Decyphering SPAC of Oil & Gas companies, the valuation enigma

First and foremost, I would like to thank the readers for the unexpectedly rousing responses to the first part of discussions on SPAC, which we had tried to unravel certain aspects of the SPAC in Malaysia.

This time round we are going to look a bit deeper into the valuation aspect of the SPAC, at IPO, before qualifying acquisition and after qualifying acquisition.

At IPO

As we all know, SPAC is a 'shell' company and in my view, works in a similar fashion as a private equity fund/outfit.Basically it does not have any business, just a 'plan to make money in the oil and gas sector' and a group of experienced professionals who, in a way, 'promised' to turn that plan into a reality via acquiring businesses or part of businesses (inorganic growth). There were in a way, no hard assets and the only 'assets' would be the know-how and know-who of the management and promoters of the SPAC.

Because of the absence of businesses, there would be no fundamental analysis or valuation based on the fundamental to find the intrinsic value of the SPAC. No PE, Price to book, EV/EBITDA or the likes. The parameters were simply not there. We can't do it. We can't even do a projection of DCF because no possible business has been identified at that juncture. That was why some quarters dubbed such pooling of funds as 'blind fund'. I don't agree with that term though, I would term is as 'pure faith' fund.

This would also explain why some investors who had invested in IPOs before might be a bit baffled, especially if they were used to having a point of reference, an intrinsic value to give an indication on the value of the shares that they were paying.

I hold this opinion about the value and price of shares listed on an exchange. They are different but linked. The intrinsic value of the shares is not the same as the price of the shares. What were transacted on the exchange were the prices of the shares, determined by the supply and demand of the shares - someone was willing to sell at that price to someone who was willing to buy at that price. Simple as that.

Intrinsic value or valuation, in my book, is akin to a shadow in a painting  or drawing. If we were to draw a chicken on a clean white canvas , the chicken will look like it is hanging in midair (this is fasting month so my analogies and references are automatically drawn to food or its source, my apologies). Once we drew the shadow for the chicken, then we would be able get the perspective of position. That, in my book, what intrinsic valuation does. It brings perspective to the price of the shares (the picture of the chicken).

So, in the case of a SPAC, that was what was missing. You have a price yet you have no calculation of intrinsic value. That should explain why some people could not grasp with the price of the SPAC - they are unable to get a perspective on the price. There was no reference point.

So then how did they arrive at RM0.75 sen a share or RM0.50 sen a share or even RM1.00 per share? What were the basis?

The only way I was able to put this into perspective was to go back to the most basic of valuation and not rely on the per share valuation techniques available. I looked at the price of equity stake. Meaning I had lumped the entire shareholders together and split them into two groups, original shareholder and IPO shareholders.

The original shareholders and IPO shareholders would make up 100% of the total equity stake in the company, no more, no less (Yes there were warrants  but they were almost evenly distributed so we can ignore it for the moment). So, if the IPO shareholders, collectively, held 75% of the SPAC after the IPO, that means the original shareholders, collectively, would have held 25% stake in the company.

To repeat what I wrote in the previous article:

"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."

Therefore, in order words, if I was to compare the three SPACs, the common denominator would be how much were the total value/worth 'given' to the original shareholders for their collective skills and connections. As rough 'ranking' (not to be taken as real valuation) indication for discussion purpose:
Hibiscus: RM78 million ( divided by 24% will give you RM3 million per 1% interest
CLIQ: RM109 million (divided by 25%, RM4.36 million per 1% interest)
SONA: RM155 million (divided by 23%, RM6.74 million per 1% interest)

Whether this is too much or too little is anybody's guess. This is, in my view and please correct me if I am wrong, the 'price' the shareholders paid to the management of the SPAC for creating this opportunity.

Before qualifying acquisition

At this juncture, the shares would be listed and traded on the stock exchange.

But the situation with regards to the intrinsic value remained the same, as there are no business and hard assets to speak of.

But the situation surrounding the shares and their prices have changed. While the IPO price was fixed, the open market price was not and would move depending on the supply and demand for the shares. But again, without the intrinsic valuations, it would be purely supply and demand.

It would be understandable if some investors, who are used to having fundamental valuation to back the price, feeling a bit queasy, almost sea sick. Some of my friends argued that I should anchor the price of SPAC to the 90% of the IPO proceeds as that was hard cash. Indeed that may be the floor IF there was no qualifying acquisition and the SPAC is still under the obligation to return the 90% of the proceeds back to the holders of the IPO shares.

I can buy into this argument at this juncture. As long as I have an unimpeded, unrestricted right, to 90% of the IPO price, the the value 'backing' the shares should be exactly that. I mean cash is cash. If the share price dropped below 90% of the IPO price, I would technically be making an arbitrage on the shares. There would be no risk (with the option to pull out on full receipt of the cash with interest) and I would be making a profit on the difference between the share price and the cash receipt (in case of pull outs).

But if there is any possibility or risk of me not getting the cash receipt in full when I opt out, then this does not work. Also I have to remember that I can only exercise this option during special occasions: when the company is seeking approval for a qualifying acquisition or after 3 years with no qualifying acquisition.

The same friends used this cash return clause to argue that SPAC investment is safe. SPAC ensured that you will get your money back (assuming the 3% annual interest makes up for the 10% of the IPO proceeds that were non-returnable) within 3 years. Well, my answer is that if you wanted risk free investment, then put the money in any (islamic :-) ) bank, you will at least make some profit at the end of the year. In my view, investment in SPAC is an equity investment which must be compared with the opportunity cost of investing in equity, oil and gas companies to be more accurate.

After qualifying acquisition

After a SPAC made its qualifying acquisition, it should now have its intrinsic value brought by the fundamentals of the acquiree company (or part thereof). It is therefore important to note the affect of the qualifying acquisition to the fundamental or intrinsic valuation of the SPAC post acquisition.  Would the numbers be able to support the share price (or IPO price) when compared with the rest of the oil and gas players.

Back to the analogy of drawing earlier, the picture of the chicken now has a shadow, a point of reference. And when we put that picture of our chicken to the picture of another chicken, we would get a perspective of scale. In a sense, where did the company rank amongst its peers.

In this situation, the SPAC is no longer a SPAC, but an oil and gas company and could be compared, fundamentally, with other oil and gas companies. And the price will adjust accordingly.

Reminder: The above are my personal views and shared with the intention of creating discussions (and in turn increases [my] understanding) of the SPAC. It is NO WAY a recommendation to buy or sell any SPAC.