Editors Note: this article was updated on April 19, 2021, to correct the cash number.
The structure of special purpose acquisition companies (SPACs) like Pershing Square Tontine (NYSE:PSTH) is relatively simple. Investors own PSTH stock until the company announces a plan to merge with an existing business. If they like the deal, they stick around. If they don’t, they get their money back.
Admittedly, that standard structure hasn’t quite played out with PSTH, at least for retail investors. Pershing Square Tontine’s own initial public offering (IPO) saw it issue units at $20, which included one share and one-ninth of a warrant to buy more shares at $23. But PSTH opened its first day of trading at $22. Investors who didn’t get into the IPO, which was oversubscribed, have had to pay a premium.
That said, the SPAC also has an innovative structure in which shareholders who elect to participate in the merger get more warrants: two-ninths of a warrant, also exercisable at $23. That incremental value offset some of the premium paid to the $20 redemption price (which is itself unusual, as most SPACs price at $10).
The details are unique, but the core argument for PSTH stock was somewhat similar to most SPACs. As one hedge-fund manager who bought units at around $21 noted, it’s “heads I win, tails I don’t lose much.”
But the problem is that PSTH is now at about $29 and is still without a merger announced. That rally gives Pershing Square Tontine the same problems facing so many other SPACs at the moment.
PSTH Stock: Don’t Ignore Dilution
Essentially, a SPAC is a big pot of money. Right now, Pershing Square Tontine has about $4 billion in its pot, after selling 200 million units at the $20 price.
But here’s the catch: the pot doesn’t have $20 per share in it. All SPAC structures reserve shares and/or warrants for initial purchasers and the SPAC sponsor. The latter, in this case, is an affiliate of hedge fund Pershing Square.
PSTH stock is no different. It has 200 million shares outstanding. But the units at IPO included 22.2 million warrants. There are 44.4 million “tontine” warrants (referring to a formerly popular investment plan) granted for investors who stay through the merger close.
Another 6.21% of the post-merger shares outstanding are subject to warrants given to the sponsor and the directors of Pershing Square Tontine. Those warrants are exercisable at $24, though they must be held for three years after the merger closes.
Suddenly, the share count is ballooning in a hurry.
What Dilution Means for PSTH
Between the higher share price for PSTH stock and the higher share count, the math becomes problematic.
Assuming the stock simply holds this level, there are effectively 266.6 million shares outstanding, including in-the-money warrants. (We’ll assume that no one redeems their shares for $20, as that move would make no sense).
Those 266.6 million shares cover a cash pot that totals $5.53 billion. ($4 billion from the IPO, plus $1.53 billion from exercise of 66.6 million warrants at $23).
But those 266.6 million shares, with PSTH at yesterday’s close of $28.87, right now are being valued at $7.69 billion.
What the current stock price says is that Pershing Square and its head, Bill Ackman, are going to create some $2 billion in equity value. But even that’s not correct.
Pershing Square Tontine has entered into forward purchase agreements to sell as much as $1 billion in additional units. These units include one-third of a warrant.
That $1 billion is added to the cash pile, obviously. But so are 66.6 million more shares, as the incremental 50 million units create 50 million new shares and 16.6 million new warrants.
So, now there are 333.2 million shares and a cash hoard of $6.91 billion (including the $1 billion in forward purchases and another $380 million from the presumed exercise of those warrants). At $28.87, those shares are worth $9.69 billion. And we haven’t covered the 6.2% ownership coming to directors and sponsors at $24 three years after close.
Too Good to Be True
SPACs sometimes look like magic: either you like the deal or you get your money back. There’s no risk. It seems too good to be true.
But the math here shows why it is too good to be true. The problem with pricing a pre-merger SPAC at a premium is that when the details are considered, the redemption price already is a premium to the actual cash in the SPAC.
And, again, that’s all a SPAC is: a pot of cash, plus optionality on a deal. The problem with the pre-merger rally in PSTH stock is that the optionality is trading at a huge price. Simply to support the current price, Pershing Square Tontine needs to get a merger target who will give it roughly $10 billion in equity value in exchange for roughly $6.9 billion in cash.
That’s a huge ask. And it’s even bigger when you consider the relatively narrow universe the SPAC is targeting.
Finding a Target
As Ackman said back in July, PSTH is “a unicorn looking to marry another unicorn.”
There aren’t many unicorns out there, however. Airbnb (NASDAQ:ABNB) and Doordash (NYSE:DASH) — two potentially logical targets — just went public. Lucid Motors might have made some sense, but it’s tying up with Churchill Capital Corp IV (NYSE:CCIV) in another deal that highlights the risk in pre-merger SPAC rallies.
So, there simply aren’t a lot of private companies out there worth $30 billion or more, which is roughly what’s contemplated by PSTH’s sheer size. Maybe the only 2020 IPOs executed at that valuation range were Airbnb, DoorDash and Snowflake (NYSE:SNOW).
This is another broader issue for SPACs. The sheer explosion in their popularity has brought an awful lot of private companies to the public markets. How many of the best choices are left?
Pershing Square Tontine has to find one of those choices. It then needs to convince that ‘unicorn’ — which already has the option of going the traditional IPO route — to hand over substantial equity value in exchange for capital it can get elsewhere. And even if it does all that, PSTH stock still doesn’t necessarily gain.
It seems like too much to ask.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.