Special purpose acquisition companies (SPACs) have been a pertinent stock market trend in the past year. Some 200 SPACs went public in 2020 and similar numbers are expected this year. One that’s been making the rounds recently, though — the largest by value — is Pershing Square Tontine Holdings (NYSE:PSTH). With rumors swirling around its merger and a few juggernaut targets, PSTH stock is up over 32% in the past three months.
In fact, this name is trading at a nearly 47% premium to its $20 redemption price. However, with little growth in the past month, it appears that most of the hype has been priced-in.
Pershing Square is not your typical SPAC that could go parabolic after merging with a high-flying upstart. Led by billionaire investor Bill Ackman, the company is looking for a “mature unicorn.” So, don’t expect the sexy returns you would normally see from a SPAC merger these days.
Maybe more importantly, though — as InvestorPlace’s Thomas Niel points out — SPACs are in the midst of a bubble that’s likely to burst in the not-so-distant future.
PSTH Stock Is Chasing a Mature Unicorn
Pershing Square laid out its long list of requirements for its merger target in a filing last year. As I said before, Ackman is not looking to merge with an up-and-coming startup. Instead, PSTH is seeking out a partner that’s stalwart in its field and could use the merger proceeds to expand its business. In adding value to that target, Pershing Square is also seeking board representation.
The most obvious requirement, though, is that PSTH is after a company with stable revenues, cash flows and a tried-and-true business model. So, the company needs to have a strong competitive advantage in its industry with little-to-no cyclicality.
The other important aspect is financial health. For Pershing to merge with a company, that target needs to have a strong liquidity position in carrying out its daily operations effectively. That means a solid track record of generating healthy free cash flows.
And finally, the target needs to have limited exposure to external forces. In other words, the regulatory risk associated with the company should be considerably low.
That’s a hefty list. So, Ackman’s search for an established-business merger target leaves PSTH stock limited runway. Much of the hype appears to be priced-in already. With little downside risk, worthwhile returns are not likely.
The SPAC Bubble Will Burst
With SPACs dominating the investment world in 2020, though, it begs a question: what will they do in 2021?
There are different schools of thought, but one interesting article in the Wall Street Journal recently brought up a big issue: SPACs are in a bubble that could burst this year.
The writers,and that the SPAC mergers between January 2019 and June 2020 “lost 12% of their value within six months following the merger.” Moreover, there is little incentive for SPAC shareholders to remain invested in a company for the long haul. Those who redeem their shares are in a much better position — and essentially dilute long-term investors’ returns in the process.
SPAC advocates have often claimed that this kind of merger is significantly cheaper than a traditional initial public offering (IPO). That’s true. However, part of the reason the process is cheaper is because SPAC shareholders have to bear the dilution cost, which is inherent to the arrangement. Therefore, the current prices for SPACs — names like PSTH stock — are significantly overvalued at this point.
Final Word on Pershing Square Tontine
When it comes to investing in the company, the rumors surrounding Pershing Square Tontine’s merger are irrelevant for the most part. As I mentioned before, much of the hype has been priced-in already. Plus, PSTH’s lofty target requirements leave little upside for investors.
But most importantly, the SPAC bubble is seemingly ready to burst. The market is frothy. So, my advice? It’s best to avoid PSTH stock for now.
On the date of publication, Muslim Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article
Muslim Farooque is a keen investor and an optimist at heart. A life-long gamer and tech enthusiast, he has a particular affinity for analyzing technology stocks. Muslim holds a bachelor’s of science degree in applied accounting from Oxford Brookes University. He does not directly own the securities mentioned above.