Bill Ackman, the CEO of Pershing Square Tontine Holdings (NYSE:PSTH) has been in the news quite a bit lately. According to Barron’s on May 17, Ackman was “cautiously optimistic” that PSTH stock, a special purpose acquisition company (SPAC), could end up reaching a merger deal soon. What’s more, Ackman’s investment firm “bought a roughly 6% stake” in Domino’s Pizza (NYSE:DPZ) last week.
This got me thinking. While these seem like two different news items, it’s not totally impossible for PSTH to go after DPZ. But, while highly unlikely, the process would be complicated and PSTH investors wouldn’t like it much.
After all, if Domino’s Pizza is already public and buyable, why do shareholders of PSTH need to take it over? It makes no sense, other than to build up an empire for Bill Ackman and his various funds.
For the sake of argument, though, let’s take a closer look at the details. Here’s what a deal like this would look like.
PSTH Stock: Thinking Through All the Scenarios
Let’s just think this through.
Currently, Domino’s has a market value of about $16.8 billion. PSTH stock, on the other hand, has a market value of about $5 billion. So, even if there wasn’t any premium paid for control, at best PSTH shareholders would own only 23% or so of the company. This is seen by taking $5 billion and dividing it by $21.8 billion (i.e., $16.8 billion + $5 billion).
So then, since PSTH remains public, it would own just 23% or less of a public company whose only asset is a pizza chain — albeit one with technology and “their own delivery infrastructure.” In effect, Domino’s would stay public through the ownership sliver that PSTH would have.
And in reality, the deal would probably involve paying a huge premium to the existing DPZ stock shareholders. There would also likely be a ton of debt to make up for the difference between $5 billion and $21.8 billion paid.
In effect, Ackman would want PSTH to become a leveraged buyout (LBO) fund. LBO funds typically buy public companies and take them private or else buy other private companies. But in this case, Domino’s wouldn’t really be private since PSTH stock will remain public. And, due to the premium paid and the likely debt piled on, the deal would also be very risky. PSTH stock could easily fall.
So, on balance, this hypothetical deal makes very little sense for PSTH stock investors. They would be better off buying long-dated in-the-money calls in DPZ stock to hedge the risk that PSTH will fall (assuming they continue to hold on).
As Barron’s points out, Ackman seems to be looking for a target for his much larger fund, Pershing Square Holdings (OTCMKTS:PSHZF). By using this fund to help PSTH buy Domino’s, he could effectively take control of the company and run it like a private company.
Where This Leaves PSTH
This is a lot different than what most SPACs do. Typically, they let the private company go public through a reverse merger with the SPAC. The SPAC shareholders then end up with about a 5% to 10% stake but no control. The reverse-merger process effectively allows the private company to raise capital and go public.
In this case, though, there would effectively be no reverse merger, since Ackman’s funds — including PSTH — would probably get effective control. Moreover, there probably wouldn’t be any cash raise for the company. Most of the cash paid out by PSTH, including any debt it takes on, would likely be paid out to shareholders of DPZ stock.
That is why I said it would make sense to buy long-dated, in-the-money calls of DPZ stock in this scenario. This would hedge the possibility that PSTH and other Ackman funds have to overpay for control of DPZ.
Here is how that would work. The in-the-money long-dated calls could go up probably by a similar amount of dollars that PSTH stock would fall. And, if the deal doesn’t go through, at least the in-the-money calls will still have good inherent value instead of crashing into worthlessness.
In any case, if this were to happen, it would be an empire-building deal for Ackman. There would likely be little gained by PSTH shareholders, other than through a high-risk leveraged buyout deal to buy Domino’s stock.
Of course, this hypothetical is unlikely in the first place. But there’s still so much mystery surrounding Ackman’s merger target here. What else can we do other than run through the scenarios?
On the date of publication, Mark R. Hake did not hold (either directly or indirectly) any of the securities in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.