Odey’s Courtenay: The SPARC Conversion Of Bill Ackman’s SPAC Is A Wise Move

Special purpose acquisition companies (SPACs) have gotten a lot of attention this year. They skyrocketed in popularity due to the ease they offer to private companies that want to go public but can’t complete a traditional initial public offering.

Pershing Square proposes converting its SPAC to a SPARC

However, there is a similar company type that investors should understand, and Adrian Courtenay of Odey explains in his November letter to investors. Bill Ackman’s Pershing Square Tontine Holdings hadn’t found a company to merge with yet, and it has proposed converting to a special purpose acquisition company (SPARC).

The Securities and Exchange Commission was set to approve the SPARC conversion on December 9, although there’s been no word on whether it did. However, all signs suggested that the SEC would indeed approve the conversion. Even if the regulator wouldn’t approve the new structure for the New York Stock Exchange, the SPARC warrants would still trade over the counter.

Courtenay is positive on the SPARC conversion as Odey owned almost 190,000 common shares of Pershing Square Tontine Holdings priced at $20.16 and more than 480,000 warrants priced at $1.58. He said the Odey Special Situations Fund should receive a sizable gain from the SPARC conversion

SPAC versus SPARC

To demonstrate the opportunity he sees for the Odey Special Situations Fund, Courtenay starts by explaining the differences between a SPAC and a SPARC. A SPAC is a blank check company, which means it is a shell company listed as a publicly-traded stock on an exchange (the New York Stock Exchange in this case). The shell company was formed for the purpose of merging with a privately-held company, taking it public in the process.

SPACs allow their shareholders to opt out after they find out what company the SPAC will merge with. However, that means shareholders must provide their capital upfront and wait up to two years to find out which company the SPAC will merge with. If they don’t like the company selected for the merger, they can have their money returned to them.

Courtenay adds that the SPAC structure has several inefficiencies that are addressed with the SPARC structure. SPARCs are the reverse of SPACs in that instead of putting their cash upfront, shareholders hold onto their money until the SPARC identifies the company it plans to merge with.

Ackman’s plans for his SPARC

On a conference call on November 18, Ackman explained that under the SPARC structure, they intend to distribute warrants to the shareholders of Pershing Square Tontine Holdings for free. If they aren’t in the middle of a transaction at that time, they plan to seek a shareholder vote to return the capital to shareholders, leaving them with no investment. They will still own a publicly-traded warrant that entitles them to invest in the company’s next transaction at net asset value when it is announced.

The conversion would result in the return of $20 for every share of the SPAC owned and the issuance of one SPAR warrant. The conversion will also distribute two SPARC warrants to every SPAC warrant holder and cancel all the old SPAC warrants. Implied pricing would be at 68 cents.

He adds that 1.1 million SPAR warrants worth 68 cents each have an aggregate market value of about $750,000 or 0.9% of the Odey Special Situations Fund‘s value. Meanwhile, the aggregated delta or market sensitivity of the holding in its current SPAC form is 9.5% of net asset value. The SPARC conversion means that just 0.9% of the Odey fund’s net asset value is at risk, versus 9.5% in the company’s SPAC form.

Courtenay sees upside scenarios for the SPAR warrants as high as $14 apiece in the base case and higher valuations when considering “more subjective inputs.” He added that relative to the warrants’ current pricing at 68 cents each, the capital allocation “offers both a meaningful asymmetry in outcomes and a significant prospective profit scenario.”

“Substantially more valuable” SPARC warrants

Ackman notes that the issuance of SPAR warrants for each SPAC warrant doesn’t appear to be widely understood and that the SPAR warrants “should be substantially more valuable.” Courtenay explained that in terms of the Odey Special Situations Fund, they have found that there is typically a “market inefficiency time window” after a deal or restructuring announcement during which market participants digest the disclosed information.

In the case of a more standard merger transaction, the time window may last only hours. However, the window may last months in more complex situations requiring regulatory appraisal and bespoke financial modeling. Courtenay believes this is why the proposed SPARC conversion “remains significantly under-priced.”

Pershing Square Tontine explained in a press release in August that one reason the SPAR warrants are more valuable than the SPAC warrants is that they have a much longer term than the existing SPAC warrants. That means they have a higher probability of becoming effective in a merger, while the SPAC warrants had a much shorter term left before a merger must be completed.

Adjusting the valuation of the SPAR warrants

At the time of the conversion, the SPAC warrants had only six months left before the company must complete a merger. On the other hand, the SPAR warrants had 10 years left, lifting their value by seven times from the implied pricing of 68 cents to $4.74, according to Courtenay, who applied a Black Scholes modeling framework to come up with this valuation.

He also explains that SPAR warrants are evergreen. After the first transaction is announced, a new successor warrant is issued free to existing warrant holders in lieu of the next transaction. On the other hand, a SPAC structure is one-off in nature. In other words, as Ackman pointed out on the November 18 conference call, the benefit of the SPARC structure is that they will “always have an evergreen entity that we can use to complete a transaction.”

That means the SPAR valuation must include the valuation of a stream of successor warrants. It’s necessary to make an assumption about the amount of time between each deal. Courtenay assumed conservatively three years. He added that they must also apply an annual discount factor to represent the time value of money and the execution risk of a multi-year series of identifying and completing mergers. Conservatively, he assumes an annual discount of 15%, which lifts the valuation of the SPAR warrant even more to $13.82.

Courtenay believes that the SPARC structure should not be understood as financial engineering. The primary variable in the SPARC structure is that it achieves much greater financial efficiency because it does not require a series of multiple SPAC IPOs, each costing 5.5% of the monies raised in underwriting expenses. It also eliminates the need for significant dilution after the merger closes to repay the sponsor’s cost in funding the initial IPO.

Courtenay also points out that the Pershing Square SPARC benefits from Bill Ackman’s experience and the experience of his team, which should also be factored into the valuation.