Description

Long Pre-Deal Tech SPACs TRNE, SFTW, GIX, IPOB, IPOC, CCAC units/common/warrants.

This trade is about gaining optionality on retail mania upside at an attractive risk/reward.

Disclaimer: SPAC is a bit of a dirty word in the value investor community. Very poor performance post-transaction close is well documented/discussed. Relative to an IPO, a SPAC enables businessowners to sell a greater portion of their business (up to 100%) faster, with fewer disclosure requirements, and at lower cost. There is also significant incentive to get a deal, sometimes any deal, done or the operator(/sponsor)’s investment is lost. Historically, this has not been a winning cohort. However, the lifetime of this trade predates operational risk, so try to throw negative preconceptions out the window. We are only interested in pre-deal SPACs and the attractive risk/reward associated with deal announcement, with retail froth upside and downside mitigated by an arbitrage opportunity.

What is a SPAC? A SPAC is a public shell which raises capital in an IPO to undertake a to-be-determined transaction. At IPO, SPACs offers units to investors for $10.00, composed of a common share with varying warrant coverage (typically 1/2, 5-year struck at $11.50) which compensates investors for uncertainty associated with the eventual transaction. IPO proceeds are placed in escrow, typically invested in treasuries, and may only be used to (1) acquire a business or (2) payout redeeming investors. Sponsors then have typically 24 months (can be extended) of wide discretion to find and execute on a transaction. Investors have the option to redeem their share of NAV (~$10) in cash at transaction. SPAC units become “separable” into common shares and warrants after 52 days.

Sponsors have significant incentive to undertake a transaction as the blank check company operations are financed through $11.50 private placement warrants to the SPAC sponsors and sponsors also purchase “founders shares” 20% of the pro-forma equity for very cheap (ex. ~$25k), which are worthless unless a transaction is done. Additionally, Sponsors also have significant incentive to announce a “hype” transaction to minimize cash redemptions – they need to trade  at a premium to NAV at transaction, or common shareholders (typically hedge funds) will redeem rather than selling the common open market. Pre-deal SPACs are mainly owned by hedge funds, and ownership is typically cycled to retail post-close.

Thesis: Pre-deal SPACs currently offer scalable retail-mania optionality with mitigated downside.

SPACs offer exposure to retail mania with limited downside. This opportunity exists because while retail has gotten a taste of tightly floated post-deal SPAC (and now directly target SPAC transaction announcements), it is a pain to get good SPAC data. I’m an analyst with a Bloomberg and still opted to purchase a dataset. This is essentially information arbitrage, but the dynamic has changed over time. Historically, “hype” “retail friendly” SPACs would complete transactions yet remain unnoticed for several months. There are structural informational reasons why: new SPACs have no equity research coverage and strange ticker/business name. For example, Virgin Galactic (SPCE) gained traction around the initiations by Credit Suisse and Morgan Stanley, yet then Draft Kings (DNKG) and Nikola Motors (NKLA) traded up earlier, around the ticker/name change (acquisition close). More recently, “hype-able” SPACs have traded up even earlier in the lifecycle, at acquisition announcement, including OPES, FMCI, SHLL, GRAF, etc. This is also why SPACs as an asset class have reverted from a positive to negative yield over the last month.

SPACs which have recently announced transactions trade at significant premium to NAV:

Meanwhile, downside is limited. Investors can exchange a share for their proportionate share of NAV, in cash, during the de-SPAC transaction. SPACs typically trade at discounts to NAV to compensate investors for illiquidity, and the arb mechanism (transaction) is often hundreds of days away. So, the most likely worst-case scenario is that you are forced out of your position at a discount to NAV, such as 5%, which is a significant discount on a historical basis. (the true worst case is a forced sale at a 20% discount to NAV, which we briefly saw in some SPACs in March 2020, though this is highly unlikely and only appears in extreme dislocation).

Why these SPACs?

TRNE, SFTW, GIX, IPOB, IPOC, and CCAC are Consumer/Technology(/ESG Cleantech/Software/Fintech) pre-deal SPACs. These SPACs were narrowed down by liquidity ($900k $volu./day), sector, SPAC transaction duration, and operators.

At our weightings, true downside here is ~10%, assuming 0 transactions occur, and you’re forced out of all positions at 5% NAV discount. On the other hand, potential upside is significant even relative to “worst-case” -10% downside.

Social Capital Hedosophia Holdings Corp II./III. (NYSE: IPOB/IPOC)

IPOB/IPOC follow Chamath Palihapitiya’s IPOA, which acquired Virgin Galactic (SPCE). To some extent this trade is long Chamath’s persona. While I’m not necessarily a Chamath fan boy, I do believe he is a very good marketer and has recently gained traction, especially with SPCE and his “let them fail” comments in April 2020. Chamath Palihapitiya is an early Facebook executive (2007-2011) who went on to found VC fund Social Capital. More recently, Chamath took Virgin Galactic (SPCE) public via SPAC (this was IPOA) and serves as Chairman. IPOC/IPOB are both trading at ~10% premium to NAV but I believe this is worthwhile given (1) I believe likelihood of acquisition is high, (2) I believe acquisition is likely to be in a retail digestible industry, and (3) acquisition is likely to get more traction as Chamath’s name is tied in.

GigCapital2, Inc. (NYSE: GIX)

GIX is led by a JANA partner looking to undertake a transaction by Dec 10th, 2020. To provide enough time to undertake the transaction (typically takes several months), GIX will need to announce a TMT acquisition in the next few months, if at all. GIX also currently trades at ~NAV.

Trine Acquisition Corp. (NYSE: TRNE)

Led by CEO Leo Hindery, the founder and former CEO/Chairman of the YES Network, TRNE is looking for an acquisition in “technology, consumer, and/or media and communications”. TRNE must complete an acquisition by March 19th, 2021. Similar to GIX, TRNE must announce an acquisition in the near-term.

Osprey Technology Acquisition Corp. (NYSE: SFTW) and CITIC Capital Acquisition Corp. (NYSE: CCAC)

SFTW is included because of a (relatively) attractive 0% premium to NAV and software acquisition mandate. CCAC will make an investment in an ESG company, with a focus on China/Asia. CCAC is included because there is currently massive ESG froth.

I believe there are also positive feedback-loop tailwinds for the asset class. Notable figures such as Chamath Palihapitiya and Bill Ackman (who has IPO’d his own SPAC) are endorsing the SPAC model, and contributing to the view that SPACs are a viable IPO alternative. Due to current equity froth, SPAC operators are also more incentivized to pursue/announce transactions, as there is a greater likelihood their SPAC will trade in excess of NAV and there will be ~zero redemptions. This has also created more visibility for the asset class, which in turn leads to higher quality sponsors, which attracts higher quality targets and vice versa. Pre-deal SPAC lifespans have been shortening. On a trailing average 10-transaction basis, SPAC pre-deal lifespans have fallen from ~2.5 years to ~1 year.

Trailing 10-Transaction SPAC Duration (years)

Time will tell if SPACs will get crushed as they did in 2008/2009, with many unable to close on transactions and investors redeeming their capital. However, the dynamic has changed, with SPACs raising roughly half of total YTD 2020 IPO dollars. Chamath says that he “thinks SPACs are the way tech companies will go public in 50 years” and that he “want[s] to do SPACs A to Z”. Bill Ackman just raised a $3b SPAC, the largest ever, to acquire “a mature unicorn”.

Overall, this trade is about playing upside “if the party goes on”, while maintaining minimal downside, which is really the key to the trade. On a risk/reward basis, this opportunity appears attractive.

Risks: Risk is that current euphoria environment subside. This trade obviously takes on SPAC asset class factor exposures. While I don’t know “when the party stops”, I believe this is a cheap (limited downside) way to access significant upside optionality.

Catalysts: Transaction announcement(s).

Other resources: Julian Klymochko, CEO and Founder of Accelerate Shares, is an excellent resource on SPACs. He publishes a monthly SPAC monitor. He also offers a SPAC arbitrage ETF fund. His Twitter: https://twitter.com/JulianKlymochko

Catalyst

Risks: Risk is that current euphoria environment subsides. This trade obviously takes on SPAC asset class factor exposures. While I don’t know “when the party stops”, I believe this is a cheap (limited downside) way to access significant upside optionality.

Catalysts: Transaction announcement(s).