SPAC + Meme Stock = A Dangerous Combination

When my five-year-old daughter attends a birthday party, she brings a present and then often leaves with a bag of token gifts from the host. The exchange takes place even if she does not stay long.

Special purpose acquisition companies offer a similar incentive to attract capital, but the distribution of spoils may be more skewed.

Take Getty Images Holdings Inc., which briefly became a meme stock — which quadrupled after its SPAC listing in July. The image and video content company was able to cancel the financial party bags normally reserved for hedge funds that provide capital (and retail investors that trade it), while company insiders were rewarded by a bag full of extra goodies.

It’s a convoluted tale of financial engineering highlighting the perverse consequences of a hype-driven stock online. This shows the importance of studying disclosures and paying attention to biased financial incentives.

To recap, in exchange for seeding a SPAC with cash, investors (often hedge funds) receive warrants granting them the right to purchase additional shares of the merged company for 11.50 $, slightly more than the $10 price at which SPACs sell their shares.

Warrants offer an added financial benefit, and they can be kept even if the investor chooses not to fund the merger and asks for their money, which often happens now that SPACs have become Wall’s most hated invention. Street since the secured debt obligation.

Getty Images’ revenues exceeded $900 million last year and it is profitable, but more than 99% of investors in its $828 million SPAC – CC Neuberger Principal Holdings II – have pulled out. The deal still went through in July as planned, thanks to additional funds provided by sponsor SPAC affiliates.

Initially, there was a small float of stocks available for trading and, as often happens in these situations, retail investors crowded in hoping to drive the price up. It worked. The stock rose from below $9 to a high near $38.

In theory, this should have been great news for the holders of the more than 20 million Getty Images warrants, as their right to buy shares at $11.50 was potentially very valuable.

But in reality, they couldn’t benefit immediately: the warrants could only be exercised once the target company had an effective S-1 registration statement. So instead, Getty Images now had the upper hand: That’s because the old SPACs have the right to force warrant holders to exercise if the stock price goes above $18 for a few weeks or else to have these securities canceled for a symbolic amount.

When he announced the redemption of the warrants almost simultaneously with the S-1 effective statement earlier this month, the stock fell back below $11.50 (because some insiders and institutional investors were now able to sell). logical for holders to exercise their warrants and these were likely worthless unless the stock price rebounded. “The structure and details of the mandate were established prior to the merger and fully disclosed as part of the merger transaction,” the company said in an emailed statement.

Getty Images certainly didn’t play along by burning out the tenure holders, but that was only possible because 99% of SPAC shareholders were unwilling to fund its merger. To better protect their warrant investment, more of them should have supported the deal.

Eliminating them benefits other shareholders by minimizing potential dilution. This is not the first former SPAC to attempt the maneuver. Private stock market Forge Global Holdings Inc. did something similar in June. Removing warrant liability “reduces potential dilution and lowers our fully diluted stock,” Forge told investors at the time. Indeed, that’s a caveat, as Getty Images has taken other sources of dilution into account. The founders of SPAC receive money orders in exchange for the money they use to create the blank check company, and these so-called “private money orders” cannot be forcibly redeemed. In this case, the sponsors were able to exercise their warrants in August, earning them an extra share of stock, which is good for them. exit clauses,” meaning tens of millions of additional shares were issued to Getty family members and a few million to SPAC sponsors. In addition, approximately 6 million employee stock awards were unlocked by the stock price gyration. And naturally, this further dilution caused the stock to sink even further.

Fortunately, SPAC stock investors were not harmed as nearly all cashed in. Warrantholders’ losses could also have been worse: Normally, warrants and stocks move in tandem, but in this case, warrants lagged far behind, indicating that investors didn’t think the pressure would be maintained. I tip my hat to this SPAC investor and Twitter user who predicted exactly what was to come.

What have we learned? Getty’s earn-out clauses were poorly designed – the share price triggers were deemed to have been met after just 20 days. As I’ve noted before, a temporary jump in the stock shouldn’t result in a payday for company insiders, but somehow it keeps happening.

To prevent warrant holders from being brought to their knees in future transactions, the SPAC rules should be revised so that the triggering of the redemption price begins after the effective declaration of S1, the date on which the share price should have stabilized. Given these misaligned financial incentives and post-merger trade volatility, no wonder no one wants to join the SPAC party anymore.

More from Bloomberg Opinion:

• Bill Ackman’s SPAC is dead. Long live SPARC? : Chris Bryant

• Matt Levine’s Money Stuff: Trump SPAC doesn’t have the votes

• The stock market’s summer adventure was not real: Jonathan Levin

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies in Europe. Previously, he was a reporter for the Financial Times.

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