Why stay away

 

By now I believe that SPAC has garnered a lot of attention (mostly unwanted).  Cliq is officially dead, SONA is struggling while REACH and RSENA are keeping their fingers crossed, hoping for the best.

 

Let me start by saying, DO NOT BUY SONA WARRANTS.

 

Sorry for the caps but I guess I just need your attention.  30th March EGM is the moment of truth for SONA.  The management, sensing many shareholders' reluctance to vote for the deal is pulling all stops to prevent it go bust, the last trick up their sleeves,basically a "conditional" capital reduction.

 

Many forumers (mostly I guess SONA warrant holders) cling on this proposal like a lifeline and hope that this could squeeze through the deal.  Hoping that some shareholders, especially the large institutions would change their mind.

 

I seriously doubt so.

 

Comparisons of outcomes

 

If you

 

(i) vote yes, the most you get back is about 7c at 4Q 2016 (based on the announcement an if QA pass thorugh); or

(ii) vote no, u get back about 48c probably before 3Q 2016 (assuming QA fail, EGM 21 days notice, liquidation for such clean company probably less than 6 months). If QA is successful and you are the lone naysayer, even better, u still get your 48c, possibly much earlier!

 

Gaming the system

 

Personally, I think those institutions are just sharks/arbitragers playing for the cash arbitrage game.  Just look at these same familiar names pop up in the substantial shareholders list of CLIQ, SONA and REACH.  They are systematically playing the game but can you blame them? when the returns are attractive and virtually secured/guaranteed by SC Equity Guideline's shareholder protection clause.

 

They are playing the SPACs like repurchase contracts where till expiry, they will just get back their principal + returns

Quick in quick out, returns secured.

 

More likely to vote NO than YES

The institutions have at least a few good reasons not to vote YES.

Firstly, motives.  The systematic way of entry suggests that it is highly likely they are aiming for the cash. So as detailed above the potential outcomes, they are going for the pie instead of the crumbs.

Secondly, they have substantial stakes not, it's not like they can dump them in the open market easily without affecting the price. If QA goes through, there is no guarantee where the price will go to, what level it will settle at. And likely, there may not be sufficient interest to gobble up their stakes at an attractive price.  Again why risk for the uncertain when the payoff is not even clear (while the opposite is true)

Thirdly, if QA goes through and SONA graduate into an O&G company, is that what they want? To invest in an O&G company where the earnings will only start trickling in, especially in times where the future oil price movement is anyone’s guess.  They would most likely need to be stuck/invest long term.

Fourthly, due to the flaws of the current SPAC structures, being a long term shareholder may not be worthwhile at all. I will detailed below in just a minute why I think the SPAC structure is flawed.

In conclusion, I would say it is more likely than not the institutions will vote NO at the EGM and the SONA QA will not go through. SONA WA holders I understand the predicament.  But consider it today if you get out, you still get 5-6c, come Wednesday, it could go up or it could go BUST.  And the odds do not seem favourable.

 

The flaws of SPACs

Now to the point why I think our SPACs are flawed.

SPACs were promoted in the first place, hopefully to spur entrepreneurship and add an alternative listing structure to our Malaysian capital markets.  It was meant for market vibrancy and diversity, nothing wrong.

HIBISCUS was the first.  And because it was met with so much scepticism but eventually end up with so much success (before share price went south of course), it was natural that future SPACs will crop up and imitate its template.

RSENA was the 5^th SPAC to be listed, almost 5 years from HIBISCUS’ debut but the listing structure is still so eerily identical.  1-for-1 warrants have become a staple for SPACs. There was no guidelines requiring SPACs to issue free warrants together with its IPO but who cares? The company gets to sell the shares easily, investment banks get an easier job getting the shares subscribed with the free warrants. Why change things when it is no broken?

That’s precisely where it goes/will go wrong.

It all went wrong from the beginning

Originally, HIBISCUS management and/or their advisers thought this structure up.  Kudos for them, it worked.  They are now full fledged O&G company.  But investors of HIBISCUS would have experienced the whirlwind ride which ultimately went south long before the oil price crashed. But why?  Shouldn’t the graduation to O&G company the ultimate platform for the SPACs to finally launch themselves?

Simply put, there are just way too many shares/potential shares outstanding

Recall that management of HIBISCUS together with the early investors got their shares and warrants almost at no cost.  Then the IPO saw 1 shares with 1 free warrants attached.  It is worth noting that SC has since then revised the Equity Guideline to require the shares to be issued to the management to be priced at least 10% of the IPO price (in a way limit the management from way too much gain)

However, it doesn’t matter much.  Subsequent SPACs imitate the same structure, even for REACH and RSENA which were listed after the revised Equity Guideline is in place.  The result of all this is that the future earnings of any potential assets will be diluted, way too much.

Let’s just go through a common hypothetical SPAC structure

E.g. a SPAC raise RM500m through 1bil shares at RM0.50, throwing in 1 bil free warrants.  All while there is an existing 200m shares and 200m free warrants issued at RM0.05 to the management (let’s ignore pre-IPO investors here).

Put some figures into this hypothetical QA:

Asset value: RM450m (assuming most of the IPO proceeds were preserved and little working capital required)

Earnings yield: 10% (let’s just assumed it’s earnings and cashflow positive from the first day, a fantastic buy shall I say)

Annual profit: RM45m

Diluted EPS: 1.88c

Now imagine original share price was 50c each, plug in whatever market price you think the price is now (since it's all hypothetical), you would still be easily stuck with PE of more than 20 times. If your mind is still trying to convince you that 20 plus times PE is ok, think again, the above are extremely generous assumptions!  It could be years before the management weave whatever magic they have over the assets to get that kind of yield.  If an asset is ripe for the taking where it’s operationally ready, cashflow and earnings positive, you can rest assured the seller would not sell at a cheap, certainly not to a SPAC where they know how much you as a listed company/SPAC have in your pockets (trust account).

If you argue that you are in for the long term, then another question looms. Is it even worth it to wait for the long term? If you know that earnings will take years to kick in and even if it materialises, you will need to share with so many other shareholders and potential shareholders, would you still stick around?

Now maybe that explains why Hibiscus is still struggling to deliver value for its shareholders.

To summarise, the fundamental problem of all the current SPACs is that they have thus far took the easy route of issuing too much free or cheap shares and warrants upfront.

SPACs at a crossroad

 

I do believe that it is high time our Securities Commission to take the lead, pause and reflects where this structure is heading.  There should be more discussion now since CLIQ has failed and SONA is more likely than not to follow in the footsteps of the former. The structure has failed.  If eventually shareholders get back what they have in the trust account, it’s a win for investor protection for SC but behind that success, it does not mask the fact that the SPAC structure would be nothing but a colossal failure since Hibiscus.

 

The initially fool proof way for SPAC investors to profit during the first day of IPO when they could sell the mother share and/or warrant to profit from the IPO is not working anymore either.  REACH is the proof, RSENA just confirms it. With the failure of CLIQ, possibly more to come, the interest is waning for SPACs.  Investors may not want to subscribe for it in the next SPAC IPO.  SPACs may need to throw in more freebies to entice subscription.  Investors subsequent to the IPO also would probably simply treat it as a repo contract where they can park their money with.

 

Moving forward

What the regulators, investment bankers and the stakeholders involved in the SPAC structures need now is a fundamental rethinking.  If the market is not mature enough to accept a SPAC without freebies like warrants, maybe it is just not ready for it.  And if we do not have a pool of entrepreneurs that has a track record that inspires trust among investors, again our market may not be deep enough for SPAC. Not everybody is a Liew Kee Sin.  And if the SPACs and the stakeholders are more concerned of pushing IPOs of SPACs to investors without really thinking long term how it can deliver shareholders value (especially when they have handicapped the company with so many shares), then again maybe SPAC is just not for our market.

In fact, looking at the profile of most management team of the SPACs in Malaysia, most of them never really build a business.  They are probably just management figures of some well-known corporations.  Does that make them superior entrepreneurs who can genuinely execute, add or maximise the values of the QA?  What I’m saying is that we should stop fooling ourselves. If in fact our market is not read, just admit it.  If there is no rock star available, don’t get some choir boys and try to continue the show.

There is a history of failure for SPACs in other countries.  Let’s hope our regulators and stakeholders would not need to take the long and hard road to learn about it, and in the way jeopardising more minority shareholders’ investments and their confidence in the market.

 

*If SPACs are eventually out of favour from the market, the author would lose one good investment vehicle with steady returns.  However, he also thinks it is more important that the stakeholders involved should now consider the future of SPACs in Malaysia