Superstar investor Bill Ackman has seen his first SPAC, Pershing Square Tontine (NYSE:PSTH) stock lose most of its prior gains as special purpose acquisition company (SPAC) mania has come and gone.
In February, it seemed SPACs were invincible. Now, though, most folks have moved on and Ackman isn’t alone.
A number of SPACs have crashed back to earth, and many are barely lingering above their initial offering prices.
Part of that was due to uncertainty for PSTH stock. It took a while for Pershing Square Tontine to finally find an acquisition partner. As people waited and waited, some of the novelty factor diminished.
And then, when the deal finally arrived, it underwhelmed compared to investors’ sky-high expectations. That said, sentiment has now swung too far to the negative, and PSTH stock is set for a solid comeback.
UMG and PSTH Stock
Recently, Bill Ackman announced his SPAC’s target: Universal Music Group “UMG”. Pershing Square Tontine will be buying a 10% stake in UMG for around $4 billion, implying a $40 billion valuation for the whole company.
PSTH stock fell sharply on the announcement of the deal, from $25 to $22. That continued a long downtrend in PSTH stock from the $30s earlier this year as the SPAC bubble deflated.
Let’s back up for a second. Pershing Square Tontine is an unusual SPAC in a number of regards. For one, it debuted at $20 instead of $10, so it’s only around 10% above the offering price now.
For another, the SPAC was created to give shareholders more extensive options to participate in the deal. Ackman said that he intended to create the most shareholder-friendly SPAC structure out there, and that seems fairly accurate as it turned out.
As far as deal mechanics go, this is an insanely complicated deal. Our Robert Lakin has the full details. The quick breakdown is that a holding in PSTH stock will become three components. There’s the stake in UMG, which will be valued at $14.75 per share at cost.
There will also be a new SPAC that keeps the other $5.25 of cash and finds another target. Ackman has been looking for deals since last year, so he might be able to deploy that residual cash into something quickly.
There will also be so-called SPARC rights that will essentially serve as a warrant or call option on the new SPAC.
Great Deal for Buyers
PSTH stock is worth an absolute minimum of $20 up until the UMG deal closes. That’s because shareholders can elect to receive back $20 per share in cash from Ackman instead of participating in the offer.
So absolute downside from buying here is $2 per share. In practice, it’s even less than that, due to the options to participate in the next Ackman SPAC (the SPARC stub) that have some value in addition to the $20.
On the upside, there’s the UMG stake, which is probably worth more than Ackman is paying for it, and there are SPARC rights, which essentially serve as a warrant to participate in the next Ackman deal.
That’s because, after UMG is paid for, PSTH will retain some cash and essentially start running another SPAC out of the same listing.
This is a novel development in SPAC land. Right now people are selling PSTH stock because they wanted Ackman to buy something glamorous with the SPAC, and UMG didn’t meet that bar.
However, once folks realize that PSTH stock is now both a stake in UMG and the next Ackman SPAC, valuation should surge.
Long story short, I expect the SPARC rights to be worth a few bucks a share, call it $3-$5 out of the gate. That plus the $20 floor means PSTH stock is mathematically undervalued just on what it is now.
If you believe there’s a reasonable chance that the market assigns a higher multiple to UMG (which I do), this looks like an obvious winner. Downside is extremely limited, and there are multiple paths to upside.
PSTH Stock Verdict
It’s important to emphasize that Pershing Square Tontine has become more interesting over the past few weeks than it was previously. For what it’s worth, I hadn’t invested in PSTH stock previously.
I bought in once PSTH stock dropped when it announced the UMG deal. This is a good deal for Pershing Square’s stockholders, yet traders impulsively sold it off.
That sets up the opportunity to profit from the market’s volatility. UMG, for what it’s worth, is trading at a slight discount to closest rival Warner Music Group (NASDAQ:WMG).
Normally, you’d expect UMG to trade at a premium to WMG since UMG has larger operating scale, better profitability metrics, and a more favorable shareholder structure.
More broadly, UMG should rise in value as investors wake up to the fact that streaming has made the record labels a growth industry once again.
In any case, Ackman is paying a fair price if not getting a bit of a discount on his Universal Music Group purchase. At the same time, PSTH stock retains some interesting dynamics given that it will also participate in another SPAC after this one.
All that added up, it makes little sense that PSTH stock is trading at $22 when its absolute floor is $20 per share. That sets up a risk/reward ratio that is highly skewed in favor of owning the stock going forward.
On the date of publication, Ian Bezek held a long position in PSTH stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.