Analysis of Tontine Warrants

By: SPAC Research

Email: bk@spacresearch.com

Published: June 29, 2020

Bill Ackman’s Pershing Square Capital Management filed an S-1 last week to raise the largest SPAC IPO ever – Pershing Square Tontine Holdings, Ltd (PSTH). Ackman is no stranger to SPACs – he previously teamed up with Martin Franklin to raise £900m in 2011 for a vehicle listed in London called Justice Holdings Limited. That SPAC acquired 29% of Burger King Worldwide from Brazilian private equity firm 3G Capital for approximately $1.4bn in 2012. But the new vehicle, which will raise $3bn, is worth a closer look because it contains a number of innovations that may change the way issuers look at SPACs going forward.

To start with, the IPO will put $20 in trust for each share of common stock sold in the offering. Related IPO terms are adjusted accordingly, with warrants struck at $23, a Crescent Term at $18.40, and a warrant redemption feature at $36.

The SPAC also includes a record forward purchase agreement, where Pershing Square affiliates will buy between $1bn and $3bn worth of units at deal closing, depending on the needs of the individual transaction. But the biggest changes come in the form of warrants.

Tontine Warrants
Each unit sold in the IPO comes with 1/3 warrant coverage. But only 1/3 of that amount (or 1/9 warrant per IPO unit) is detachable for separate trading. The remaining 2/9 warrant coverage will remain attached to the shares of PSTH common stock until the SPAC closes a business combination.

With $20 per share in trust and excluding over-allotment, the SPAC will have 150mm shares outstanding, meaning that approximately 16.7mm warrants will trade separately and 33.3mm warrants will effectively be a due-bill attached to PSTH common stock. Fans of financial arcana may be familiar with an instrument called a tontine, a pooled vehicle that effectively awards dividends to participants who outlive their co-investors. The 33.3mm “distributable tontine” warrants will be awarded pro rata to public shareholders who don’t redeem for cash at deal closing. To clarify: if no public shares redeem for cash, then each share gets 2/9 distributable tontine warrants. If half of all public shares redeem for cash, then each remaining share gets 4/9 distributable tontine warrants.

We’ve heard sponsors ruminate about including a mechanism like this for years. Anybody who’s ever sponsored a SPAC has asked themselves “How can we provide additional incentive for shareholders to stick around past our business combination?” The tontine warrant concept is appealing to fundamental investors and sponsors, even as it limits the upside for “yield” investors seeking to flip SPAC IPO units and monetize a risk-free yield from warrants.

Innovation is driven by market leaders and it is no surprise that it took someone of Ackman’s caliber to introduce this innovation to the SPAC market. The SPAC’s bankers would not have filed their S-1 without confidence in their ability to sell the entire book on current terms. And while Ackman has had his share of market ups and downs, he has significant investor credibility and will likely attract strong demand for SPAC shares in a moment when top-tier issuers are already a hot commodity. The book for this IPO may have proportionally fewer SPAC arbs and more fundamental investors than most other SPAC IPOs.

The tontine warrants will likely create a fascinating trading dynamic in PSTH common stock. Participants know that each share comes with at least 2/9 tontine warrants, so the share price should reflect that receivable. Meanwhile, the implied value of the tontine warrants will be set by activity in PSTH/W, the detachable warrants, a security that will only have a float of 16.7mm. It’s a clever mechanism that will likely support the trading price of PSTH common stock and may reduce the number of public redemptions overall.

No Fixed Promote
PSTH’s other new twist is the elimination of the sponsor promote. In its place, the sponsor will pay an estimated $45mm for a sponsor warrant that’s exercisable for 5.95% of the fully diluted share count of the post-combination entity.

Many sponsors have previously included an anti-dilution mechanism to peg their ownership percentage to a minimum of 20% of the capital they bring to a transaction. But we can only think of one instance where the anti-dilution mechanism wasn’t waived in connection with deal closing.

The sponsor warrant creates an incentive for Ackman to go hunting for the largest unicorn possible to maximize the number of shares that his warrant controls. Of course, SPAC sponsors are used to the market asking them to sacrifice some of their promote, and it seems reasonable that PSTH’s pool of acquisition targets will be well-advised and will request some concession from that 5.95% number. But the way this warrant is structured will likely make it easier for Ackman to control a larger stake in the combined company at closing. After all, it’s easier to hold on to shares you already have than it is to ask for more to be issued at deal closing.

The sponsor warrant has an exercise price of $24 and so will only be in the money if PSTH common stock trades up 20% from its initial cash in trust value. But the warrant has a 10-year life, so Ackman will have plenty of time to realize its full value.

In general, many of the best SPAC deals are struck when sponsors are willing to make concessions like subjecting some of their promote to an earnout. But this SPAC is already beautifully aligned. Pershing Square’s sponsor investment will only pay out if the rest of shareholders are at least 20% in the money.

It will be fascinating to watch this SPAC and its eventual business combination. And we’ll be looking for more sponsors to incorporate whatever pieces of this new structure work for them in future SPAC issuance.

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