THE WRITINGS BELOW ARE FOR EDUCATIONAL DISCUSSIONS ONLY. IT IS NOT AN ADVICE TO BUY OR SELL ANY SHARES OR SECURITIES
What is a SPAC?
In my book it is like a private equity investment model made available to the public. Private equity investment is where people pool their money together with the intention of investing in businesses that will generate profit and cash flow back to the shareholders. The main difference between SPAC and a conventional private equity model is that in a conventional private equity model, the fund is held private; meaning it is not offered to the public and it is not publicly traded. SPAC, through an IPO makes its shares available to the public, and by having the company listed on an exchange like Bursa Malaysia makes it possible to trade the shares over the exchange.
In a nutshell, although the liquidity of shares are different, the business model is still the same. As an acquisition company (which is similar to a private equity fund), the company makes its money by making SUCCESSFUL acquisitions. Unsuccessful acquisition should technically destroys value (which we would understand once we see how value and price are different animals.
If SPAC is so risky why did the regulators allow the listing?
I don't know.
But if I were to hazard a guess it would be because the regulators want to make the market more attractive to the local and international investing community by having more products on the market. A stock market is not unlike a wet market, the more products there are in the market, more people will come and buy things. We can see the regulators in the recent past introduced Closed Ended Funds, REIT (somewhat successful now), Exchange Traded Funds (lukewarm), Exchange Traded Bonds (almost cold), Business Trust (huh really?) and now SPAC.
Whether this is good or bad for the market is subjective and only time will tell. There has been talks that the SPAC market in the US has fizzled down and that other more developed market not even allowing SPAC listing on their market due to its risky nature but I think this time I agree with the regulators. In developing the market you got to take chances and SPAC is kinda a calculated risk. In development, you are going to end up either a hero or a zero, but that is better than not doing anything.
Are the investors paying too much for the SPAC?
Everything has a price and the key principle to investing is to get back more than what you paid for the investment. In the case of SPAC, the investing public paid the IPO price to get the investment. Collectively, the public paid RM235 million for approximately 74% stake in Hibiscus Petroleum, RM364 million for roughly 75% stake in CLIQ Enengy and RM550 million for roughly 77% stake in Sona Petroleum.
The rest of the respective stake in the companies are owned by the management and pre-ipo investors and this is how much they are worth (approximately) at ipo: Hibiscus (RM78 million), CLIQ (RM109 million) and Sona (RM155 million). Since there are no assets in the company except the expertise of the management, I would look at it as this being the value of the management (mostly) and their aim to generate return by making successful acquisition(s) in the oil and gas industry.
Someone was quick to point out that these are only on paper and they cannot sell the shares. True. But then you need to remember that the company does not have to return back the 10% of funds raised from the IPO and up until recently when the regulators changed the guidelines, that amount could be used to pay the salaries of the management. With regards to the 3 SPAC above, the approximate numbers are RM23 million for Hibiscus, RM36 million for CLIQ and RM55 million for Sona, CASH. Not a bad return for all the cost and expenses in setting up the SPAC and going through the IPO.
Anyway, back to the investors. Based on my opinion that this is a private equity in nature, what kind of return would I expect? This is important as it would determine the price I would be willing to pay and the quality of the qualifying investments later.
For me as an investor, I would expect at least a 30% return on my investment in a risky private equity venture. If normal equity investment in a running business, the high teens should be acceptable but the risk in SPAC is way higher, so I personally would put 30% as the expected hurdle rate. We all have different views and risk tolerance so you got to find your own. But what does 30% means. It means that I would get 30% return (profit) on my investment each year. If I invested RM1 ringgit, I want 30 sen profit back every year.
Too much? Well, that is when the concept of opportunity cost come into play because if it is not going to give me 30 sen return, I could use the same RM1.00 to get a profit of say 18 sen from a company which is already running and has a track record.
So, is the hundreds of millions for approximately 75% stake in the company, was it a fair price? At the point of listing, nobody knows. It will depend on the belief of the investors of what would be the management's capability to generate the returns, the profits. For the purpose of illustration, if you (the public shareholders) had paid RM100 million for 75% of the company, the entire company would assume a value of RM133 million. 30% profit from RM133 million would be RM39 million. This would give you a PER of 3.4 times, crudely.
What would be my floor? Well in order to find the minimum level of expected profits, I would have to look at the average earnings of the other oil and gas companies. Lets assume the PER is 18 times. That means the price is 18 times of the expected earnings and if the price is RM133 million, then the expected annual earnings should be just over RM7 million per annum.
In any case, the above is based on RM100 million arbitrary figure, so the expected amount of profits will be proportionately higher the more money you collected from the public (for the same percentage of ownership).
Therefore SPAC is a great vehicle for those who understands the risks and expectations. It is a sheer gamble if you don't.
However, the value and expected return that were mentioned above are related to the intrinsic value of the business, not the price. I always hold the belief that the value and price of a business in not the same, and SPAC is the epitome of this concept. And this is most prevalent in a publicly traded company.
In an publicly traded SPAC, when the public shareholders invest they would hold tradable shares (we will talk about warrants later). The price of this shares is at the mercy of the supply and demand of the shares and valuations (PE, DCF etc) merely serve as a reference point relative to the price. The price of the shares include expectations, greed, risk aversion, liquidity, mandate, excess cash and other external factors, all rolled into one transacted price. In the case of SPAC then, even if there is no assets or profits being generated by the company, changes in expectation, greed level or risk aversions of the investors at large would have an impact on the prices the shares of the SPACs. If it goes up more than the IPO price, then the shareholders would make a positive return on its investment, if the price went down, then they would have made a capital loss. This is more pertinent to short term investors who has short holding period. They would be looking at the capital gain as a measure of return as opposed to the increase in the intrinsic value of the SPAC.
In a nutshell, short term investors in SPAC would need to bank on the increasing demand for SPAC shares to have the chance to make the return.For the long term investors, in addition to the demand for the shares, they would also need to take into consideration qualifying acquisition when it happens. This is important because once a qualifying acquisition takes place, the SPAC is no longer a SPAC; it then becomes an oil and gas company where the reference point now exists. As the profits and assets adds to the perspective of long term return, the price might adjust itself upwards or downwards accordingly.
It is also important when looking at a qualifying acquisition to ascertain the ability of the SPAC to realise the return of its investments in qualifying acquisitions. Some SPAC takes just enough equity interest to equity account the profit of the qualifying acqusition by in reality, have limited ability to realise that investment within SPAC itself at it does not have access to the cashflow of the company. In such case, it would be dependent on the dividend up-flow to the SPAC only. Therefore, take a bit more time to understand the weight of the 'profit' of a SPAC whenever you are presented with one.
Are the management and Pre-IPO shareholders getting too much from SPAC?
The answer to this question is that only time will tell as it would depend on the success of the qualifying acquisitions.
Why does SPAC issue warrants?
Warrant is an instrument of chance and probability. It is a derivative where the return on the warrants depends on the price of the shares (in this case shares of SPAC) rather than the intrinsic value of the company (directly). As we have discussed earlier, price and value are two different things and hence the price of share depends, significantly, over the demand and hype of the shares rather than just the valuation of the shares.
Warrants are also an instrument of volatility where the more volatile the underlying shares (of the SPAC), the more valuable would the warrant be. In addition to that the longer the duration of the warrants, the more valuable the warrant is.
Therefore, a warrant over a SPAC seemed like a perfect fit as SPAC, in the early days are almost purely speculative and is expected to be volatile. Offering free warrants to the subscribers of the IPO is in a way akin to giving a discount on the cost of subscribing for the shares. Hence if you were to say, forked out RM0.50 sen for one share and a warrant, your cost for the shares would reduce if you are able to sell your warrants for say 15 sen.
But why would there be a demand for warrants for SPAC? One of the reason could be that some people might find SPAC to be a very risky investment but they do not want to miss the boat if the SPAC managed to be a success. Well, warrants would just be a cheaper way to gain an indirect exposure to the price appreciation of the SPAC.
Well, these are some of the things that we have discussed about SPAC. If you have any question, please feel free to post them on the comments section below.
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