March 30, 2022 – Negative sentiment in the SPAC market has been pervasive.
Three factors have driven this negative sentiment:
1. Geopolitical conflict and rising interest rates causing volatility in equities and fixed income, leading to a skittish IPO market.
2. Continuous jawboning from the SEC on increased SPAC regulation (likely an attempt to eliminate overly ambitious SPAC target forecasts).
3. Poor deSPAC performance due to the popping of the growth stock bubble and the concentration of speculative targets in the blank check market (of which similar performance has been exhibited in recently IPO’d companies).
The media has continuously parroted these factors, leading to investors souring on special purpose acquisition companies.
As SPAC arbitrageurs, the negative sentiment has opened up opportunities for what can be viewed as “free money” investments.
Specifically, a total $4.4 billion of arbitrage profit, measured as the cumulative difference between SPAC prices and their redeemable NAVs, is available for those willing to pick it up. This $4.4 billion compares to $0 arbitrage profit available one year ago when all SPACs traded at a premium to NAV.
98% of SPACs now trade at discounts, offering hundreds of arbitrage opportunities. Many short-dated SPACs offer double-digit yields for those operating a buy-to-redeem investment strategy.
In addition, SPAC warrant prices appear to be irrationally low. If we assume an average deSPAC price of $6.00 per share, according to the Black–Scholes model the average deSPAC warrant should be worth approximately $1.00. In addition, we see “seasoned” deSPAC warrants trading in the $0.70 to $1.30 range.
Despite this indication of value, SPAC warrants have been crushed this year, falling -47.3% from $0.74 to $0.39.
Source: Accelerate
The average deal SPAC warrant trades at $0.74 and the average pre-deal SPAC warrant trades at $0.33.
If we assume the average deSPAC warrant trades to $1.00 once “seasoned” in the market (i.e. trading for a few months), then a pre-deal SPAC warrant at $0.33 implies 3x upside if it can successfully complete a deal.
Therein lies the rub.
Currently, the negative sentiment has generated widespread fear of mass SPAC liquidations, in which a SPAC fails to secure a deal before its deadline and returns principal plus accrued interest to investors instead of seeking more time.
While we’ve seen just one blank check liquidation thus far in 2022, SPAC warrant prices show the market is pricing in a 400x increase in SPAC liquidations.
Here’s the math backing that liquidation estimate.
If we assume that a seasoned deSPAC warrant has a fair value of $1.00, and the average pre-deal SPAC warrant trades at just $0.33, this discrepancy implies that only one-third of blank check companies seeking a target will complete a deal and that two-thirds will liquidate.
There are currently 610 SPACs searching for a target, and therefore the pre-deal SPAC prices imply that more than 400 SPACs will end up liquidating.
This bearish prediction of nearly 70% liquidations is unlikely, in our opinion, given the historical liquidation rate of less than 2% over the past 11 years.
Nonetheless, given the skittish market conditions and the excess supply of blank check companies, we believe liquidations may rise above average.
That being said, SPAC liquidations are fine for arbitrageurs, given that we still make money (as long as we are buying below NAV). However, a SPAC liquidation is devastating for a warrant holder, given the warrant becomes worthless.
An arbitrageur could play the increase in the value of warrants in a low-risk manner by acquiring discounted pre-deal SPAC units, given these come with free warrants stapled to the units.
In this “arbitrageur’s market”, 90% of pre-deal SPAC units (inclusive of free warrants) trade below NAV, giving the arbitrageur low-risk returns while offering upside to a recovery in warrant values (along with upside optionality should market sentiment turn on the underlying SPAC).
In an environment where investors are worried about war, rising interest rates, surging inflation and a potential recession, an investment with mitigated downside risk and attractive upside may be warranted (pun intended!).
The Accelerate AlphaRank SPAC Monitor details various metrics on the current opportunity set while offering details on every individual SPAC currently outstanding. The Accelerate AlphaRank SPAC Effective Yield tracks the average arbitrage yield offered in the market. The Accelerate AlphaRank SPAC Index tracks the price return of the SPAC universe.
* AlphaRank is exclusively produced by Accelerate Financial Technologies Inc. (“Accelerate”). The Accelerate Arbitrage Fund may hold a number of securities discussed in this research. Visit AccelerateShares.com for more information.
