What is the latest free money for Wall Street Hedge Funds? SPAC Arbitrage, which is an investment strategy that seeks to acquire shares or units of a special purpose acquisition company (“SPAC”) at or below its net asset value (“NAV”) in order to generate a return through either:
Down here to have a good time they after all how different can it be from the all the luck in the world isn’t going to change things for these guys there’s an on a poker game and you don’t see a sucker get up from the table you are the sucker this rule applies quite often in the world of finance too now if there’s
An investment structure where three types of investor are involved and two of them have access to a risk-free profit opportunity it’s possibly reasonable to think that the third is the source of their profits so what is this structure and who are the winners and who are the losers well the structure is of course the
Hottest investment product of the last 12 months the spec and i’m hoping that you the viewer are not the sucker at this poker table spike promoters are so busy banging out new products right now that they don’t even bother to come up with names for them anymore earlier this month a spack named two was announced
It’s spelled with a lowercase t the goal is to raise 200 million dollars and take a company public the name’s hardly creative but i suppose it’s easier to remember than x a e a dash 12 but i’m getting off topic so what are spacks well i covered this in more detail in an earlier video and i’ll include a link to that but
Spike stands for special purpose acquisition company and spikes basically raise cash through an ipo they then invest that cash in risk-free bonds and have up to two years to search for a private company to buy buying the company has the effect of taking that company public when a spec proposes a merger spec
Shareholders have an option to redeem their shares rather than participate in the merger if they do this they get back their full investment plus some interest if a spike fails to complete a merger in the two-year period it sells off the bonds and returns the capital to its shareholders with interest so why is this a
Scandal in the making well it reminds me an awful lot of the mutual fund timing scandal from 2003 and interestingly enough some of the same people are even involved today the way these deals are structured means that the spax sponsor and some hedge fund investors who are being pitched these deals as a poor man’s
Private equity investment let’s think about it if the sponsor and some hedge funds are making risk-free profits in this structure who is shielding them from the risk and taking the losses maybe you don’t want poor man’s private equity the biggest winner in this structure is of course the spac promoter or sponsor they
Organize this and then take 20 percent of the shares as a fee which they called the promote they often put in as little as 25 000 of their own money now of course they could put in more but why would they want to it’s a no-lose deal for sponsors the incentive is to do any deal it doesn’t matter if it’s a good
Deal or not but once it’s done they get to own end up with one-fifth of a company like nicola you just sell it right away and move on the only reason the sponsor cares at all about doing a good deal is that if the deal looks like a success they then get to raise more capital and do it again most prolific spac founders
With six listed vehicles and three deals done so far he’s filed to launch seven more spacs this year with the sec some of the biggest hedge funds have piled into this trade too big names in the space include millennium management baupost group archegos and magnetar capital according to the financial times
These funds can earn high returns with almost no risk of losses if the deal goes wrong does it work well the trick to spec arbitrage is to get in early early investors who are usually hedge funds and not the retail investors who get ten dollars a piece prior to it being listed at this point it’s pretty safe as the
Money you put in is invested in bonds and as long as you get out before the merger the money is still there once the merger happens the sponsor then takes want out before that happens unit holders interest at any point up until the merger occurs typically for each share you get a warrant which is a bit like a
Call option but it causes equity dilution and it allows you to buy a quarter of a share at 11.50 usually the early investors can split the spike units into shares and warrants shortly after the structure starts trading if they return the shares prior to the merger they get their ten dollars back and crucially
They get to keep these warrants the warrant which is worth only a fraction of a share is a sweetener for early backers who can redeem their investment or sell out at any point while keeping hold of the warrant when the spec has merged with a target the warrants convert to relatively inexpensive stakes in the new company
At a strike price of 11.50 this gives early backers the ability to profit from a hot spark merger even if they redeemed their original investment well in advance of the deal now this might not sound like much of a return but because the pre-merger spike can be redeemed for ten dollars and costs ten dollars hedge funds
Can usually borrow money and lever up this investment significantly getting a pretty good return out of it it’s a low risk investment with equity upside has been announced preferring to sell their study conducted by klausner and all rogue where they analyzed a group of 47 spikes that merged between january 2019
And june 2020 97 before a deal was consummated it’s this separation that creates the trade opportunity meanwhile those who stay in for a stake in the merged company bear the risks of both a potentially bad deal and significant dilution from the free warrants that have been handed out to early backers
There are a few ways hedge funds can win in these deals should the sponsor announce a deal that the market likes the shares might rally above ten dollars and the hedge fund can then simply just sell them in the market for a profit their initial ten dollars having never really been at risk they have a potential for
Profit but not much of a risk of loss if the share price doesn’t pop they can just cash in their shares before the merger get the ten dollars back plus interest and hold a success the warrants earn them a profit a good recent example is churchill capital four once again catchy name when rumors spread the
Cciv was close to striking a deal with electric car maker lucid motors which i think is just to almost 60 dollars shareholders who bought could exit with a 600 return on investment when the deal was finally confirmed last month cciv fell by more than half to 26 dollars electric car hype paid a huge premium for
A dollars now why would a sponsor give such intention of ever being there for the merger well as i mentioned earlier the sponsor gets 20 of the shares let’s imagine that there’s a spec that has 100 shares 80 shares are sold to the public and 20 shares go to the sponsor if half of the spike’s 80 public
Shares are redeemed before the ipo the sponsor’s 20 share promote will equal 50 so the sponsor wins the hedge fund wins would point out two out of three ain’t bad the academic study that i mentioned earlier which i’ve linked to in the description shows that spac shares tend to drop by one-third of their value
Or more within a year following the merger this suggests that investors who stay invested in spax on average take a financial hit although spax issue shares for roughly ten dollars and value their shares at ten dollars when the merger occurs per share according to that study so a spec typically sells shares to one set of
Investors set of investors when it comes time to merge a more retail investor base nearly all pre-merger shareholders exit at the time of the merger either by redeeming their shares or by selling them on in the market in effect a spac pays ipo investors so that other investors can later buy shares once a
Target has been selected to bring public just to be clear i’m not saying that the hedge funds are the villains in this story they’ve been offered a low risk trade and they’ve taken it the spike sponsors on the other hand are pitching a structure that destroys value for retail investors but makes the sponsors and hedge fund
Investors rich more and more these deals are being rushed to market right now before the boom ends you don’t actually have to be a hedge fund to do this trade anyone can but as a retail investor you might not be able to lever it up as much as a hedge fund can of course the problem here is that if everyone involved
Did the same thing and followed the be invested in bonds and then when a deal was announced everyone would pull out ending the deal making the warrants worthless for this arbitrage to work there must be a sucker at the poker table if you found this video helpful do hit the like button and subscribe if you want to see more of
Transcribed from video
The Next Hedge Fund Scandal By Patrick BoyleliveBroadcastDetails{isLiveNowfalsestartTimestamp2021-03-16T215318+0000endTimestamp2021-03-16T220701+0000}