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Bram de Haas
Bram de Haas
Articles (458)  | Author's Website |

Why I'm Betting on Ackman

A review of Pershing Square Tontine Holdings

Last week I wrote here on Gurufocus about the Pershing Square Holding (LSE:PSH) vehicle run by Bill Ackman (Trades, Portfolio). This vehicle is essentially a closed-end fund trading at a massive 30% discount to its net asset value.

A discount like that is especially large given the size of the fund, the fact that it has a star manager and the fact that Ackman is going to great lengths to try and close the discount. One additional reason for my optimism regarding the future of Ackman's vehicle is that a small part of its net asset value is accounted for by sponsor warrants in Pershing Square Tontine Holdings (NYSE:PSTH.U).

Pershing Square Tontine Holdings is Ackman's special purpose acquisition company (SPAC), or blank-check company. Historically, these companies have a bad reputation. In my opinion, that's a reputation that's well deserved. The purpose of a vehicle like this is to raise money from investors into a publicly-traded trust. Then the sponsor of the trust, usually a business person of some fame, goes out and searches for a private company to buy or to acquire a stake in. That effectively takes the private company public, kind of like in an IPO or direct listing (though there are quite a few differences with the method).

When the business combination is announced, the trust holders get to vote for or against the deal and if they don't like it, they can effectively redeem the money they put in at that point. Sometimes after redemption these investors were even up because of interest on the trust, though these days that's not a major factor.

Historically, the sponsor usually took down an enormous part of the economics. For example, after the business combination, the sponsor would receive 20% of the equity of the combination while putting in almost no capital. That practice has resulted in a lot of SPACs delivering very poor results for minority investors.

Ackman is doing things differently. He raised the largest SPAC in history with $4 billion in capital. In addition, Pershing Square has committed another $1 billion. Pershing also has the option to funnel in another $2 billion, but Pershing Square only owns sponsor warrants worth 5.95% of the business combination. Historically, the sponsor would take a much larger bite out of the pie.

Ackman also leveraged the size of the vehicle to negotiate underwriting terms down aggressively from ~5% to 1.5%. He also invited what he calls a set of world class investors to invest in the SPAC. Names haven't been disclosed, but based on Ackman's descriptions, I believe Fidelity could be one.

Finally, Pershing brought an interesting innovation to the SPAC world which inspired the Tontine moniker. If shares are held through the business combination, instead of redeemed, holders receive an additional 2/9 warrants per share. You can't exercise fractional warrants, so it seems wise to buy in multiples of nine.

The units of the SPAC were separated into shares (with attached rights to the tontine distributable warrants) and warrants. The warrants now trade for $6.18. The shares now trade for $21.60.

The warrants have a strike price of $23 per share. You exercise one full warrant to purchase a share at $23.00 per share. These warrants expire five years after the completion of the initial business combination. What's tricky is that they are redeemable warrants. The business combination can effectively redeem the warrants if the shares trade above $36 for 10 days. That would still constitute a massive 100%+ gain but I think that takes away a lot of the attractiveness of such long term warrants.

To get an idea of what a warrant like this should be worth I've pulled up prices for long term options on major and characteristic Pershing Square holdings. Volatility doesn't tend to be off the charts for Pershing Square companies because Ackman puts a premium on quality, predictable cash flows and durable businesses with moats.

  • Starbucks (NASDAQ:SBUX) January 2022: slightly out of the money (OTM) call is $10 vs share price $85
  • Restaurant Brands (NYSE:QSR) January 2022: slightly OTM call is $7 vs share price $54
  • Lowe's (NYSE:LOW) January 2022: slighlty OTM call is $20 vs share price $161
  • Chipotle (NYSE:CMG) January 2022: slightly OTM call is $232 vs share price $1360

Given the redemption feature, I'm afraid a Pershing Tontine $23 warrant should at best trade at something like $5. I would still believe it to be overvalued. The key here is really the redemption feature that potentially caps the upside in short order. To me, the price of the warrant implies the market expects there is a good chance of huge upside volatility like we've seen with other SPACs. For example, the one bringing DraftKings (DKNG) has about quadrupled in its first year.

I think that makes the shares even more promising. If the deal is truly awful it is possible to redeem shares and receive $20 back. That's a ~7% loss. However, if the business combination is consummated, you receive roughly 2/9 of a warrant per share (watch out for the treatment of fractionals). Embedded in every share is $1.36 worth of warrants (given where they trade in the market currently). If a percentage of investors redeem the lost warrants are distributed pro-rata which could increase the value further.

The warrant pricing seems to communicate the option of massive upside volatility, but the shares don't reflect that. If you subtract the warrant value embedded in the shares they trade at a $0.24 or 1.18% premium to redemption value. It is an unusual structure and possibly not every trader is realizing the shares have these contingent rights.

Disclosure: The author is long warrants and shares of Pershing Square Tontine Holdings. The author is also long Pershing Square Holding.

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About the author:

Bram de Haas
Bram de Haas is managing editor of The Special Situations Report and Founder of Starshot Capital B.V.

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