Valuation Update: SPAC-Related Securities

Back in April, the SEC issued guidance on accounting and reporting for the warrants that special-purpose acquisition companies use to raise money. Since then, there has been considerable effort to get the numbers right for these warrants and a number of other SPAC-related securities as well.

A SPAC, or blank check company, issues equity for the sole purpose of acquiring a private company, bringing them public in a manner other than a direct IPO listing. (This event may be referred to as a business combination, a merger, or simply a de-SPAC event.) Typically, a share of SPAC stock is priced at $10.00. Upon the merger, the holders of the stock can elect to have their shares converted based on a $10.00 assumed merger value or redeem the shares at $10.00 plus accrued interest. If a merger doesn’t occur, the $10.00 investment is returned to the investors with interest.

In this blog post, we discuss some of the more frequent elements we’ve seen and considerations for their valuation.[1]

Instruments Issued in Conjunction with a SPAC IPO

Warrants

Still the most frequent valuation concern for SPACs is the warrants. These securities allow for holders to buy the underlying stock at a fixed price, usually $11.50, anytime during the five years from the de-SPAC merger date. SPAC warrants will be divided into two groups, public warrants that are sold to outside investors and private warrants that are granted to sponsors and other related entities.

When working with SPAC warrants, it’s crucial to consider both the lifecycle and the economic rights of the securities. A few things to keep in mind about the lifecycle:

• At the IPO, a unit is sold which includes a fraction of a warrant along with a common share. After a 52-day period, the warrants begin to trade separately. The initial valuations incorporate the fact that the unit value is $10.00 (or the traded unit price after IPO).
• After the separation date, the trading price of the public warrant can be used. However, there may need to be adjustments based on the rights of the preferred stock.
• After the business combination, there may be a difference in volatility between the public warrants, peer companies, and implied volatility for the warrants. Care should be exercised in developing a volatility estimate in these cases.

As with any security, the economic rights can have a significant impact on the model used. The critical features on SPAC warrants typically involve the call provisions and differences between them for the public and private warrants.

• Public SPAC warrants typically have two calls, one if the stock trades above $18.00 for 20 out of 30 trading days, and one with a make-whole provision if the stock trades between $10.00 and $18.00. For valuing this, the specific rights should be considered, often resulting in a lattice or Monte Carlo model.
• The make-whole provision provides a specific added number of shares on calls. At low volatilities, it’s often ineffective. But at higher public company volatilities, it may be advantageous for the company to call. This requires a lattice model such as a binomial to model the company’s decision.
• In some cases, the private warrant is subject to a call provision wherein it can be called on the same or similar terms to the public warrants. In this case, the value should be identical or very similar. In other cases, the private warrants are not callable and thus they will have a higher value. This difference in value can be significant if the stock price approaches the $18.00 call threshold, as the public warrant will lose their time value.

Overallotment Option

An overallotment option is given to underwriters of an IPO and allows them to sell more of the security—in this case, the SPAC units—up to 45 days after the IPO if demand warrants. These overallotment options are nothing new to SPACs. They’re frequently called greenshoe options, or simply the “shoe,” after the first company to include this: Green Shoe Manufacturing in 1960.[2]

If the option is exercised alongside the IPO, this option would have no value, as the fair value of the units sold are equal to other units. If the option is available after the IPO, the underwriters can profit if the unit value increases. In this case, volatility is limited as the entire term of the option will be over well before the company has found a merger target, so only the fluctuation of new SPACs should be considered.

Forward Purchase Agreement

A forward purchase agreement, or FPA, is a contract to buy additional units in the SPAC upon a business combination. They may be designed as either optional or mandatory purchases, and again stick to the $10.00 unit purchase price.

Like many other instruments involving a SPAC, the value of this agreement relies on the fact that it may be reasonable to assume the future stock price is equal to the redemption price. In this case, if the stock is $10.00 as of the business combination, the unit value must be above, so an FPA may be deemed to have the same value as the underlying warrant fraction.

Instruments Issued During a SPAC’s Lifecycle

Convertible Promissory Notes

SPACs frequently receive convertible promissory notes from affiliates of their sponsors. These notes may not pay interest and are payable only in cases of a business combination. They’re convertible into warrants at a fixed price.

Because these notes are with an affiliate of the sponsor, there’s no expectation that they’re entered into at their fair value. When valuing these, we consider that the stock price in the future is expected to be $10.00, based on the redemption and conversion price related to the deal. As such, it’s possible to determine what the expected value of the warrants will be—and based on this, the expected value of the convertibility feature of these promissory notes.

It’s very common for warrants to trade well below the conversion price for the whole term of the SPAC prior to the business combination. In this case, it may be possible to conclude that they have little or no value by considering what changes would need to occur to generate a higher value of the warrants, and whether these changes appear plausible.

Instruments Issued in Conjunction with a Business Combination

Earn-Out Shares

Earn-out shares are shares payable after the de-SPAC merger and pay shares if the stock price exceeds a hurdle amount for 20 of 30 days.  We’ve seen this barrier range from $12.50 to $50.00 for various tranches and purposes. These earn-out shares are typically covered by ASC 718 because they’re equity securities granted to employees and others based on service.

The valuation methodology is the same as that for similar performance-vested restricted stock units. Since the hurdle can be hit at any time, a Monte Carlo simulation model is used.

Private Investment in Public Equity

To increase the market capitalization of the SPAC and cover for redemptions, SPACs often carry out a private investment in public equity (PIPE) deal in which they sell stock to outside companies. This deal can give a direct indication of the value of the equity, often for the $10.00 redemption price. There are two significant considerations when looking at PIPE deals as an indicator of value.

• In recent deals, we’ve often seen more complex transactions where the $10.00 purchase will include a sweetener like extra warrants or earn-out shares. In these cases, the value of this component should be backed out in determining the value of the shares.
• Often this deal will involve restrictions on the sale of the security—a six-month lockup, for example. These restrictions, which help to stabilize the stock price, are typically accompanied by a discounted price that investors pay.

Equity in the Pre-Merger Target

While not related to the SPAC, some investors may have shares of a company that has announced a deal with a SPAC. For these entities, we consider two potential differences between the SPAC value and their own.

• The first is the probability of a deal breaking up. Although rare, deals have broken up post announcement. The most high-profile example is The Topps Company, whose deal with Mudrick Capital Acquisition Corp. II fell through after losing a licensing deal with Major League Baseball. In this case, holders of Topps bore all of the losses, while SPAC holders were able to redeem for their original $10.00.
• The second potential difference is that the shares in the target are not marketable until the merger occurs. While this discount may be smaller than other discounts due to the shorter horizon, it still may be a meaningful difference between the target and SPAC cost.

Of course, every deal has its own unique factors. So pay close attention to the facts and circumstances in valuing any instrument related to these novel deal structures.

[1] The figures or features we discuss here are based on structures that are typical for most deals in which they occur.

[2] Green Shoe Manufacturing changed their name in 1966 to the Stride Rite Corporation, continuing to this day as part of Wolverine Worldwide. Despite their original name, they were never a company in the business of footwear for Santa’s elves. Rather the name comes from founder Philip Green.