Editor’s Note: This article was updated on March 24, 2021, to remove incorrect information that said a Department of Justice investigation into Clover was still ongoing.
With all the buzz surrounding it, the shares of Clover Health Investments (NASDAQ:CLOV) have lost 18.4% of their value in the last month. The class-action lawyers are actively recruiting clients who own CLOV stock in light of the probe for all kinds of improper business practices.
Short-seller Hindenburg Research in February went after Clover’s business model which is predicated on selling and managing Medicare insurance in “low-income and often overlooked communities.” The report questioned the company’s practices and claimed that the DOJ is currently investigating multiple issue involving Clover, including potential kickbacks. Clover replied to the accusations, saying the only investigation the DOJ had done was a routine request for information, which was promptly complied with and completed.
My InvestorPlace colleagues Larry Ramer and Josh Enomoto discussed the issues hanging over Clover Health in late February and early March. I’ve linked to their articles should you want to read up on the subject.
The only time I’ve written about Clover Health’s special purpose acquisition company (SPAC) predecessor, Social Capital Hedosophia Corp. III, was last September before it merged with Clover in January.
IPOC, the SPAC’s symbol before changing to CLOV, was one of 10 SPACs I thought were worth considering as the investment vehicle grew in popularity. The fact that Social Capital Hedosophia had wisely tied itself to Richard Branson’s wagon by merging with Virgin Galactic (NYSE:SPCE) didn’t hurt its cause.
Little did I know that the SPAC would merge with a company that would ultimately get tied up in short-seller allegations knocking Clover’s share price down to below $9.
Yet, there’s one group of investors who aren’t sweating the details. Let me explain.
CLOV Stock Redemption
One of the attributes of SPACs is that you can buy units for $10, vote on the ultimate combination, redeem your shares with interest, and hang on to your warrants to buy shares at $11.50.
As a result, hedge funds love buying into them, as Bloomberg discussed in a December article.
“Until a merger is concluded SPAC investors always have the right to redeem their shares and receive back the cash they invested, plus interest; they get to keep the share warrants whatever they decide. Provided they don’t buy the SPAC for more than the value of its cash, don’t miss the redemption deadline and aren’t forced out of the trade by a margin call, hedge funds can be pretty confident of not losing money,” Bloomberg News’ Chris Bryant wrote on Dec. 9, 2020.
“However, once SPAC shareholders approve a merger, they lose the right to redeem. The merged entity is now like any other publicly traded stock — the value can in theory fall to zero. The arbitrage crowd almost always makes for the door before this point.”
In the case of IPOC/CLOV, approximately 24,892 IPOC shares were redeemed due to the combination, for an aggregate redemption payment of $249,000. That’s a tad over $10 per share.
Assuming you bought 900 IPOC units in its April 2020 initial public offering at $10, you would have gotten 900 shares plus 300 warrants to buy additional shares at $11.50.
Under the redemption option, you would have gotten back approximately $9,002.89 [900 multiplied by $10.0032]. However, you’d get to keep the 300 warrants. Those are currently trading around $1.85, or approximately $555. Over the past month, the warrants have traded as high as $3.39 and as low as $1.74 a piece.
Theoretically, the warrants have no intrinsic value until Clover’s share price rises above the exercise target of $11.50. However, because the warrants have five years until their expiry in January 2026, they continue to hold time value based on the potential to appreciate over the 60 months.
So, for any IPOC shareholders who didn’t redeem and bought 900 units, rather than having $9,557.89 in cash and warrants, they would currently have $8,430 (Current share price of $8.75 multiplied by 900 shares plus $555 for 300 warrants), 12% less than the shareholders who opted to redeem.
What Does This All Mean?
To me, it suggests that investors interested in investing in SPACs ought to do one of two things:
- Commit to redeeming the common shares of a SPAC once a combination is announced, while holding on to the warrants for potential future appreciation; or,
- Invest in the SPAC shares only after the target company is announced, and the share price doesn’t jump too much on the news.
At the end of the day, like any investment, public or private, you’re buying a piece of the company’s future cash flows discounted at today’s value. A business ultimately has to make money to be a good long-term investment, no matter the jockey.
In the case of Clover Health, while it’s still early, it looks as though the owners of the 24,892 IPOC shares who chose to redeem them made the right call.
That said, CLOV has until January 2026 to prove me wrong.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.