Trinity Merger Corp (warrants trade under “TMCXW”) is a $358mm SPAC formed in May of 2018 that is only 2 months from closing its proposed transaction. Proceeds will be used to merge with Broadmark Realty’s four real estate lending funds while internalizing the asset manager into a publicly traded mortgage REIT with an attractive dividend yield (11.9%-12.4% yield). Trinity secured a $75mm PIPE from Farallon with an option for another $25mm investment in Broadmark shares and sponsor warrants.
After initially lowballing warrant holders, the sponsor has increased its offer to $1.60 of cash per warrant plus warrants exercisable into ¼ of a share at $11.50 (or $2.875 per quarter) while removing the anti-dilution provision that would have lowered the warrant strikes when dividends were paid. We believe Black Scholes assigns an approximate $0.30 value to the pro-forma warrants. TMXCW trades at $1.27 today; if the deal closes as planned, investors will receive $1.60 in cash and a pro-forma warrant worth an estimated $0.30 for a 50% total return.
Broadmark will be an internally managed unlevered mREIT that makes short-term secured loans to CRE developers and investors. As of March 2019, their book had approximately $1bn of loan commitments, $661mm of which are funded, represented by 200 different borrowers. Typical loan size is under $4mm and repaid in 15 months. Broadmark’s book is funded entirely by equity and has a maximum LTV of 65% on all loans. The company was originally founded in 2010 to fill the vacuum left by banks that pulled back from the developer space post the 2007-2008 financial crisis. If you’d like more details on their loan book and returns, their website and accompanying investor deck lays it out.
Bottom line for TMCXW buyers is that the Broadmark team has developed a robust underwriting track record over the last 9 years with very low loss rates (30 out of 965 loans have defaulted) and an emphasis on growing, non-judicial states. From our analysis, there is no reason to believe Broadmark would not be warmly accepted by yield chasing public markets.
Purpose of Transaction
Broadmark will pay $162.5mm to purchase the management companies of each fund (5.4x expected TTM adjusted net income of $30.1mm as of March 31, 2019) in a 60% ash 40% stock deal. The sponsor believes internalizing Broadmark’s four loan funds will generate $31.2mm of annual cash savings in return. In addition to the accretive management company acquisitions, Broadmark will have an additional $280mm of cash to invest in new loans. Historically Broadmark has squeezed an all-in yield of 16.7% out of these deals.
The newly formed REIT also intends to raise and manage private REITs in the future, which will generate additional fees for shareholders. Lastly, managers of permanent public capital typically trade at premium multiples to book, creating a potential valuation bump for shareholders down the road.
We use the following Black-Scholes inputs to arrive at a $0.29-$0.42 value for the ¼ warrants:
TMCXW last traded at $1.27. Even assuming a one month delay, if the transaction is closed and cash payment made by 12/31/2019, we arrive at a total return of 50% and an IRR of 394% over a 3 month holding period, using a warrant value of $0.30. Given the company has already lined up Farralon to backstop the deal, we think the likelihood of closing is extremely high. Nearly all deals with a PIPE / forward financing agreement close.
In our experience with SPACs, once the deal has gotten to this stage it takes a credit market collapse or act of God to prevent it from going through. The bankers, sponsors, sellers, Farallon and warrant holders are all incentivized to close. Of course if the deal does fail, the warrants will be worthless. We estimate the market is assigning a 33% chance of failure to the deal based on a market ask of $1.27 for a warrant with $1.90 of potential value if it goes through. This is an excessively pessimistic view on the odds of closing for a deal so close to the finish line.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.