Implied Yields and IPO Issuance

By: SPAC Research

Email: bk@spacresearch.com

Published: August 17, 2020

It was a busy week for those of us digging into the minutiae of SPAC trust account balances, with almost all of the 144 active SPACs filing their quarterly reports for the period ended 6/30/2020.

We frequently get subscriber questions about the historical yield on SPAC common equity. Unfortunately, we don’t have any historical data (though we’ve now started tracking the median yield from our estimated YTM tool). But our analysis below shows the implied yield on SPAC common equity since the beginning of 2019.

We took the amount of cash in trust at each quarterly endpoint, netted out any taxes payable, and compared that to the last trade of each SPAC’s common equity. Then we annualized that discount or premium. (For instance, a SPAC trading at $9.90 with $10.00 in trust and one year remaining would have a 1.0% annualized discount to trust, while a SPAC trading at $9.61 with $10.00 in trust and two years remaining would have a 2.0% annualized discount to trust).

Then we added the 6-month Treasury rate to the annualized discount. The result is the implied yield on SPAC common equity at the end of each quarter back to the beginning of 2019.

You can use the implied yield to get a sense of how cheap or expensive the market is pricing SPAC common equity at a given time. Higher yields mean the market is less optimistic on potential SPAC deals and participants need to get paid more to own the zero coupon bond portion of a SPAC’s ultimate redemption value. Lower yields mean the market is more optimistic and is willing to pay closer to (or above) cash in trust for the option to own the company a SPAC’s sponsor eventually brings to market.

The chart above likely confirms what participants have noticed in active trading. Coming out of the market selloff in Q4 2018, SPACs were weak and yields were high, with the median implied yield at almost 6%. The SPAC market was strong and rallied through 2019, before pulling back to new lows and higher yields in March of this year. Then SPACs went into hyperdrive as exciting business combinations and a broader market recovery drove newfound interest in the product.

The chart doesn’t quite capture the mania we saw in July — we noted on 7/13/2020 that the median SPAC was yielding -1.3%! But it does generally track the SPAC Research Warrant Index, our other measure of how expensive SPAC securities are.

You can see sentiment has cooled a bit since peaking in late July. Trading activity in common stock reflects that as well, with a number of new IPOs breaking issue and trading below $10 on day one. Plenty of SPAC common shares have traded back into meaningfully positive yields — though many others are firmly negative, as you can see below (and as compared to this chart from a month ago).

Record demand for SPACs precipitated an unprecedented surge of new S-1 filings in July. One might expect that the pullback in stock and warrant prices would propagate through to new issuance as well. But the IPO pipeline continues to set records, and an all-time high 27 SPACs are seeking to raise almost $8bn right now.

Meanwhile, the 10-deal rolling average of warrant coverage has moved to an all-time low. The last 10 SPAC IPOs contained an average of 0.30 warrants per unit, including two with no warrant coverage at all.

Warrant coverage keeps declining but issuance doesn’t show any signs of slowing down. For those who were wondering if Pershing Square Tontine Holdings’ (PSTH) $4bn IPO in July would throw a wrench in the steady stream of IPOs, the answer was: clearly not. Since that time, Churchill Capital Corp IV (CCIV) upsized from $1bn to $1.5bn to $1.8bn, and the underwriters exercised the full shoe for a trust account that has over $2bn in it. SPACs have raised more than $4.5bn in August already, and Dragoneer Growth Opportunities Corp. (DGNR) was able to cut its warrant coverage twice in the week leading up to its IPO and still close its first day of trading at $10.68.

If we’re looking for an explanation of why common stock and warrant prices have pulled back a bit but IPO issuance has remained strong, it’s probably worth looking toward the composition of day one SPAC investors. Historically, SPAC arb funds took most of the available IPO allocations, but it seems likely that the product’s basic appeal of principal-protected downside with equity-like upside has finally taken hold with a much broader investor base.

If a new crop of market participants has made a long-term decision to allocate to SPACs as an asset class without watching every security tick-by-tick, it’s possible the market can support elevated issuance for a while to come. Either way, we’re looking forward to analyzing the recently filed 13Fs this week to see where the traditional SPAC holders stand and how they positioned themselves during Q2.

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