Non-Redemption Tontines — A step forward in SPAC Price Discovery
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A true price discovery mechanism would be a key improvement in the SPAC structure. To date, there have some approaches that provide some measure of price validation but lack true price discovery. For example, the classic approach of a $10/share common equity PIPE from an arms-length credible investor was a useful price validation mechanism. But these are uncommon now, with most PIPEs coming from affiliates who have different effective entry prices or as structured financings that do little to validate price.
If the SPAC shares trade above cash in trust per share in the period between announcement and the redemption deadline, that is true price discovery in action. But the company suffers more dilution than necessary in these cases, so they have an incentive to be optimistic in their valuation aspiration. Consequently, only about 7% of all announced SPACs are currently trading above cash in trust. The only price discovery we have for the other 93% is that the market thinks the valuation should be less than cash in trust. This leads to high redemption rates and chaotic post-close share price trajectories.
Non-Redemption Tontines
Bill Ackman’s ill-fated Pershing Square Tontine SPAC attempted to incent IPO investors to hold their shares through redemption without the shareholder rotation necessary in a price discovery mechanism. But three recently announced non-redemption tontines reflect a huge step forward in terms of price discovery mechanisms.
These three introduce a share bonus pool to be ratably shared only among those shareholders who elect not to redeem. The higher the redemption rate, the larger the ratable bonus each non-redeeming shareholder receives, and the lower their effective entry valuation becomes. The first of these was the FirstMark Horizon (FMAC) & Starry announcement in October, followed by the Cohn Robbins (CRHC) & Allwyn deal in January and the DPCM Capital (XPOA) acquisition of D-Wave in February. They each cap the range of redemption values over which the mechanism can operate — generally constrained to meeting a minimum cash level.
The chart below shows the effective pro forma enterprise value as a function of redemption rate for the CRHC & Allwyn transaction. This illustrates a true price discovery supply-demand mechanism. Effective share price is a function of redemption rate, allowing supply and demand to match — but only if the market clearing price lies within this fairly narrow price range. As the chart illustrates, the relatively low redemption rate cap leads to a difference between the largest and smallest possible pro forma enterprise value of only 3.4%. This doesn’t seem like a very meaningful range over which to allow price discovery to operate.
XPOA & D-Wave
The XPOA & D-Wave non-redemption tontine operates using the same mechanism as the CRHC & Allwyn transaction, but with a much larger range of effective valuations over which it operates. The plot below illustrates the 20.0% effective valuation range — over five times the 3.4% range of the CRHC & Allwyn transaction. The FMAC & Starry transaction has a valuation range of 9.0%; it also has several other transaction features making it less of a direct comparable. Market participants will have different opinions about what prices are attractive entry/exit points, but a broader range in effective valuations should increase the chance of the true market clearing price falling within the range. Of course, a broad range at an unreasonably high valuation isn’t likely to yield a match, and there are additional terms beyond price at play, so it’s a bit simplistic to consider valuation range in isolation.
Is it working?
The FMAC & Starry redemption deadline was March 14, so there may be redemption results available by the time you read this, but there are lots of moving parts in that transaction, including shares subject to a non-redemption agreement. We’ll have to wait for the redemption deadlines for the other two deals to pass — those are not yet scheduled — to have a better read on how this approach has worked in practice.
But we can get an initial indication on market receptivity. We do that by looking at normalized trading volumes (normalized by the number of SPAC public shares outstanding) since announcement. The plot below shows the cumulative normalized trading volumes for XPOA (& D-Wave), FMAC (& Starry), CRHC (& Allwyn), and the median for all the other SPACs that announced transactions in January or February. As we would expect from the analysis above, all three of the announcements with non-redemption tontines have seen relatively high trading volumes. Consistent with the analysis above, the trading volume increases with a broader effective price range over which price discovery can operate.
There are likely additional improvements that could be made to aid in more direct price discovery, but these initial non-redemption bonus tontine structures represent an important innovation.
All data from SPAC Research as of 3/14/22.
