The Weekend Edition #6

Welcome to the sixth issue of the Weekend Edition. 

Grab a cup of coffee ☕️, and relax while we take a quick look at what happened in the markets this week. 

This week, I decided to focus on one particular topic - Pershing Square Tontine Holdings. The SPAC debate is heating up and I thought it would be useful to take a closer look.

Here’s what we cover:

• Market Recap - a look at the major indices and the Jackson Hole Speech

• Earnings of Week - Takeaways in Brief

• SPACs and SPARCs - What’s going on with Bill Ackman?

• The Week Ahead

• Closing Thoughts

Let’s dive in ⬇️

Market Recap - 23 Aug 2021 to 27 Aug 2021

I really thought the markets were going to be choppy this week because of the Jackson Hole Conference on Friday. I’m so glad I was wrong! Thursday was a little bumpy but markets recovered with a vengeance on Friday. Here’s the VTI:

What Happened at Jackson Hole?

I think by now the news is everywhere. Chief Powell was very optimistic about the sustained improvement in price levels and the strong job numbers. They’re favoring a tapering of asset purchases by the end of the year, although nothing was confirmed. He did cautiously add a word of warning on the Delta Variant.

And rates… would not be linked to the tapering. For a rate change to take place, we would need to see inflation at the target rate of 2% for a sustained period of time.

So now we know what to expect and it’s quite likely we will get a firm announcement on asset purchases at the September FOMC meeting (22 Sep).

I wrote about the effects of these changes in last week’s newsletter here ⬇️

Earnings of Week 

Mostly top line and bottom line beats all around, except for Peloton ($PTON).

• Palo Alto Networks ($PANW) soared almost 19% on news of their earnings results. The CEO said that the company saw “notable strength in large customer transactions). The recent series of cyberattacks seems to have has boosted the company’s business.

• Toll Brothers ($TOL) had a fantastic quarter. Home sales revenues were up 37%, and EPS more than doubled compared to one year ago. They’ve broadened their product offering and price points and continue to expand margins. They have a backlog of $9.44B with projected Q4 deliveries of 3450 units at an average of $840,000 per home.

• Salesforce ($CRM) had yet another outstanding quarter and is seeing the benefits of their Slack acquisition. They see FY22 EPS $4.36-$4.38 (est. $3.82) and FY22 revenue at $26.2B-$26.3B, (est. $26.01B) with operating cash flow growth of 14%-15%.

• Peloton ($PTON) had a tough quarter with wider-than-expected loss due to treadmill recalls. They’ve also announced offering a lower-priced version of their bikes at $1495. As of yesterday, the DOJ had subpoenaed records related to the treadmill injuries and the SEC is also investigating them for related disclosures.

• Dick’s Sporting Goods ($DKS) was a real winner this quarter, beating their EPS estimate by almost 2x. They raised their EPS estimate for FY2021 to $12.45 - $12.95 (est. $9.01). They’re also raising FY21 revenue view to $11.52B-$11.72B from $10.515B - $10.81B, (est. $10.9B) and see FY21 same-store sales growth at 18%-20%. This company has really been underestimated.

SPACs and SPARCs - What’s going on with the SPACkman?

The NY times published an article on 17 Aug 2021 about Bill Ackman’s SPAC, Pershing Square Tontine Holdings, getting sued. So started a series of questions and concerns around what was going on with $PSTH and SPACs and Ackman’s response to this was the SPARC. Here’s a quick rundown of what happened, what’s going on and what it all means.

Background

Bill Ackman is one of the savviest investors of our times and the PSTH SPAC was not his first. It was proclaimed one the largest SPACs in the market, raising $4B at $20 a share for 200million shares through its IPO, in late July 2020. It was the only SPAC to debut at $20 instead of $10.

The SPAC structure was also unique. It was in fact, more “investor friendly”. This is how:

A typical SPAC sponsor takes about 10% - 20% of shares and warrants that pay out regardless of the performance of the company after a merger. PSTH gave the sponsor a warrant, that would only pay out if the deal was proved successful and which were redeemable at $24 (a higher strike to the warrants for unit investors).

The Warrants were not structured like a typical SPAC either. [Each warrant gives you the right to convert to one share at the exercise price].

Each unit of PSTH came with one share, 1/9th of a redeemable warrant at $23 and 2/9th of a Distributable Warrant exercisable at $23, if they are not redeemed. This last type of warrant is not detachable, meaning if the investor decided to redeem (not be part of the merger) they lose their 2/9 of a warrant.

If a shareholder decides to vote for the deal they get to keep this warrant. In addition, any warrants given up by redeemers will be distributed evenly among any shareholders who do not redeem.

This is where the “Tontine” part comes in.

The SPAC had till July 2022 to complete its merger and the market had really high hopes for this one.

After a lot of speculation by investors, PSTH finally announced their merger target in June 2021 and it really wasn’t what the market was expecting. Instead of actually merging with a “Unicorn” as Bill Ackman had alluded to on multiple occasions, the SPAC was actually going to buy 10% of Universal Music Group (UMG) which was going to be spun off from Vivendi, a European conglomerate. The deal structure was complicated. I read the 130-page slide deck and it’s not something you can really peruse at your leisure.

But the kicker to this deal was that the existing shareholders of PSTH would get warrants to opt-in to a future merger that PSTH would do for about $1.6B.

The stock price, which people hoped would appreciate, actually fell and retail investors lost a lot of money on options, stocks and warrants and they were probably looking for some retribution.

Worse still, the deal didn’t go through because the SEC said that the deal didn’t meet the NYSE’s standard for a SPAC merger.

The Lawsuit

One of the investors, George Assad, file the lawsuit but it seems more like a crusade than anything else. The case is being argued by Robert Jackson, a former SEC commissioner, and John Morley, a law professor at Yale, claiming that PSTH was operating as an illegal investment company and should have been subjected to the Investment Company Act of 1940, which has stringent rules around how an investment company can managed funds and fees.

The UMG deal would’ve essentially made PSTH an investment company but the deal didn’t go through. Still, I think investors were just outraged and now they’re claiming that all PSTH has done is invest in government securities and treasuries, like a typical investing company.

SPARC - Ackman’s Solution

This about sums it up.

Two days after the news on the suit was announced, Bill Ackman posted a letter to the Shareholders, with a solution to straighten things out.

They’d filed for the SPARC (Special Purpose Acquisition Rights Company) during the UMG merger. This would give shareholders a “modified opt-in” solution where the shareholders would’ve received long-dated warrants for a future merger. The SPARC however, requires a change in NYSE rules to come into effect.

Given the cloud of the lawsuit and 11 months remaining to find a merger candidate, Ackman is proposing to use the SPARC warrants instead. He proposes

1. to return the $20 cash to shareholders

2. + one SPARC warrant (to be exercised at a share price equal to SPARC’s NAV per share)

3. + change the Distributable Warrants to Distributable SPARC Warrants.

Sound’s like a sweet enough deal, and it probably will work out if he doesn’t decide to do yet another complicated transaction. If he does in fact, manage to get the SPARC approved, this may change the landscape of the SPAC market.

The Week Ahead

Earnings season is waning. But, it’s not dead yet. Next week we have Zoom, Crowdstrike, Okta, Chewy, Docusign and a few others to look out for:

Closing Thoughts

Ackman’s letter claims that the lawsuit brought against PSTH is just a cause to bring reform and regulations to the SPAC Market. But in essence, he says it’s just hurting PSTH and its shareholders. He also argues that Robert Jackson shouldn’t have approved over 100 SPACs while he was the SEC Commissioner and probably should have thought about taking action during his term in office. Ackman further refutes many of the false statements in the lawsuits.

I do think there’s some upside to all of this. Once all the rage, SPACs have come under a lot of scrutiny in the past 6 months and quite possibly for good reason. SPACs have low ticket prices and investors have bought in with the hope that these businesses will soar once they merge. But, I can’t help but wonder whether the time pressure to find a business to merge with and the lack of scrutiny in the listing process has led to sub-par holdings.

A Bloomberg study shows a list of SPACs that have yielded significantly negative returns since their merger.

Would these companies have done better going public through the traditional route? I don’t know. I don’t have enough information to say definitively that they would’ve. But, as quickly as things become popular in this market, so do they become unpopular. And it feels like the SPACs are taking the heat for now and maybe the solution to all of this really is Ackman’s SPARC.

Here’s wishing you a happy weekend and safe investing. 

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers

None of the above is Investment Advice. I may or may not have positions in any of the stocks mentioned. I have a long position in $TOL as of the date of publication of this newsletter. I have no affiliation with any of the companies that are mentioned.