Profit from Hedge Fund Redemptions Using SPAC Liquidation Arbitrage

by: Thomas Kirchner

Among the least-damaged victims of the boom’s unwinding are SPACs, which arguably were among the worst manifestations of the irrational exuberance driven by excess liquidity. Despite their relative resilience to the bust, their cash hoards coupled with limited life offer an interesting arbitrage opportunity with yields that, in some cases, reach well into the double digits.

SPACs are an outgrowth of blank check companies, which got a bad name when some were scams run through boiler room operations. The SEC

blank check company / SPAC liquidation arbitrage

clamped down on the worst abuses by introducing Rule 419, which forced blank checks to hold their IPO proceeds in escrow, and by banning the use of Rule 144 for certain blank check companies through its January 2000 letter to Ken Worm of NASD Regulation. With the market cleaned up, bankers at Early Bird Capital discovered blank checks as a viable vehicle to take private companies public, invented and trademarked the moniker Special Purpose Acquisition Company and launched the first SPAC in 2003, Millstream Acquisition Corp.

SPACs were structured so that the proceeds of the IPO are held in an escrow (trust) account until the SPAC uses these funds to acquire a private company. If no acquisition is completed within two years, the SPAC will liquidate and distribute its escrow account to shareholders. And that’s where the arbitrage comes in.

It turns out that the major buyers of SPACs were hedge funds that liked the low volatility of a company that consists mostly of cash, and the potential large upside on the shares once an acquisition is announced. Or so the theory went. In the current deal climate, no acquisitions get done at all. As a result, SPACs liquidate en masse. To make things worse, hedge funds are under pressure from redemptions and have to sell their SPACs. With few natural buyers of such specialized vehicles, the only way to sell is at a steep discount to cash.

As a result, SPACs now trade at a discount to their cash holdings. Unlike many other firms that trade below cash in today’s market, SPACs have a limited life and will liquidate within a short time frame. While going concerns often trade below cash for a reason, SPACs below cash are an actual arbitrage opportunity. The table below lists the SPACs with the highest yields until their drop-dead dates. The table is excerpted from Maxim Group’s Common Yields research; Rodman & Renshaw and Morgan Joseph have similar research for their clients, although assumptions about timing and interest earned on escrow vary slightly.

Name

Ticker

Status

Size ($MM)

Recent price

Expected escrow at deadline

Yield through deadline

Yield deadline + 60 days

Deadline

Trans-India Acquisition Corporation

TIL

Seeking

92

7.86

7.97

32.5%

7.3%

02/14/09

Middle Kingdom Alliance Corp. B

MKGBB

Deal Annc’d

27.4

7.5

8.41

21.3%

16.4%

08/31/09

Tailwind Financial Inc.

TNF

Deal Annc’d

100

7.91

8.23

21.1%

11.4%

04/11/09

Santa Monica Media Corporation

MEJ

LOI

100

7.81

8.07

19.7%

10.1%

04/02/09

TransTech Services Partners

TTSP

LOI

41.4

7.6

7.97

16.1%

10.6%

05/23/09

Shermen WSC Acquisition Corp.

SACQ

Deal Annc’d

138

5.76

6.04

15.7%

10.3%

05/24/09

MBF Healthcare Acquisition Corp

MBH

Seeking

172.5

8.02

8.27

13.6%

8.0%

04/23/09

Pantheon China Acquisition Corp.

PCQC

Deal Annc’d

34.5

5.5

5.99

13.5%

10.9%

09/30/09

Victory Acquisition Corp.

VRY

Seeking

330

9.72

10.02

13.4%

8.0%

04/24/09

Source: Maxim Group

Click to enlarge

Liquidity is an issue in trading SPACs, and many of the high yielding ones trade little volume at all. If you can pick up some shares you can enjoy decent low-volatility returns, courtesy of hedge fund redemptions.

Disclosure:

Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which holds arbitrage positions in SPACs not mentioned here.