Pershing Square Tontine Holdings - Not Your Average SPAC
Bill Ackman recently organized a “blank check company” also known as a special purpose acquisition company, or SPAC. The company filed its S-1 on June 22nd under the name Pershing Square Tontine Holdings and ticker PSTHU. A SPAC is a public company that raises capital with the intent to merge, acquire, or otherwise combine with a yet to be determined private business. If no transaction occurs within two years investors get their money back at par.
Generally, SPACs should be viewed as highly speculative endeavors and accordingly are not something we spend much time investigating. However, this opportunity is more interesting than usual for several reasons:
· Ackman’s investment style resembles ours;
· Pershing Square has had past success in SPACs;
· Market conditions from the pandemic may provide a unique opportunity set for acquisitions;
· This is the largest ever SPAC with a unique structure.
While it is unlikely we would own a SPAC pre-acquisition because they cannot be reliably valued, getting to know the structure of this company is both interesting and may make for a potential investment once a transaction is announced.
Sponsor
Bill Ackman, founder of Pershing Square Capital Management, has an exceptional investment record and an approach to investing and portfolio construction that closely mirrors ours at Eagle Point. Below are Pershing Square’s returns since inception. We have previously written about the investment appeal of Pershing Square Holdings.
Source: Pershing Square Holdings 2019 Annual Report
Also, as outlined in our recent QSR post, this won’t be Ackman’s first SPAC. He formed a blank check company called Justice Holdings which ultimately merged with Burger King in 2012 and has since produced excellent 20% annual returns.
Because of the types of businesses Ackman focuses on, our portfolio, research process, writings, and investment style have substantial overlap - some of it intentional and some coincidental. Needless to say, we pay attention when Ackman or Pershing Square make a big move.
Acquisition Criteria
Pershing Square likes to invest in “high-quality, high-return on capital business that generates predictable growing cash flows that can be estimated within a reasonable range over the long term.”
The SPAC will follow the same criteria for potential investments with target attributes including:
o Simple, predictable, and free-cash-flow-generative
o Formidable barriers to entry
o Limited exposure to uncontrollable extrinsic factors
o Strong balance sheet
o Minimal capital markets dependency
o Large capitalization
o Attractive valuation
o Exceptional management team and governance
While it’s impossible to predict exactly what company or industry with which the company will combine, as long as it checks many of the boxes above there’s a good chance it will be a business that I am interested in exploring further.
Opportunistic Timing and Target Industries
In the simplest form Ackman wants to take advantage of recent capital market dislocations to take a high-quality company public on favorable terms. In the filing they discuss four types of businesses that have been impacted from COVID-19 related volatility.
1. Well managed private companies
Due to volatility in debt and equity markets since March, it has been increasingly difficult for even well-managed private companies to execute IPOs on advantageous terms. There have been a few IPOs recently, but the market has largely dried up which has deterred private companies from tapping public markets.
2. Mature Unicorns
Investors in “mature unicorns”, which are private, venture-backed companies that have achieved significant scale, cash flow, and competitive advantages, have recently started to eye liquidity. The recent push to realize gains amidst the pandemic has substantially reduced their ability to attract the private capital needed to continue their growth trajectories. This, in conjunction with recent high-profile private investment failures and disappointing IPOs, combine to form potentially attractive opportunities for PSTHU.
3. Private equity portfolio companies
Many large private equity portfolio companies with substantial leverage will need equity infusions due to the economic dislocations caused by COVID-19. Merging with a SPAC will provide them capital and access to Ackman’s business acumen.
4. Family-owned companies that need to recapitalize
Many privately held family companies will need to recapitalize for similar reasons, especially those that face an outsized impact from COVD-19 and similarly over-leveraged capital structures.
Value Proposition
Each of these businesses share a common need to tap public markets for capital at a time when the IPO market has dried up.
Even in normal market conditions, the IPO process typically involves years of planning and a time consuming, expensive, and distracting roadshow to promote the offering to institutional investors. After much effort, a successful IPO is still no guarantee - just ask WeWork. The SPAC aims to offer these companies a back door way to conduct an IPO with significantly more speed and certainty than a traditional listing.
This dynamic could be especially advantageous for the deal terms or valuation PSTHU receives. When a company needs capital, speed and certainty trump largely all other considerations, including price. Each structural advantage below reinforces this overarching value proposition.
Unique Structure
Ackman has structured the SPAC in four unique ways to aid in sourcing a deal on favorable terms.
Size
The simplest advantage PSTHU has is its size. No one has ever filed a SPAC this large and the offering will result in an estimated $4B - $6.45B in equity to deploy. This advantage manifests itself in the form of limited competition. The only realistic competition for target companies will come from a traditional IPO listing which as noted above may not be viable for many companies in this environment.
Forward Purchase Agreement
Pershing Square entered into a forward purchase agreement committing to purchase at least $1B worth of units and up to $3B. This sizeable capital commitment and potential incremental capital provides further certainty and should act as another advantage when sourcing combination targets.
Minority Position
Another unique aspect of PSTHU is its willingness to accept a minority position in a target company. This very much follows Ackman’s standard playbook as he rarely, if ever, acquires majority positions in portfolio companies. This should allow the business to avoid a “control premium” and pay a substantially lower valuation than if it were to acquire a controlling interest in the same company. It is also likely that strong management teams and/or owner-operators will look favorably on this as they could retain majority control.
Warrant Structure
Warrants are often attached to common units in a SPAC and Tontine Holdings has added a few favorable twists to its warrant structure.
Any shareholder who does not redeem their shares will receive two-ninths of a warrant for each share they hold, thereby increasing their ownership. Shareholders who redeem shares will forfeit their warrants which will be re-distributed back to remaining shareholders, increasing their potential ownership on a pro rata basis. This should lead to a lower level of redemptions and increase the dry powder the company has for a combination.
Also, SPACs usually have “sponsor warrants”, amounting to a 20% stake in the business, which can normally be exercised at a nominal price regardless of the performance of the investment. Pershing Square has elected to purchase its warrants at fair market value and make the warrants exercisable at $24 per share. So, Pershing Square will only participate in the value of their warrants if and when the stock increases 20% from the offering price of $20. This provides better alignment between sponsors and shareholders and considerably less dilution than a typical incentive structure.
Ackman has structured this acquisition vehicle more favorably than a typical SPAC, and has reasonable advantages in terms of scale, committed capital, and minority ownership focus. These should afford the company the chance to source a deal on favorable terms – i.e. a better valuation – than traditional sources of capital.
Board
A final point worth mentioning is the board and deal sourcing ability, which go somewhat hand in hand. Obviously, a large pipeline and expansive network to source potential investments is critical for a SPAC, and Ackman and the board easily check those boxes. Besides Ackman, the board members for PSTHU are:
· Lisa Gersh, who co-founded Oxygen Media in 1999. She subsequently served as an executive at NBC, Martha Stewart Living Omniedia, Inc., and a variety of fashion brands.
· Michael Ovitz who co-founded Creative Artists Agency in 1974, a leading talent agency. He also served as president of Walt Disney Company after leaving CAA in 1995. In 2010 he launched a venture capital fund with thirteen portfolio companies and has served on prominent boards such as Palantir.
· Jacqueline D. Reses, head of Square Capital, LLC, a subsidiary of Square, Inc. Previously she served as Chief Development Officer at Yahoo! Inc. and the head of the U.S. media group at Apax Partners Worldwide LLP.
· Joseph S. Steinberg is currently the chairman of Jeffries Financial Group Inc. after serving as its president for over 20 years.
It is somewhat curious that all independent directors, other than Steinberg, have media experience. Media is not historically in Ackman’s sweet spot. Perhaps Pershing Square is eyeing a private player in this arena, or maybe it’s just a coincidence.
It is no surprise that the company has assembled an impressive group of directors to oversee the SPAC, and it should help aid in creating an attractive investment pipeline.
Investment Appeal and Approach
Because a SPAC, by definition, cannot reliably be valued, they are largely a bet on the jockey. Given his track record and prior experience with SPACs, there are far worse jockeys to bet on than Ackman. When he stays in his circle of competence he rarely misses.
At $20 the opportunity is best thought of as an intelligent speculation. If the company fails to identify a merger candidate early on and begins to approach the capital return deadline, the share price may drop sharply providing investors an opportunity to buy at a significant discount to the offering price. There is also a good chance that once a target is identified the business combination can be analyzed with enough rigor to build a position.
Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.