SPAC warrants are options that give the investors the right but not the obligation to purchase a stock at a strike price. SPAC (Special Purpose Acquisition Company) is basically a shell company whose aim is to acquire a private company within a specified time period. The SPAC needs to file an S-1 form in the Security and Exchange Commission (SEC) which defines how many units they want to sell and at what price.
Generally, the price per unit is kept at $10 but may vary as in the case of PSTH, whose per-unit price is $20. Once SEC has approved the S-1 filing, SPAC will announce Initial Public Offering (IPO) and the public investors can invest by purchasing a certain number of units. A Unit is the combination of a share and a fraction of a warrant. The capital they have generated through IPO will be held in a trust account. Within the time period of 2 years, the SPAC will acquire a private company that wants to go public; this is known as the SPAC merger. If the SPAC cannot acquire a private company within 2 years, all the investment of the investors will be given back at a price of Net asset value (NAV) per share.
Table of Contents
Unit vs Shares vs Warrants
Investors will invest in SPAC IPO by purchasing units. Each unit is the combination of one share and a certain fraction of a warrant. Warrants give you the right (but not the obligation) to purchase a share for a certain strike price from the company after the merger.
i.e. Unit = 1 share + 1/x of a warrant
So basically what happens is that once you have purchased units through IPO, after 52 days these units will split into shares and warrants. These shares and warrants will be listed on the New York Stock Exchange or NASDAQ from where trading can be done. This fraction of the warrant could be 1/3rd or 1/4th depending upon the company. This fraction of the warrant cannot be traded, it needs to be a full one warrant.
Let’s get a little deeper into warrants. As the definition says, with warrants you have the right to purchase a share at a defined price. This price is generally $11.50 but could be different like PSTH where the price is $23. You can also buy warrants at a price that is relatively less than that of the share price.
Let us take an example of a SPAC “VPC Impact Acquisition Holdings” which is listed on NASDAQ and is trading under the ticker symbol “VIH” for ordinary shares and “VIHAW” for warrants.
Each unit consists of 1 share and 1/2 redeemable warrant. i.e. if you purchase two units you will have two shares and one warrant. With one warrant investors can purchase one Class A ordinary share at a price of $11.50.
Also, the S-1 filing says that the warrants will be exercisable only after 30 days of the merger. This means that anyone who wants to redeem their warrants into shares will need to wait for 30 days after the merger. Or after 12 months from the closing of the IPO.
The current market of VIH shows the following:
If you see, the share price is $10.13 while the warrant price is $1.68. As an investor you have the option to either purchase the ordinary share at a price of $10.13 or purchase warrants at a price of $1.68, the choice is yours. If you purchased one warrant at a price of $1.68 then you can redeem one share by investing an extra $11.50 with a total cost of $11.50 + $1.68 = $13.18 which will be considered as premium as the current market price is only $10.13.
So the question arises should you still purchase warrants of VIH at $1.68 or should you purchase shares at market price. Well, it depends. Both have their own risks and benefits. Warrants are more like high-risk high reward options.
Benefit of investing in warrants
The main benefit of having warrants is leverage. That is, you will have more exposure to the stock for less cost. Consider you want to invest $100 in a SPAC whose market price is $10 and warrants price is $2. So with that $100 you can either purchase 10 shares or you can purchase 50 warrants. As you know, 50 warrants can be redeemed into 50 shares by investing an extra $11.50. So you see, you are controlling 50 shares with just $100. Suppose that after the merger the stock price went to $18.
If you invested in warrants:
50 warrants x $11.50 = 50 shares
Total investment = ($2+$11.50) x 50
= 13.50 x 50 = 675
Total revenue = $18 x 50 = $900
Total profit = $900 – $675 = $225
If you invested in common shares:
You have 10 shares which you bought for $100.
Total revenue = $10 x $18 = $180
Total profit = $180 – $100 = $80
Thus we see that investing in warrants gives a higher total profit than the common shares.
Note: Obviously, if you have invested $675 in common shares you will have more profit, but we started by investing $100 and found out that warrants provide leverage with which you can control more shares.
Risk associated with warrants
There are three main risks associated with warrants:
If the merger never proceeds, you will lose all your investment. At least with common shares, you will have your investment back plus some interest.
If the stock price after the merger never goes up or crashes. This risk is common to both shares and warrants.
When SPAC warrants get closer to the exercisable date, shareholders tend to sell their stocks as warrants will dilute the outstanding. Because of this, the share price decreases drastically turning a discount into a premium.
Expiration period of warrants
Usually, SPAC warrants last as long as 5 years after the merger. But most SPACs add a clause that they can force redemption if the stock price equals or exceeds $18.0 per share for any 20 trading days within a 30-trading day period. They will send notice to warrant holders for the redemption of their warrants. If the warrant holders do not redeem, they will lose all the money they invested in the warrants.
SPAC warrants are like options trading which can be traded on stock exchanges. They give the investors the right to purchase stocks at a specified price. They provide more coverage but also have a higher risk to invest in. Tools like SPACrun can help to know when the redemption date is. SPACrun provides real-time alerts based on news like redemption deadlines, de-spac news, and ticker news. Signup to SPACrun now and get your free trial.