Description

This is a special situations write-up on SPAC rights. We will use KYCHR as an example and provide a basket of SPAC rights to invest in at the end.

Disclosure: We own rights in each of the names in the basket. This article represents our work product and expresses our opinion. We are not receiving any compensation for it.

Background

SPACs tend to be horrible investments.*

*However, SPACs tend to be great investments for the sponsor.

A SPAC sponsor puts up a few million of its own capital for underwriting fees, offering expenses, legal expenses, and overfunds trust value in some cases.

In return, the SPAC sponsor receives 20% of the SPAC, which represents a MOIC of >6x assuming the deSPAC shares trade at $10. The SPAC investment only becomes a loser to the SPAC sponsor at $1-2/share.

The risk to the SPAC sponsor is not getting a deal done as they are out a few million and have no free shares to show for it. What if there was a way to play the SPAC Sponsor’s incentive to get a deal done with a publicly-traded instrument? [Insert some Munger quote on incentives being powerful]

Thesis

That instrument is SPAC rights. Even better, they are currently dislocated in our opinion. Generally, these rights entitle the holder to receive one-tenth of one Class A ordinary share upon the completion of an initial business combination. If you think there is an 80% chance a SPAC sponsor gets a deal done and fair value for the deSPAC shares is down 20% to $8, that implies fair value of $0.64 for the right.

20% probability: no deal = $0 as the rights expire worthless

80% probability: deal with SPAC entity @ $8 = 80% * $8 = $6.4

$0 + $6.4 = $6.4/share

$6.4 / 10 = $0.64/right

What do rights currently trade at? Less than $0.20/right, so there is >3x upside to this trade.

Hold up, $8/share for the deSPAC shares? – no chance. I know some real bad ones trading less than that. SKLZ has traded down to $3/share.

Well, you’re in luck. $3/share still implies $0.24/right as the Fair Value. While SKLZ doesn’t have a right, for reference, KYCHR is trading at $0.15/right. That would imply 60% upside in a draconian deal break scenario.

Given the chance of a right expiring worthless, we think a basket approach is the best way to play this.

KYCHR Example

Prospectus (Form 424B4)

Keyarch Acquisition Corp is a $100mm SPAC that was upsized to $115mm due to the overallotment.

KYCHU IPO’d on 1/24/2022 and separated into KYCH, KYCHW, and KYCHR on 3/1/2022.

KYCHR currently trades at $0.15/right and we believe fair value is $0.64/right or 4x upside.

They are 1/10 rights:

“Each right entitles the holder to receive one-tenth of one Class A ordinary share upon the completion of an initial business combination.”

The Sponsor bought 490,500 private units for $10/share = $4.9mm in costs to fund the SPAC

In return, the Sponsor gets 2.875mm Class B ordinary shares * $10 = $28.75mm value

Breakeven Price: $1.7/share

MOIC @ $10/share: 6x

Note: This ignores the rights and warrants the Sponsor receives.

Downside Risk

The other risk besides SPAC Price post-close is the probability of deal close.

The percentage of SPACs that have been liquidated is way less than 20%. Since 2016, there have been 11 liquidations:

BTAQ, ZGYH, FLLC, ALGR, RWGE, STNL, VEAC, SCAC, BHAC, ELEC, AAPC

That compares to 360 closed SPACs or 2.9% of closed deals that end up in liquidation.

We do think that percentage will increase due to a large amount of SPAC issuances in recent years. Nonetheless, the probability of liquidations should remain low given the incentives.

Furthermore, SPAC deals are still closing with significant redemptions. Sponsors are pulling out all the stops to get these deals over the finish line.

Rights Basket

20 names trading for less than $0.18/right after adjusting for those that give you more than 1/10 shares per right with 3.5x-5.0x upside:

AIBBR US Equity – 1/10 shares per right

ALSAR US Equity – 1/7 shares per right

ASCAR US Equity – 1/10 shares per right

ATAKR US Equity – 1/10 shares per right

BWAQR US Equity – 1/10 shares per right

CSLMR US Equity – 1/10 shares per right

ENERR US Equity – 1/10 shares per right

FEXDR US Equity – 1/10 shares per right

FXCOR US Equity – 1/10 shares per right

GBRGR US Equity – 1/10 shares per right

GLLIR US Equity – 1/10 shares per right

IGTAR US Equity – 1/10 shares per right

JWACR US Equity – 1/8 shares per right

KACLR US Equity – 1/10 shares per right

KYCHR US Equity – 1/10 shares per right

MAAQR US Equity – 1/7 shares per right

NVACR US Equity – 1/10 shares per right

SAGAR US Equity – 1/10 shares per right

WINVR US Equity – 1/15 shares per right

WTMAR US Equity – 1/10 shares per right

Catalyst

Positive: SPAC announces a deal to bring a company public

Positive: SPAC closes the deal to bring a company public and gets converted into shares

Negative: SPAC liquidates