Last Monday, Therapeutics Acquisition Corp. (TXAC) filed an amendment to its S-1 dropping the warrant coverage included in its IPO units from 1/3 all the way down to zero. Then on Wednesday, TXAC became the first SPAC IPO ever to price with $10.00 in trust and no warrants. Even more remarkably, the opening auction cleared at $11.25 and shares traded up above $20 later in the week. We’ve heard that the book was almost entirely composed of fundamental investors and that SPAC arb funds received no allocation in the upsized $136mm IPO. It’s quite an accomplishment for Jefferies, TXAC’s book-runner, which also helped deliver a return of upwards of 40% to any investor who’s still holding shares and warrants from the bank’s last healthcare SPAC IPO – ARYA Sciences Acquisition Corp.
We’ve watched warrant coverage drift lower recently — five 2020 IPOs have priced with 1/4 warrant and the lion’s share of IPO proceeds this year have come from SPACs with less than 1/2 warrant coverage. You can see on the chart below that the average warrant coverage for the last ten SPAC IPOs is at an all-time low of 0.36.
Part of the decreasing warrant coverage is a reflection of increased demand for the SPAC product. For years, trust accounts were mostly funded by SPAC arb funds, but 2020 has seen a spate of deals that have traded extremely well. The result has been a surge in interest for SPACs from fundamental investors. And while the amount of issuance has increased this year, demand has increased more than supply. Deal announcements and LOIs are seeing a more positive reception than ever, and so it makes sense that traders have started paying higher prices for SPACs without an announced business combination. But the movement we’ve seen in the past six weeks has been staggering.
The chart below plots the estimated SPAC yield curve, showing time remaining against estimated YTM for all SPACs without an announced deal.
If you’ve been following the SPAC yield curve for a while, this chart should look completely alien. Historically, over 90% of SPACs without an announced deal have provided buyers a positive yield. Now, the median SPAC is yielding -1.3%! Plenty of SPACs are yielding -3% or worse, and buyers of SPAC common equity in the open market are taking principal risk for the first time ever.
We’ve been writing about retail participation in SPACs for over a month now. It’s impossible to distill the exact impact retail is having, but you can’t ignore the fact that SPAC deals are being received more enthusiastically than ever before. Almost every pending deal right now is trading at a premium to cash in trust.
We looked last month at how shares are trading up on LOI announcements, in many cases without even the name or enterprise value of the SPAC’s intended target company. Of course there’s no guarantee an LOI will turn into a definitive agreement, and it can take months to hammer out the finer points of a deal. But buyers of some shares on LOI news have ultimately been rewarded with well-received transactions and share price increases on deal announcement. That has driven prices higher and yields negative, especially for SPACs with the shortest amount of time remaining, as speculators have bought shares in anticipation of news as a positive catalyst for stock price.
Meanwhile, plenty of experienced sponsors with a recent successful deal under their belt are also trading at large negative yields. It’s a conundrum for the SPAC arb players who are used to funding the majority of SPAC trust accounts at IPO. Whatever your cost of capital is, you need to earn a guaranteed spread on top of that if you hope to apply leverage to a portfolio of SPAC investments. Traditional SPAC investors would like to see increased warrant coverage given the drop to near-zero in T-bill rates. But instead, we’re seeing SPACs being priced like equities rather than bonds with a call option attached. Which is great for sponsors and targets, since fundamental investors are more likely than SPAC arbs to take a given deal seriously enough to stick around past its closing date.
Here’s another visualization of the price of SPAC common equity – the trading discount to trust value for all SPACs that are pre-deal announcement.
Historical versions of this chart have shown most SPACs clustered around a clearly defined trendline at some discount to current trust value. Even just a month ago, only a handful of SPACs were trading at a meaningful premium to trust. But now there are far too many to highlight.
Of course, price is a function of supply and demand. And this week, Bill Ackman’s new SPAC, Pershing Square Tontine Holdings (PSTH) is set to raise $3bn in the largest SPAC IPO ever. We’ve never seen that much paper hit the market at once, and it’s fair to wonder if the IPO will have an impact on the market in general. If recent price appreciation is any clue, demand for the product remains incredibly strong.
And what about new SPAC issuance? Will we see more and larger warrantless SPACs in the future?
It might be easier to fill a $120mm healthcare book with fundamental investors than a $500mm generalist book. But if the market stays this strong, at some point issuers will try to capture more of the consumer surplus from an IPO that immediately trades to $10.50 or higher. We’ll have to wait and see if the rolling average warrant coverage keeps trending lower as the next crop of IPOs comes to market.