With Meager Expected Returns, Don’t Buy CCIV Stock on a Rumor

Churchill Capital IV (NYSE:CCIV), a special purpose acquisition company (SPAC) that has not yet declared any merger target, spiked this week on rumors of a deal. The question is whether to chase CCIV stock in hope that the rumors are true.

Depth of field shot of an electric vehicle being charged.

Source: Shutterstock

On Jan. 11, CCIV stock rose to $13.20 and later spiked to $18.36 by Friday, Jan. 15. based on news reports of a huge merger deal. It will open this morning at around $17.90

The problem is you should never buy a SPAC stock based on a rumored deal, especially since the deal might fall through.

As it stands, the Bloomberg report on Jan. 11 was pretty specific. Apparently, Lucid Motors, another electric vehicle manufacturer, is considering going public via CCIV stock in a reverse merger.

The report said that both companies were in talks and that the deal could be valued at up to $15 billion. However, neither the company nor Churchill Capital would confirm or deny the deal.

The Rumored Deal and CCIV Stock

And that is the quandary. The report implies that investing in CCIV stock is highly speculative.

What if Lucid Motors rejects any deal from this particular SPAC? They could easily move on to the next interested SPAC and cut a sweeter deal. Then where would all the CCIV stock owners be, especially those that bought close to $18.00?

In fact, Seeking Alpha reported on Jan. 14, that the deal might not go through after all. The problem for most buyers of CCIV stock is they have to guess whether any kind of merger will go through.

In that case, even if deal is announced, CCIV stock is likely to move significantly higher. This is because the deal, at a $15 billion valuation, assumes a $10 price for CCIV stock.

Assuming a merger goes through, with say, $1 billion in cash provided to Lucid Motors, could result in a $25 to $30 billion valuation. That implies a price of $25 to $30 for CCIV stock.

That is the theory about why anyone would buy CCIV stock at $18.00 and change. But if the deal falls through, you face a potential loss of close to $8.00 per share, or 43.6%. This is seen by dividing $8.00 into the near-top price of $18.36.

So, here is the quandary again. It is a binary scenario. If a deal is announced, there could be a gain of 80% to 100%. but if the deal falls through, there is a potential 46% loss.

Let’s use probability analysis to come up with an expected return.

Probability Analysis on a Lucid Deal

Given that there are a number of solid rumors and press speculation on a Lucid – CCIV stock deal, we can set the odds at greater than 50-50. Let’s call it 55%.

Therefore we multiply 55% by the gain of at least 80%, the expected return is 44% (i.e., 80% times 55%).

However, the possibility of an 80% loss is 45% (i.e. 1 minus the 55% chance of a deal). Therefore, in that scenario, the expected return is negative 36%. This is found by multiplying a negative 80% by 45%.

Now we can add up the two scenarios. The expected return with a deal is +44%, and the expected return without a deal is -36%. Therefore the total expected return is still positive at 8% (i.e., 44% minus 36%).

But let’s be honest. That is not a great return. In fact, the deal is breakeven with just a 50% chance of a deal. Those are not good odds.

What to Do With CCIV Stock

An 8% ROI after buying CCIV stock at this price today is not a good deal. It would be much better to wait until a deal is announced.

For example, let’s say that once a merger proposition is put forward the company presents what it believes its earnings will be in the next five years. That might allow an investor to judge that CCIV stock could do more than double as in our scenario.

As a result, the odds would be better once more information is known. Therefore, the moral of the story here is never be in a rush to buy a SPAC stock before a merger deal is announced.

On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.

Mark Hake runs the Total Yield Value Guide which you can review here.

Article printed from InvestorPlace Media, https://investorplace.com/2021/01/dont-buy-cciv-stock-on-rumors/.

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