SPACs: Risk Arbitrage with Special Purpose Acquisition Companies Long and IPOed Companies Short (2)

 For a recap of what a SPAC is and how to exploit emerging risk arbitrage opportunities in SPACs and their subsequent IPOed companies, please read the initial blog post regarding this matter which can be accessed by the following link: https://relativevalueinvesting.blogspot.com/2020/07/spacs-risk-arbitrage-with-special.html

Famed tech investor, founder and managing principal of Social Capital Chamath Palihapitya recently announced the release of three additional SPACs: IPOD, IPOE and IPOF, all intended to IPO by 2022. Each SPAC team contains one additional member from a background indicating the sector of the target company that is preferred. IPOD's extra member is Nirav Tolia, a former executive at Yahoo, Benchmark and Shopping.com, and former CEO & co-founder of Epinions and NextDoor. The presumably mid-cap consumer discretionary focused SPAC sought to raise $350 million and ultimately achieved well in excess of their goal with IPOD closing at $13.60 its first day trading representing a $400 million capitalization. IPOE's extra member is Jay Parikh, the former head of software engineering at Facebook and current board member of Atlassian corporation. This likely large-cap technology oriented SPAC planned a capital raise of $650 million which was exceeded in its debut on the NYSE by about $50 million, with shares closing at $11.62 representing an almost $700 million valuation. Finally and most impressively, IPOF's special team member is Richard Costolo, the former CEO of twitter and founder of FeedBurner which was acquired by Alphabet in 2007. The technology services aligned SPAC closed at 11.80 today with an implied market capitalization of approximately $1 Billion. 

    Comparable to conventional mergers and acquisitions, shareholders in the beneficiary of these deals which is likely to be the SPACs as purported by their proprietors, such as Social Capital will liquidate their position in the merged, or acquired company as was observed in the Virgin Galactic, or SPCE IPO shortly proceeding its listing on the NYSE where from October 18 to November 29, it declined by $3.13 to $7.25 per share, an approximately 30% loss. This is a common occurrence among many mergers and acquisitions according to Guy Wyser-Pratte who in his 1975 book, Risk Arbitrage suggested that many short-term shareholders in the acquired or benefiting company seeking to secure their profit, sell their shares in the new or merged company immediately upon listing or once the merger is finalized. A rally often encompasses the company benefiting from the deal preceding its closure until the benefit or consequent discount relative to the price it is presumed to be acquired for, or likely to gain is arbitraged away. Thus, one might initiate an initial long position in any of the preceding SPAC IPO of a multiple of 100 shares, or more if optimistic as to their future growth potential, write OTM covered call options, sell the options continually until the profit negates or exceeds the cost of the shares (obviously utilizing technical analysis or charting tools to ensure precise timing as rallies frequently subside within weeks or months of the listing, then cyclically recur before the merger), write ATM puts for new stock of merged company during first weeks of listing when short-term shareholders are liquidating(again utilizing technical analysis or chartings tools, etc.), and finally await the short term appreciation of the remaining stock held in the merged company, assuming Palihipitiya creates value for shareholders in these SPAC IPOs as achieved in their previous ventures, (e.g. Virgin Galactic, or SPCE which appreciated by an excess of 200% from its IPO in October to February 19).

Why Value-Oriented Investor Seth Klarman Recently Invested in Bill Ackman's SPAC: Pershing Square Tontine

The Boston-based hedge fund Baupost Group's 3rd Quarter 13F Filing which was released just weeks ago disclosed a 4.3 % portfolio weighting in Bill Ackman's SPAC, Pershing Square Tontine Holdings (PSTH) whose ideal or target company is a high growth large-cap unicorn with a growing market share according to the transcript of David Rubinstein's Bloomberg Interview with Bill Ackman. This is a rather unordinary investment decision in stark contrast to the firm's self-described value oriented and longer term approach. Baupost Group's founder, president, and chief investment officer, Seth Klarman became ubiquitously known throughout the finance industry in the wake of the 2008 financial crisis after acquiring the shares of many insolvent and undervalued companies in anticipation of an impending government bailout and a resumption of sanity within the markets. Additionally, the legendary value investor is quite familiar with SPACs and has held numerous positions in similar blank-check companies in the past. In his interview with Dave Rubenstein, Ackman stated that the structure of his SPAC was such that his firm's exposure to the outcome of the deal is significant since no fees can be incurred unless a deal that is profitable for all investors occurs; hence, the name "Tontine" because if individual investors take a loss, his firm will endure the same fate. 

    Ackman's Pershing Square despite its decline in AUM has experienced a wild ride these past two years with annual returns in excess of 50% for 2019 and 70% for 2020 which Ackman attributes to his new marriage and purchase of credit default swaps preceding the liquidity crises that transpired during the first  few weeks of the lockdown in March. Additionally, Ackman's self-characterization as a value investor and long-term track record of acquiring, seeding, and merging companies is probably perceived favorably by like-minded experienced SPAC investors, such as Klarman. Examples of Pershing Square's successful SPACs include Justice Holdings which raised $1.5 Billion with a 30% stake from Pershing amongst other funds that co-sponsored the offering. Justice Holdings later acquired a 29% of Burger King's shares and forced a merger between it and Restaurant Brands (QSR). This outstanding long-term and short-term investment track record in SPACs and special situations in addition to the Pershing Square Tontine's equitable structure (ignoring the Herbalife and Valeant debacles that plagued the fund's returns for five years and ultimately lead to the outflow of most of its AUM) is probably what has attracted other fund managers and investors like Seth Klarman, whose recent performance cannot justify scrutiny of Ackman's failures. Finally and most importantly, Pershing Square will only receive a 6.21% performance fee after other investors achieve a 20% return which incentivizes superior performance while rendering its fate inextricably linked to that of other investors. 

FPRX Short, BIIB Long

             On Wednesday, FPRX opened up 380% at $24.02 after significant after hours and premarket trading Tuesday based on positive-phase two pre-clinical trial data for their experimental gastric cancer treatment, Bemarituzumab. Five Prime Pharmaceutical's CEO Thomas Civik recently announced the offering of 7.2 million shares at $18.00  to fund phase three trials as the company remains net income negative, and consequently suffers from low cash-on-hand. This will ultimately result in a total share dilution of approximately 24% or 7.2 / 30 million excluding the 30-day warrants granted to underwriters. Cowen and SVB Leerink, the managers of this proposed offering will presumably also receive warrants as an incentive for their services. If the  warrants provided to underwiters and the warrants paid to offering manager firms, Cowen and SVB Leerink are exercised by their expiration date, then further dilution will inevitably ensue. Five Prime's gastric cancer treatment is only in pre-clinical trials and the phase two data is somewhat ambiguous, though certainly not positive. Retail investors, market makers, and the institutions that own 78% of the stock will likely grow inpatient with its dismal range-bound performance, liquidate their position, and book their profit. Irrespective of the treatment's success or future approval, a reversion is imminent as investors frequently refuse to forgo present opportunities and will likely lose patience preceding the drug's approval.

         Conversely, Biogen's aducanumab passed phase three of clinical trials and is likely to receive approval by the FDA despite the protest of its third-party counsel. Nonetheless, the patience of investors and traders is waning; consequently, it currently trades at a significant discount. A compounded ROE valuation of the company indicates an intrinsic value of $298.00 per share while the average analyst estimate is $291.40 according to Yahoo Finance. Unlike other biotech and pharmaceutical companies, Biogen is blue chip and financially very healthy with strong operating margins and high F-score; hence, an implied lack of margin of safety. Whether you concur with its compounded ROE valuation and average analyst estimate or believe that a DCF approach may provide a more accurate price range, it is certainly undervalued and worthy of consideration as an addition to your portfolio.

Fund Arbitrage with AMS:PSH

         Fund arbitrage is a method of attaining risk-free or low risk profit like most arbitrage strategies where the arbitrageur buys a fund whose net current asset value exceeds its capitalization, and shorts the underlying assets within its holdings. The arbitrageur waits until a logical parity is realized, meaning a convergence in market and asset values, or iniates a controlling position and requests immediate liquidation of the company's portfolio holdings.

            Pershing Square Capital Management which is managed by famed investor Bill Ackman currently trades at $25.16, an almost 40% discount from its NCAV. The fund's performance this summer and throughout the pandemic was outstanding with asset values increasing 150% owing greatly to its acquisition of credit default swaps for corporate debt preceding the lockdown in March.  A persistent concern to consider is the possibility that its trading price may further diverge from its NCAV as fund arbitrage assumes market value is inextricably linked to asset value which is often false contemporarily. Though it is very unlikely that Pershing Squares discount to NCAV will remain in light of its recent performance and SPAC deals.

How The Fed's Current Quantitative Easing Measures Exacerbate Wage Stagnation, Poverty, and Every Increasing Socioeconomic Disparity

The United States' solution to essentially every recession within the past few decades was and is presently to create new currency and requisition debt to increase liquidity in financial markets by injecting the money directly into repos, corporate bonds, and now company shares. The United States Federal Reserve is printing $150 million every day as the president recently signed an unlimited bond purchasing agreement with the Federal Reserve.

Consequently, the U.S. stock market will persist to appreciate to ever greater valuations.

Examine how it almost doubled their balance sheet in 2020 alone…

Or, let’s zoom out, from 2002 to 2020…

Now examine the average hourly earnings of all employees…

The Fed septupled its balance sheet from 2006 to 2020, and average hourly earnings of all employees only increased 33% during this period.

Wages remain stagnant while as a result of excessive inflation or currency creation, the cost of goods continually increases.

An interesting fact from US Department of Agriculture’s website:

“The food-at-home (grocery store or supermarket food items) CPI decreased 1.0 percent from June to July 2020 and was 4.6 percent higher than last July.”

Thus, if the Fed refuses to institute quantitative tightening measures, then riots and protests may ensue if wages do not increase.

Concurrently, the U.S. Stock market will appreciate continually ever more as the value of each dollar persists to decline.

This is eerily reminiscent of Venezuela whose economy is suffering a catastrophic recession; however, due to the increase in liquidity, or new currency being injected into their stock market, it continues to appreciate.

Venezuela’s Bursatil stock index, indexed to 0 as at Sept 2018 to present…

Ostensibly, it appears as though their stock market is in a bull market.

However, when you examine the the index in terms of USD value

It seems like the implementation of poor monetary policies is causing dilution of currency value.

So, even if equity markets are doing really well it doesn’t actually mean that you are actually holding your head above water in “real” terms. Thus, despite the purported performance of equity markets, if we examine them in terms of their currency value, a recession is obviously latent within the nation's economy, but obfuscated by the fed's quantitative easing measures.

A hyper-inflationary environment seems imminent as the globe, not exclusively the U.S. pursue erroneous quantitative easing measures to conceal the true states of their economies and alleviate the fears of investors and their corporate constituency. If you're invested largely in tech stocks, or popular indices like NASDAQ or S&P 500 which are primarily composed of technologies companies, then I recommend liquidating and investing your money in a all weather-proof portfolio or alternative investment strategy that prevails in any market environment. If seeking ideas, please read past and future blog posts in addition to this sites reference materials pages to further educate yourself.

Bill Ackman's Proposal to Solve Socioeconomic Inequity

         Bill Ackman in his firm, Pershing Square's recent interim financial statement release to investors makes a rather unconventional proposal to reduce economic disparity in the United States and ensure every American the right to retirement. This proposal entails spending approximately, $26 billion annually or $6,750 per person, assuming birth rates remain constant to create retirement accounts for each person which would be invested in a basket of index funds whose returns if compounded at the average annual return of the past few decade of roughly 8 %, should provide in excess of $1 million for retirement. Of course, this is contingent upon access to the account being restricted until the individual turns 65 or retirement age at which point they opt to make account disbursements. 

        To put the cost of this proposal into perspective, the United States spends more than $80 billion annually on education alone. Hypothetically, if it were to cut spending on education subsidies and grants which presently fail to adequately address the ever increasing socioeconomic disparity and inability for  citizens retire to secure funds for this new program, then it may be worth the risk; especially, if it succeeds to achieve what education often cannot for those of lesser means. 

        The average millennial will require approximately $1.8 million to retire and a typical Gen Z'er will need around $2.6 million. This comes out to about $14,787 which equates to $57 billion, far less than the government pends on education. Implications of this idea consist of proxy voting for all citizens who determine the vote of the large mutual funds who in turn participate in voting as to the governance of the companies. This effectively allows citizens to have a stake in the companies they work for, and vote regarding how they should operate and govern themselves; thus, rendering our system more democratic and equitable without destroying capitalism or raising taxes above the Laffer curve.

Is TSLA a Cult Stock or Emergent Innovator

        Some may contend that Tesla is a disruptive sector innovative and altruistic force for good in terms of its environmental impact extenuating its 536% annualized gain this year by referring to its immense revenue growth; nevertheless, scrutiny of its peculiar balance sheet and lack of profitability is not unwarranted. Its total sales and revenue growth during the second and third quarters of this year fail to justify its current valuation. Assuming a basic median price/sales ratio and a nominal discount rate, its valuation of $181.86 is far exceeded by its current share price of $425.68. Even Elon Musk, the company's founder himself admitted that the stock may be a bit inflated in an interview months ago preceding a subsequent 352% gain and stock split. This is what Vitaliy Katsenelson refers to in his book as a cult stock, a company that is so inconceivably overpriced its 'followers' or shareholders must justify it current price by other means, such as revenue or sales growth. Tesla comparable to FANG companies which were elaborated upon in a previous post, is so illogically overvalued, but followed and owned or 'worshipped' that it may not present an optimal potential short position. Famous short seller and hedge fund manager David Einhorn initiated a gargantuan short position in the company earlier this year that cost him $500 million of his net worth. It is obvious to short  outrageously overpriced securities, but not fanatically followed cults.