I generally don’t have much interest in Initial Public Offerings (IPOs). They are often overpriced, overhyped, and not meant for long-term investors. In last couple of years, IPOs have seen a resurgence along with Direct Listings and SPACs. These IPOs, DLs, and SPACs are different in structures, but they share a common end goal: taking private companies public.
What caught my attention recently was a SPAC offer from none other than the Simon Property Group (SPG). I’ve written about Simon Property many times in these pages. It’s a founder run public REIT that is mainly in traditional brick-and-mortar retail properties, like malls and outlet centers. I am a happy Simon shareholder for many years.
I don’t consider Special Purpose Acquisition Companies (or SPACs) to be good investment vehicles for long-term investors. It’s mainly because when a SPAC goes public, we don’t know which business it may acquire with our capital and how that business would perform post acquisition. Most SPACs also give their sponsors broad discretion to pick an industry and size of business to acquire. SPACs are called blank check companies for a reason.
Simon announced in February that it is sponsoring a SPAC IPO called Simon Property Acquisition Holdings (SPGS). The terms of the IPO don’t stand out from other recent SPACs. As its sponsor, Simon Property would get 20% founders’ shares and additional warrants for investing $8.9M of its own capital. The IPO was oversubscribed and resulted in $345MM of gross proceeds. Each SPGS unit was offered at $10. With $10 units, an investor get one share of the SPAC and 1/5th of a stock warrant, where each whole warrant can be exercised for a share at $11.50.
This was pretty standard fare for a SPAC IPO. Nothing out of ordinary. So why my interest in it? There were two big reasons. First, the SPAC units were trading in the secondary market near its IPO price of $10, with very little premium given to its warrants. Secondly, it was sponsored by Simon Property with its CEO David Simon as chair of the newly-formed company board.
The fact that Simon Property sponsored this SPAC gives me more confidence than I’d have otherwise in this SPAC. I’ve been following David Simon since the time I became an SPG shareholder about four years ago. And even though SPG stock hasn’t done much for me in last four years [I am about breakeven when counting dividends] , I admire David Simon’s share-friendly approach to the running this business. I profiled David Simon in a blog post here. Unlike many other SPACs of recent times, this SPAC is not sponsored by a celebrity investor or a star athlete. Simon Property, the world’s largest retail REIT (and a public company since 1993) is behind the offering.
With about $340M in its coffers, I expect SPGS to find a business worth around $1.5—$2 billion to combine with. Even with SPG owning 20% of the company (though this could change during future merger negotiations), I don’t expect this SPAC to be hugely significant to the parent Simon’s own financials. Simon Property is today about a $37 billion market cap. Still, I expect David Simon to carefully weave through lofty private business valuations today and do a sensible deal that would be long-term accretive. He has his company’s reputation and investor goodwill to protect.
On the other hand, there will be pressure on the SPAC board to find a deal within the allotted two year time period. Otherwise, SPG could stand to lose its $9M investment in it. Note that even in such unlikely event, ordinary investors like me still get to redeem our shares from the SPAC’s trust.
But the bigger reason for my interest in this SPAC was its price. At the time I bought the units, they were trading at around $10.25 each. This was about three weeks after its IPO. So the $10 per piece that IPO investors paid, that money was put into a trust until the SPAC closes a merger with some private business. At the time of a merger announcement, we all will have the option to get back our $10 from the trust. Or keep them as shares in the newly merged company. This is how all SPACs work.
I figure that my $10 shares are quite safe. I could always redeem them for cash at the time of the merger. This SPAC has at most two years to find a partner to take public. The extra $0.25 I am paying is the premium for keeping my warrants. As most SPACs do, SPGS began trading as units (SPGS.U) first and about two months later (by April 16th), these units will split into stock shares (SPGS) and warrants (SPGS.W). Each will then trade independently.
That 2.5% premium is what I could lose if the post-merger company never trades above $11.50. It is a relatively small price to pay for potential upside in case David Simon is able to pull off another good acquisition. Simon has a good track record, indeed. In previous four years, Simon has bought several struggling retailers at near bankruptcy prices, improved their operations, and in the process generated excellent return on investments so far. Today it co-owns JC Penney, Aeropostale, Forever 21, Brooks Brothers, and some other retail brands.
This is what David Simon said in his 2020 annual shareholder letter published this month:
The SPAC’s focus is on finding a target company that will benefit from Simon’s strengths, including our physical global real estate footprint, relationships with portfolio companies and others in various industries, and our expertise and market insights.
2020 Simon Property Annual Report, David Simon
In contrast, most popular SPACs trade at much higher premiums. For instance, Bill Ackman’s well-known Pershing Square has a SPAC called Tontine Holdings (PSTH). It IPO’ed at $20 a share and has been trading 30% to 70% higher since then. PSTH appears to be a good SPAC with very shareholder friendly terms. But it’s much higher risk than SPGS given where its valuation is today.
There is an outside chance that a SPAC could lose some of its trust funds if it runs into legal trouble while pursuing merger candidates. However, that risk is quite low. In recent times, there haven’t been a SPAC IPO that lost trust funds to legal spats.
Risk-reward tradeoff for this purchase appealed to me. I don’t expect this to be a long-term investment. Since I can’t really do any business analysis for something that is essentially a shell company looking for private businesses to take public. SPGS prospectus as expected gave itself a wide range of potential industries from which to pick a company. I expect David Simon to stick to SPG’s core areas of expertise such as retail, ecommerce, entertainment, hospitality, and of course real-estate. However, I am mindful that there is a lot of money sloshing around in SPACs these days. Target companies have high expectations too, and so it is not clear if Simon will be able to find a good business at reasonable price level. Only time will tell.
The other day, I read a great research report from Stanford on SPACs: A Sober Look at SPACs. The report studied behavior of 47 SPACs that merged with private businesses from January 2019 to June 2020. The key takeaway from the report was this:
SPAC investors who hold their shares at the time of a SPAC’s merger see post-merger share prices drop on average by a third or more.
A Sober Look at SPACs, Michael Klausner, et al
Main reason for this is the dilution embedded in SPACs because of warrants and other pre-merger private investments (called PIPEs). Today, I can figure out how much dilution is caused by already issued warrants but what I don’t know yet is how much further share dilution might be required to pull off a merger.
Nearly all pre-merger [SPAC] shareholders exit at the time of the merger, either by redeeming their shares or selling them on the market. In effect, a SPAC pays IPO investors generously to get the SPAC up and running as a public company so that other investors can later buy shares once a target has been selected to bring public.
A Sober Look at SPACs, Michael Klausner, et al
So, I plan to do what most savvy investors apparently do at a SPAC merger: Redeem original shares (at or near $10) and hold on to my warrants. I expect post-merger share price to drop as most SPACs do. If Simon plays its cards well, it will have a winning acquisition that could make my warrants very valuable. I will have up to five years from the merger to exercise my warrants.
Since I am going to get majority of my capital returned to me in less than two years (about 97% of it), I consider this a very safe position. In fact, I don’t even consider it a stock holding. It’s more like buying long-term call options, albeit at a very low premium. I used some of my dry powder cash to buy the units. If it all works out, I will redeem my shares just prior to the merger. I give SPGS about a year to find some good business to take public. That 2.5% premium I paid for the warrants is my risk capital. Even if I lose it all, it still won’t amount to a whole lot.
That research paper from Stanford went on to say that SPACs are good deals for its sponsors and private businesses looking to go public, but they haven’t always generated good returns for retail investors. I took a position in SPGS knowing this. I figured that even if my position doesn’t work out, Simon Property likely will have acquired a good business. And I being its shareholder will be fine. After all, Simon Property—the public REIT itself—is the sponsor of this SPAC. Not some celebrity investor lining his own pockets. In fact, David Simon himself did not get any of the founders’ shares. Nor did any other Simon’s employee. A profitable merger-acquisition will be good for Simon Property’s financials long term. And in turn it will make my own shares in SPG more valuable.