July 27,2020- Bill Ackman Launches Largest SPAC IPO on Record at $4 Billion. Which Company is he Going to Acquire?
Tesla Reports Profitable Quarter as Shares Hit New All-Time High. Will it be Added to the S&P 500?
Consolidation in the Oil Patch: Chevron Buys Noble for $13 Billion. What do Shareholders Think of the Deal?
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.
Julian Klymochko: Welcome ladies and gents to episode 79 of The Absolute Return Podcast. I am Julian Klymochko.
Michael Kesslering: And I am Mike Kesslering.
Julian Klymochko: Were finished another week of market activities. It’s Friday, July 24. A number of interesting events, specifically three that we wanted to touch on covering SPACs M&A and some interesting index talk.
- But to start off, I wanted to chat about Bill Ackman massive, massive, special purpose acquisition company doing a $4 billion dollar IPO. That is right, the largest by far SPAC IPO of all time. We speculate on, which companies this SPAC is going to acquire?
- Onto some index news. Tesla reports its first profitable quarter or its first profitable year, four quarters in a row. And its shares hit a new all-time high and those four profitable quarters in a row make it eligible to be in the big time S&P 500 index, but will it actually get added?
- And lastly, we were talking a bit of M&A. Consolidation in the oil patch, Chevron, a huge player in the oil market. They announced a deal to buy Noble for $13 billion dollars. What do shareholders think of this deal?
Bill ACKMAN LAUNCHES LARGEST SPAC IPO ON RECORD AT $4 BILLION
Julian Klymochko: But first Mike let’s chat about a Bill Ackman or should I call him Bill SPACman? I mean a huge splash into the blank check space, launching a $4 billion IPO, I guess when Bill Ackman does things he does them big. Launched a SPAC called Pershing Square Tontine Holdings. And what’s super interesting about this SPAC is not only is it $4 billion dollars and to give you some context, the average SPAC market cap is roughly 350 million. Huge SPAC IPO have been in the $1 billion range, so this is the basically quadruple the biggest that’s ever been done. And in addition to that, his investment firm Pershing Square as committed to adding an additional one to $1 to 3 billion dollars on top, so this SPAC could ultimately be as large as $7 billion dollars and to provide additional context prior to this Pershing Square Tontine IPO, the entire spec market was $44 billion dollars in market cap. So this represents, you know, an increase of about 10% to the entire sector.
What type of deal is he going to do? With this $4 to $7 billion dollars or I should say $5 to $7 billion dollars after his investment firm chunks up another, a few billion into it. He is targeting very large profitable private companies that he refers to as quote mature unicorns. And as our listeners would know, unicorn is just a billion dollar plus private company. Some of these start-ups that are considering going public, but may consider a SPAC which are super-hot these days instead of your boring traditional IPO. We are seeing a lot of interesting start-ups go the SPAC route as opposed to even direct listing like some other start-ups have done.
Some trading news on the deal. It was actually three times over subscribed, so demand was upwards of $12 billion dollars. And with that demand and in this market not surprised to see a trade up. It was up 6.5% on its first day of trading, which meant it was trading about $200 to $300 million north of its cash value, which is pretty significant. Pershing Square will now how have about two years to strike a deal? So Mike, which company do you think they will buy?
Michael Kesslering: I mean, like you look at Airbnb, they’re looking to go public. There is certain restaurants looking to go public. I believe we were talking about Shake Shack before the call, but you know, this is a very interesting situation, especially like you had mentioned with that with that $1 to $3 billion forward purchase agreement, that means that they could have, you know, $7 billion worth of cash to deploy. Their whale hunting and there is not many companies that would fit their criteria.
Julian Klymochko: Yeah, it is interesting because we look at it versus other SPACs and they are quadruple the size of the largest. So that really gives them a leg up in terms of targets because they are looking at companies that every single other SPAC could not consider because these private companies are too large. So Pershing Square would more so be competing with, you know, some of the largest private equity firms out there because the SPAC with the cash on hand, you can issue more shares and so, in fact, they can be doing a deal that has a pro form of value in kind of the, even $20 to $30 billion range and what buyout firm can do a deal that big? So, I think Bill Ackman indicated that there’s roughly 150 targets that they would consider in terms of size. I mean, there is not a ton of private companies that are worth more than $10 billion, right?
Michael Kesslering: Yeah, exactly and I just wanted to go back and look at a little bit of the structure here. Right in the name, you have Tontine and with this structure, you have the Tontine warrants and I do believe on a previous podcast when they first came out, we briefly touched on this structure. But just to go back to it a little bit is, this comes back to a what a tontine is, a pooled vehicle that really effectively awards dividends to participants who had outlived their co-investors. So this is early archaic investment structure from, you know, 80 to a 100 years ago. That was quite popular for a little while, but really, why they went with this sort of warrant structure was looking at a way to incentivize investors to stick around and not redeem for cash and stick around for the shareholders for the actual business combination.
And so what effectively happens is right now, the warrant coverage, if you got a unit on the IPO, or if you purchased one in the market after the IPO. Is the warrant coverage is one ninth of a warrant, so one third of one third with the remaining two ninths to come after the SPAC closes the business combination. And it really also depends on how many shareholders are deemed. If no shareholders are deemed, then you just end up with those remaining two ninths, if 50%, for example, redeem, you would end up with an additional four ninths of a warrant. And so it’s a very interesting structure, a little bit of game theory, and really just kind of trying to move away, I guess, from some of this SPAC ARBs that really fill out the demand of these IPOs, which is an interesting structure. It has something that only somebody of Bill Ackman, he is such a popular investor that they knew that demand was going to be strong for this so that they can try something creative.
Julian Klymochko: Yeah, he can drive terms just given his reputation and this novel structure is really to drive incentives, right? It incentivizes investors not to redeem and stay in the fund. And I mean, if it’s trading at a big premium to NAV, then no one’s going to redeem, and so our theories behind SPACs is if you don’t want people to redeem, announce a good deal and the share price will trade up above NAV and, you know, that is the easiest formula to success here.
Michael Kesslering: Exactly, and one other thing that I think would be good to reflect on is because of the rising popularity of SPACs, there has been the debate for a while about whether it is more cost effective or a more favourable option for a company to go public via traditional IPO, a direct listing or a SPAC. And there’s just a lot of confusion here around what I’m hearing from folks in the industry, confusion around carry and other fees. And I mean, just IPO at its baseline, looking at an IPO versus using a SPAC, if you are a company wanting to go public, number one speed to market, you can quote, if you sign a deal with a SPAC, you can be public within a three-month timeframe. Whereas if you go on the road show, you are looking at six to nine months, but really, there is a lot of confusion on the carry is especially with regards to what probiotic portion of the company, the sponsor of this SPAC will have after the deal closes as I keep hearing, the 20% number is tossed around.
Julian Klymochko: Hold on Mike, and in terms of just so our listeners are clear in terms of carry, you mean basically free shares given to the sponsor or founders of this SPAC for doing the deal.
Michael Kesslering: Exactly, it is their incentive for doing the IPO of a SPAC in the first place, but that is where it gets a little bit confusing because the 20% number that is typical for a SPAC is only on the amount raised in the IPO. And so the market cap of the actual SPAC itself, and so when you combine with say a larger entity, that doesn’t mean that, you know, that they are going to have 20% of that combined entity.
Julian Klymochko: Yeah, that is a good point.
Michael Kesslering: The initial capital raise.
Julian Klymochko: Yeah, so to give you a quick example. One SPAC that recently announced a deal, in which we do have a position in, in our accelerated arbitrage fund is Fortress Value Acquisition, so they did a $300 million dollar IPO in April of this year. And they just announced a business combination with MP Materials and the structure results in a proforma entity with equity value of 1.5 billion. So Fortress Value, their carrier, their 20% is enough that 1.5 billion, the equity value of the proforma entity when the deal is complete, it is actually of the 300 million SPAC IPO, right? And then that’s at the upper end of the range. They typically get dialled back on this carry during this business combination, Don’t they?
Michael Kesslering: Exactly, it is just a starting point. It is a starting point that they have at the beginning, most deals that are done, I believe there has only been a couple where that carry has not been dialled back. And so it’s really just something that ends up getting negotiated out anyway as well. Something that has always been talked about has been the fees for investment bankers. I think it is fairly similar in terms of fees for an IPO and fees for on the whole a SPAC process. When you look at the SPAC process, the investment bankers they’re getting paid, and I’ve heard estimates that it’s kind of around $20 million throughout the entire SPAC process, but that’s based on the average SPAC size, as you had mentioned, Julian around $300 million dollars.
Julian Klymochko: Yeah, bankers typically take a percentage and IPOs, you kind of see a 5 to 7%, but the SPACs have a different structure such that in my opinion, it ends up with something quite a bit less than your traditional IPO.
Michael Kesslering: Yeah and where did that Delta can be either wider or narrower would be, I guess, number one; you have the underwriting fee for the IPO of the SPAC. That would be shared amongst a syndicate of banks, but that would be kind of in that that 5 to 7% range of the cash raised in the SPAC, but then really where you have that Delta that is with the buy side M&A, and that is something that it really depends. That is very deal specific and what this SPAC is able to negotiate with their bankers, and also there’s just a lot less clarity on that.
Julian Klymochko: Yeah, and the other thing to consider is when a SPAC is formed, the sponsor puts at risk capital into it, either through units or it’s typically these private placement warrants. And so that provides the capital covering basically half of the IPO underwriting fee and therefore the actual cost to investors, if there’s no deal, there’s zero underwriting fees born of the investors. If there is a deal, investors are paying like half of the fee out of the actual SPAC because the sponsor is covering the other half, so that’s another thing to consider.
I saw another criticism, which is that you know, special purpose acquisition companies that are doing acquisitions and acquisitions typically destroy value. And, you know, you look at studies and typically M&A is value destroying. Obviously, there are certain segments of the market that can do it successfully. I mean, basically the private equity industry has formed this massive trillion dollar industry on exclusively doing M&A. So clearly some people can do it and add value, and that sort of criticism on SPACs is just a criticism to all M&A, which really is not valid in my opinion. Obviously some can do it well, some can’t, but the difference in like a SPAC, they have a higher chance of success than a private equity firm, because a SPAC, isn’t paying a control premium. Meanwhile, a private equity firm is paying that control premium, which is typically 30% higher than the market price, so there is another thing to consider.
Michael Kesslering: Yeah, and one other thing that I did see mentioned. Was that the only reason that SPACs are becoming a more popular option for companies to go public is because in the pandemic, you are only in this situation. You are only negotiating with one party, you are negotiating with the SPAC on the deal terms and pricing and whatnot and valuation. But that doesn’t really hold a lot of value or hold a lot of weight in my opinion. This has been a trend like SPAC; issuance has been going up over the last 10 years.
Julian Klymochko: Quality as well.
Michael Kesslering: Exactly and that’s the other thing is that there’s a little bit of a feedback loop where it’s becoming legitimized and institutionalized because you’re getting more legitimate sponsors that are launching SPACs, which means more larger IPOs can be done, raising more money. Then they are able to target larger popular companies that many people have heard of like the potential for Airbnb going public through a SPAC or Virgin Galactic, one that has already gone through a spec process. Then because of that, you get a lot more legitimization of this as an investment vehicle, as well as a vehicle to go public, so there is a little bit of a feedback loop there.
Julian Klymochko: Yeah, some good points there on SPACs as for what Ackman going to buy with the Pershing Square blank check company. My three top picks, you mentioned it Airbnb. He is also really in restaurants, I think in Chick-Fil-A could make for a good one, and lastly, one of the biggest unicorn start-ups out there, Stripe. Those are my top picks. We will see what happens. We will closely follow this one, obviously.
TELSEA REPORT PROFITABLE QUARTER AS SHARES HIT NEW ALL-TIME HIGH
Julian Klymochko: Now onto some Tesla news. What happened here was electric vehicle manufacturer Tesla, or as Elon Musk called it, Tezzla. Reported a profitable Q2, which marked its fourth consecutive profitable quarter in a row, and what’s notable about four profitable quarters in a row at it stage is that makes it eligible for the benchmark S&P 500 index inclusion and why this is so important is, you know, everyone refers to the S&P 500. The market, it is all that anyone talks about when talking about stocks, not just that, but trillions and trillions of dollars globally are benchmarked to the S&P 500. So if Tesla does get added to the index, that could spur buying by these index funds that track the index of as much as $50 billion dollars. Which is obviously a huge amount, but given the company’s historical lack of profitability combined with stringent index addition requirements, Tesla is not in the index despite its market cap being nearly $300 billion dollars. And it’s just absurd in my opinion, because at 300 billion that makes it the 12th largest U.S company, and when you think of the S&P 500, typically you would think of all the largest companies would be in there, but that’s in fact not true because at this point, Tesla is not in the index. And really there’s no guarantee because although Standard and Poor’s the company that runs the S&P 500. They say it is systematic and quantitative in nature in terms of the rules to get into the index; they still have a fair bit of discretion.
And so it’s more of like an actively managed index, despite what the industry tells you. They say it is passive. It is not. There is a bunch of subjectivity and discretion that goes into it. I’ve got a quote here from Howard Silverblatt. He is a senior index analyst at S&P Dow Jones Indices. He stated, “The purpose of the index is to emulate the U.S. domestic common market. When you go to put a company in to actually select it, it’s got to fit into the algorithm in that it represents the market, and it has liquidity. It has the size”. So there’s no guarantee, which is somewhat ridiculous. In my opinion, I think if you are running an index, should be a hundred percent rule space, not, you know, this index committee making active decisions, so no guarantees there, but I think at the end of the day, Tesla is going to make it into the S&P 500. And if it does, or when it does, you’ll have a tremendous amount of demand, upwards of $50 billion dollars, which is probably the reason the stock, or one of the reasons the stock has been absolutely on fire this year, despite a really poor macro environment for auto manufacturers. What is your thoughts on this one Mike?
Michael Kesslering: Well, first, just to go back to the quote from the index analyst is if it was true that the S&P 500 was supposed to represent U.S. stocks in general. It would be equal weighted. It would not be market cap weighted, because what you are seeing right now in terms of the index performance. Especially on, I believe I tweeted out this week, a little chart of like the last 12 months performance of the S&P 500 index. Which is market cap weighted versus the S&P 500 equal weighted index. Where the equal weighted index is basically flat on a trailing 12 months basis where the S&P 500 is up about 10%. So that gives you an indication of the top companies are the ones that are responsible for most of the growth in the S&P 500.
So it’s not just a representation of the U.S. stock, so that is something that should be clear when looking at the index. But as well, I mean, part like up until now, despite being such a large portion of, you know, overall market capitalization, being Tesla with their size right now. I mean, they did not meet one of the criteria up until now, which was four consecutive quarters of profits.
Julian Klymochko: Yeah.
Michael Kesslering: That would be the last remaining hurdle for them to qualify. So I’m not too worried about them qualifying for the index. I think they will highly likely be included in the index once there is another company, because I believe it would be when a another company has either acquired or doesn’t fit their criteria at that point, then they would be up for debate for inclusion into the index, but that’ll be interesting to watch. As well, I mean, it is just an incredibly volatile stock. It is down 11% over the last two days. As well as Elon Musk, himself really got a nice big payday for his equity option grant.
Julian Klymochko: 2.1 billion.
Michael Kesslering: Yeah, the second of 12 performance targets for tranches.
Julian Klymochko: What is crazy is that. That performance bonus is just based off share price.
Michael Kesslering: Yes, Musk is a professional at promoting the stock.
Julian Klymochko: Perhaps the greatest stock promoter of all time, for sure.
Michael Kesslering: Yeah, exactly.
Julian Klymochko: Not to take away. Like, obviously I believe Tesla makes some great products. I have never driven one, but they certainly look cool. But certainly he has his detractors, short sellers and he does a tremendous job. I mean, what other CEO can promote a company and a stock that well, like he is one of the most popular out there.
Michael Kesslering: Yeah. When you think of stock promoter, you think of a, you know, the traditional. In Canada, at least. A stock promoter promoting metals and mined micro caps in Vancouver. But no, this is on a scale that has never been seen before. I mean, and in terms of their profits, I mean, yeah. The majority of them do come from regulatory credits, which is certainly fair. I mean, it is not like there is anything shady in and of itself, but yeah. I mean their core business. It is an absolute wild evaluation when you look at it at, you know, about a third of a trillion dollars right now. But yeah, it’ll be interesting to watch and there will be added buying power or by demand if, and when, which I think it’s just a matter of when. They get added to the index.
Julian Klymochko: I believe that, is one of the major reasons why the stock has rallied so much lately. It is having an astounding share price performance this year. A lot of investors sort of front running the index, which is one major criticism of passive investing. Is that active investor’s go push around prices, either speculating on an index edition or index deletion. Look at front run index investors, so that is something to keep in mind. In addition, obviously highly likely to enter the index and Elon, man, $2.1 billion payday, obviously he is having a great week.
CONSILDATION IN THE OIL PATCH: CHEVRON BUYS NOBLE FOR $13 BILLION
Julian Klymochko: Onto some M&A news, some much needed consolidation in the oil patch; finally, commands after a brutal, brutal seven year bear market and energy in the context of really, really constructive equity markets and a highly simulative environment as well. What happened here was Chevron announced the acquisition of Noble Energy for 13 billion inclusive of debt, market capitalization on Noble, roughly 5 billion.
So it’s fairly leveraged company, strategic rationale. This deal does Chevron investments in the U.S. shale and in natural gas with Noble, flagship Leviathan field in Israel. So expanding in the Middle East, it is the largest natural gas field out there, and the thesis in oil and gas. I mean, it has been an absolutely brutal bear market. You have seen a ton of bankruptcies and really, there is too many oil and gas companies out there. It appears that Noble is really throwing in the towel. Capitulating, they have had enough. They really can’t go on anymore. They are selling out for a measly premium of just 7.5% as we indicated the typical control premium in and M&A situation is in the 25 to 30% range. So seven and a half percent is quite slim and the other thing is Noble stock is being acquired or Noble selling to Chevron at the same price that traded at for in 1996.
So 24 years ago with no shareholder value creation and I wanted to talk about deal dynamics.
One deal that we talked about quite a bit over on the podcast last year was Occidental absolutely disastrous $57 billion dollar acquisition of Anadarko, which Chevron famously sidestepped, as you remember, Chevron was in a bidding war with Occidental. Chevron choosing to bow out, showing that they are a disciplined acquire. And man that really paid off for them because Occidental hurting. They have felt nothing but pain. It was a highly leveraged deal, right before the bear market energy got worse and worse and worse. You saw Occidental surprise go from 50 something dollars to sub 10, so it has been a horrific time for them. Carl Icahn, the activist got involved trying to get the stock back up, trying to get the CEO fired. He was trying to run a proxy contest, kicked out the board at one point.
So fact of the matter here is Chevron is a very disciplined. A buyer and what we are seeing in the market here. If we look at the M&A spread. Noble energy is actually trading at a 2.4% premium to the consideration. That’s an all share deal at a 0.119 share exchange ratio. And when it’s trading at a premium, that indicates that either arbitragers expect Chevron to pay more, or they expect to see another company come over the top and turn into perhaps a bidding war. I’m bearish on that thesis. I don’t think Chevron will bump, as we indicated historically, they have been a very disciplined buyer as we saw in the Anadarko precedent. The other thing, I mean, you don’t typically see bidding wars in bear markets, right. And wearing an absolutely brutal ENP bear market, the worst oil and gas bear market I’ve ever seen. Worse than, you know, what happened in 2008, while that one was deep, it bounce back pretty quickly, but this one has just been the longest down cycle for a long time. At least longest that I can remember, so I am bearish on the thesis that Chevron will bump and I am bearish on the thesis that a bidding war will ensue. So I don’t think it’s worthwhile being involved on this one from a merger arbitrage perspective. Mike, what is your perspective on this much needed oil patch consolidation?
Michael Kesslering: Yeah, definitely agree on much needed, and back to your previous point about whether a bidding war would perhaps transpire here. I would agree that this is a low probability for a bidding war. When you look at the major oil producers, Chevron had, you know, they have one of the strongest balance sheets in the industry. And so, it’s no small feat to take on Noble debt and they are able to do that fairly easily.
Julian Klymochko: $8 billion worth.
Michael Kesslering: Yeah, and the rest of their competitors are worried about like debt competence, they are worried about their leverage ratios. But also worried about their dividends and, you know, for a company like Exxon who has spent, you know, Chevron spend substantially less than Exxon over the last few years in growing production. Companies like Exxon there are worried about paying dividends and things of that nature. I think you are quite correct being a low probability of a bidding war. Another stat, as you had mentioned. Chevron price, it’s basically sat around for 24 years here. But as well, it’s a 7% premium to the previous day trading before announcement, but a 57% discount to its 2020 pre pandemic high, which was on January 2nd. So really not much of a premium, but as well in other oil and gas news. I did want to bring up that north of the border here in Canada. There is actually a really interesting deal where Kelt was actually able to sell half of their Montney assets to ConocoPhillips, which as we know the Houston based company for $510 million dollars, which also included some assumption of the debt that was involved with those assets.
Julian Klymochko: And that is actually quite a bit larger than the current market cap of $360 million.
Michael Kesslering: Exactly, it was a great deal for Kelt as there has been nothing happening in M&A in Calgary.
Julian Klymochko: Zero.
Michael Kesslering: This is a really big deal, especially because Conoco being one of the large U.S. producers with Canadian exposure, all of their peers, all the other U.S. producers. We have talked about it on the podcast before. They have been exiting Canada, they are selling their assets and companies like CNRL and you know, and Suncor are making some acquisitions. Canadian companies they are buying the U.S. assets, so this is really where Conoco, because these assets are adjacent to their existing Montney grid. This is really them doubling down and as a Calgary resident, I mean, this is a big deal and very positive to see for the Canadian energy sector. So hopefully that will spur some more demand for assets from U.S. producers in Canada, but at the very least, it is just one company that is not exiting.
Julian Klymochko: I would not hold your breath on that one Mike. Certainly a head scratch to see a U.S. company coming back to Canada. As you indicated, they have all been packing up their bags and leaving as quickly as possible. And it seemed to be selling it, whatever price they could get for their assets. They just wanted to get the heck out of Canada just because the investment environment was just brutal.
Michael Kesslering: And regulatory environment, right? Like its ridiculous regulatory environment here in Canada capital pipelines.
Julian Klymochko: Yeah, so a horrible place to be investing capital. And as they say, capital goes to where it’s treated well. Certainly not treated well in the Canadian oil patch and Kelton investors really can’t catch a break here despite the huge price and stock was barely up on the news, but I digress. Interesting deal, as you indicated, and the Chevron, Nobel deal. It is one that we will watch, not involved from a merger ARB standpoint. Currently just given spreads on unattractive and that is about it for The Absolute Return Podcast this week. Folks hope you enjoyed it. If you did, you can always check out more at absolutereturnpodcast.com. Feel free to leave us a review, recommend it to your friends. Definitely follow us on Twitter. My handle is @JulianKlymochko, K-L-Y-M-C-H-K-O. Mike, what is your Twitter handle?
Michael Kesslering: You can find me at M_Kesslering, and you can find not only some, overall investment analysis, but also with the NHL playoffs coming back coming back in the next couple of weeks, some mediocre hockey coverage as well.
Julian Klymochko: Oh, great. Go Jets, and to all the investors, listeners, short sellers, we wish you all the best in your trading and investing this week and we will chat with you soon. Bye everyone.
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