M trust they are likely shopping in the $500M  - $2B range.

Deal flow in that range is likely more quiet, particularly during the entirety of 2020 and the start of 2021. That being said, the team didn't likely see much interest on the market before July 2021 - giving them only about a year or so to shop around. 

That being said, Warburg is shopping around RimRock around the target range of ERES. I think the deal makes sense with Warburg likely trying to sell the asset for non-financial reasons with a core focus on TMT / Financial Services investments. Warburg showed patience in not selling prematurely in 2021 and thus would likely be willing to sell a chunk for $345M at a higher valuation to ERES.

https://warburgpincus.com/sectors/

https://www.reuters.com/business/energy/warburg-pincus-places-rimrock-oil-gas-sale-sources-2022-04-11/

Prospectus: https://www.sec.gov/Archives/edgar/data/0001814287/000156459020033386/eres-424b3.htm

Catalyst

Target announcement