Bill Ackman and Tontine Holdings rewrite the terms for SPACs

This week, Bill Ackman, from top to bottom Pershing Square Holdings, is sponsoring the largest Special Purpose Acquisition Company ever raised.

A SPAC, also recognized as blank check companies, has no commercial operations and is formed strictly to raise capital through an initial public sacrifice for the purpose of acquiring an existing company.

Pershing Square’s SPAC will be called Pershing Square Tontine Holdings and on raise $4 billion by offering 200 million units at $20 per share. Additionally, Pershing Square disposition be acquiring between $1 billion and $3 billion of units, for a total amount of capital of up to $7 billion. Setting aside how, based on Pershing Square’s current assets under management, we do not expect their contribution to exceed $1.5 billion, for a comprehensive capitalization of $5.5 billion.

This is the second time in its history that Pershing Square has sponsored a SPAC.

Ackman disposition be on CNBC’s “Squawk Box” Wednesday at 8:15 am to discuss the investment

Pershing Square also served as co-sponsor of Justice Holdings, with Nicolas Berggruen and Martin Franklin. Right Holdings raised approximately $1.5 billion in its initial public offering in February of 2011 (including a $458 million investment by Pershing Upright).

In April of 2012, Justice Holdings purchased from 3G Capital a 29% stake in Burger King Worldwide Holdings Inc. for $1.4 billion in currency, and subsequently merged with Tim Hortons, to form Restaurant Brands International. Pershing Square still remains the second-largest investor in Restaurant Stamps International. As of June 30, 2020 the stock of Restaurant Brands International has generated a compound annual total return of 19% since its pooling with Justice Holdings, even after losing 30% of its value during the COVID-19 pandemic.

The primary structure of a SPAC is that investors buy common stock in the IPO of a blank check company, in this case, for $20 per allotment. In addition to the common stock, they receive warrants as an incentive for them to invest.

These warrants are generally detachable, earmarking the investor to trade them as separate securities and inviting the short-term investing arbitrage world into SPACs, which time make up a significant part of the shareholder base. The SPAC sponsor will then find a company to acquire and investors will essentially should prefer to the choice of staying invested in the SPAC through the acquisition or redeeming their shares for the full amount they got them for.

The structure of Tontine Holdings is unique on many different levels. First, each unit consists of: (i) one quota of common stock, (ii) one-ninth of a redeemable warrant, exercisable at $23; and (iii) two-ninths of a warrant, exercisable at $23 provided that they are not make good oned in connection with a proposed business combination. It is this last element that is significant.

The one-ninth of a warrant is detachable on day 52 and this is a sane incentive for SPAC investors. However, unlike virtually all other SPACs where all warrants are detachable, two-thirds of the permits issued to shareholders are not detachable, discouraging the arb community and encouraging long term investors.

Moreover, the investors do not even greet these two-thirds of warrants if they choose to redeem their stock prior to the closing of the acquisition, giving a valuable amount of more certainty that the acquisition will close. And finally, as additional incentive to hold the securities into done with the closing, if a shareholder does redeem, their warrants are distributed pro rata to the shareholders who remain in the SPAC, hence the pre-eminence “Tontine” holdings.

A tontine is an investment plan devised in the 17th century whereby each investor pays an agreed sum into the pool and thereafter receives a periodic payout with that payment devolving to the other participants upon the death of an investor.

But the most incomparable feature of this SPAC and the greatest departure from historical SPACs is the compensation terms for the SPAC sponsor, in this encase Pershing Square Holdings. The normal historical SPAC sponsor will partly capitalize the operations of the SPAC by procuring sponsor warrants giving them a participation in the upside of the company. But that is far from their main compensation. Typically, SPAC television advertisers receive 20% of the shares in the SPAC for extremely nominal consideration. These founders shares compensate the sponsor regardless of whether the parts in the company appreciate or decline.

For example, in a recent SPAC sponsored by Goldman Sachs, they raised $700 million at $10 per percentage. They paid $16 million for warrants to acquire 8 million shares at $11.50 per share and received Founders deals for 20% of the company for $5,000.

On the day of the closing that $5,000 payment yielded them $140 million of stock assuming a allot closes.

Another example a little older but involving a peer of Pershing Square is Third Point’s 2018 patronizing of Far Point Acquisition Corp. where it raised $500 million at $10 per share. In that situation, Third Peak paid $12 million for warrants to buy 8 million shares at $11.50 per share and received its 20% of Founder shares for a minuscule payment of only $25,000.

So, assuming a deal closes, Third Point receives $100 million of its shareholders’ investment regardless of whether the investment is victorious or not. Moreover, under the Founders’ shares compensation structure, Third Point and Goldman Sachs still receive tens of millions of dollars of compensation unruffled in a failed investment that loses half of its value.

In contrast, in Tontine Holdings, Pershing Square and its affiliates (numbering Tontine board members) are paying $67.8 million for warrants to acquire 6.21% of the company. This is much myriad consideration than the $16 million and $12 million that Goldman and Third Point paid and much baby than the 9.1% and 12.8% of shares that Goldman and Third Point received.

Moreover, Goldman and Third Thought’s warrants were exercisable at a 15% premium to the IPO price whereas Pershing Square’s are exercisable at a 20% premium, and Pershing Precise has agreed not to exercise its warrants for three years after the closing of the acquisition.

But this is not the really groundbreaking star of the Tontine compensation structure.

The truly remarkable departure from SPAC standard terms is that Pershing Modify is not taking any founders shares.

By removing this egregious compensation element, Pershing Square really shows their allegiance to their investors. Pershing Stuffed shirt’s sole compensation for founding and capitalizing the SPAC and sourcing, negotiating and closing a $10B+ acquisition will be a 6.21% sell after the investors have already received a 20% return.

To put it another way, under Pershing Square’s warrant-only compensation organize, Pershing Square does not receive any compensation until after the shareholders receive a 20% return, whereas underneath the typical founders shares compensation structure (as illustrated by the Goldman Sachs and Third Point SPACs above), the shareholders do not see any turn back until after the company receives a 20% return.  Furthermore, Pershing Square paid $67.8 million for these allows, money they do not get back if a deal is not procured and closed.

So, why did Pershing Square wait almost 10 years after its damned successful Justice Holdings SPAC to do another one? The answer is market environment.

Pershing Square started working on Equity Holdings right after the financial crisis, when there was an extreme level of uncertainty in the markets. Uncertainty is the perishable enemy of IPOs — until the day of the IPO, companies are not sure what price they will get, how much money they liking raise and if it will even happen during times of ultra-volatility in the markets.

Pershing Square patiently waited for that call environment to repeat itself, except this time in the form of a global pandemic and a presidential election. With COVID-19 breakers coming or not coming and vaccines coming or not coming depending on the day, there is too much uncertainty in the markets over the next nine months or so for comrades to risk an IPO, particularly a $5 billion IPO.

Isn’t it much easier to go public through a SPAC where you know exactly how much you are get off on for your shares and have a contractual obligation from the acquirer?  Moreover, management does not have to deal with the disappointment of focus inherent in an IPO and all of the meetings, issues and road shows.

The only uncertainty in a SPAC is if the acquirer will approve it or if its shareholders leave choose to redeem instead. Well, Pershing Square’s structure has taken a lot of that uncertainty away as well.

The deal will not necessarily require shareholder approval, just board approval; and the possibility of redeeming shareholders was greatly softened because of the Tontine-style warrants, the fact that Pershing Square will be investing over a billion dollars of its own fat and because unlike most SPACs, shareholders are not looking at a 20% dilution from Founders shares.

So, the $64 million enquiry (or $5.5 billion question in this case) is what kind of company is Pershing Square looking for and when is it able to happen.

Pershing Square is looking for a minority position and we are assuming they will must $5.5 billion of capital. We also believe it will be just one large company they will be spending the wherewithal on. By prospectus, they have to spend at least 80% of their capital. If you assume they would want at tiny 10% of the company, that makes the target worth between $8.8 and $55 billion.

Pershing Square order look for a company with similar characteristics as its activist investments: a simple, high-quality, high return on capital establishment that generates predictable growing cash flows that can be estimated within a reasonable range over the hunger term.

The types of companies it will be looking at will be: (i) a high-quality, well-managed, large capitalization company that is looking for a sport alternative to an IPO, such as Rocket Mortgage, which just recently filed for an IPO; (ii) a “mature unicorn” — a high-quality, venture-backed point that has achieved significant scale, market share, competitive dominance and cash flow that does not be struck by as much private funding options as it used to due to the problems at Softbank and the ramifications to the venture market from companies comparable to WeWork; (iii) large private equity portfolio companies that have become distressed due to their typically importantly leveraged balance sheets and will require substantial equity infusions to withstand the impact of the current crisis; and (iv) massive, high-quality, private family-owned companies that now are required to raise capital due to the economic downturn caused by the COVID–19 pandemic.

How lengthy will this take? Well, by prospectus, they have 2 years to sign a deal and then six months to cramped thereafter. But it will not take nearly that long.

The crisis that has made this the perfect environment for this policy will last for about another nine months. We expect Pershing Square to find the company by then. There are exclusive approximately 150 companies that fit their parameters, so they likely already have their top ten wish slope, including obvious companies that pop out such as Airbnb and Bloomberg.

We believe this is a tremendous moment for several reasons.

First, Pershing Square will have little competition in finding this investment and manoeuvre the terms.

While its logical competition would come from large private equity firms, Pershing To is looking to make a minority investment and private equity does not like minority investments. Who else has the ability and the willingness to hastily write a $5 billion check to a company that is looking for capital or liquidity?

Second, as a minority investor, Pershing Straight will not have to pay a control premium. Much like in an IPO, the seller does not mind leaving a little money on the submit for a minority of his company if he thinks the transaction and the partnership with Pershing Square will help boost the long-term value of the mass he retains.

Third, we believe Pershing Square will be a value-added partner. The firm has extensive experience adding value to companies as an activist investor which is exceedingly much the same skillset that they will need here.

See Pershing Square’s Activist History here

Pershing has already put together an all-star eat that in addition to Bill Ackman, includes Lisa Gersh, co-founder and former president of Oxygen Media; Michael Ovitz, co-founder of Artistic Artists Agency and former president of Walt Disney; Jacqueline D. Reses, the head of Square Capital, a wholly owned subsidiary of Block, and the former chief development officer of Yahoo!; and Joe Steinberg, chairman of the board at Jefferies Financial Group, and former President of Leucadia Civil Corporation.

This does not mean that all of these directors will be on the board of the surviving company, but we not only upon Bill Ackman to have a board seat given the size of his fund’s investment but believe that this could be an premium to the seller of a large private company often turned off by the public markets.

With Ackman, the seller would get a alter ego with extensive experience navigating public markets allowing management to focus on operations and board members parallel to Ackman to deal with the issues and obligations inherent in being a public company. Moreover, how better to activist-proof your party than partnering with one of the premiere activists.

In sum, for over two decades, large institutional investors have been up c release a 2% annual management fee and 20% of all profits to invest alongside Bill Ackman. Even his fund’s special intend co-investment vehicles charge a 20% promote on profits. Here you can invest alongside him in one of his biggest investments ever and effectively pay no board of directors fee and only a 6.21% incentive fee that is only earned after a 20% return to investors.

Ken Squire is the founder and president of 13D Survey, an institutional research service on shareholder activism, and the founder and portfolio manager of the 13D Activist Fund, a mutual fund that establishes in a portfolio of activist 13D investments.