Pershing Square Tontine: Beaten Down, Unloved, Forgotten, But Compelling

Summary

• Bill Ackman's SPAC trades at a discount to NAV, offering investors a virtually risk-free look at any upside he can produce.
• Ackman remains highly incentivized to consummate an accretive merger with PSTH.
• In capital return scenarios - both via failure to find a deal or via the "SPARC" - investors stand to make a low single digit IRR.

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Investment Thesis

Pershing Square Tontine Holdings (PSTH) is an attractive pre-deal SPAC. With PSTH, we get a top tier sponsor with a strong history of finding attractive SPAC deals (including the recent, failed Universal Music Group (OTCPK:UMGNF) deal) at a discount. This discount will produce a cash/treasury beating, low risk 1-2% IRR in a return of capital scenario and a somewhat higher, 2-4% IRR in a SPARC scenario with a tradeable right as a bonus. On the upside, Ackman remains a top tier sponsor and remains heavily incentivized to consummate a highly accretive SPAC deal, offering investors the opportunity for significant upside (plus 2/9ths of warrants per share). With PSTH shares trading at a discount of 1-2% to NAV, PSTH represents a highly compelling risk/reward.

Introduction (AKA the Messy History)

Pershing Square Tontine Holdings is Bill Ackman's $4 billion SPAC. A lot has changed since Ackman initially IPO'd the SPAC in mid 2020. As an investment vehicle, PSTH has brought investors through the full cycle of investing emotions. Once the darling of SPAC-land, Bill Ackman's Pershing Square Tontine Holdings has fallen on some very hard times. The chart says it all:

Data by YCharts

For a cash vehicle this is... absolutely nuts. Honestly, I have no words.

Shares started trading at a small but likely warranted premium - when I released my first bullish article on PSTH. Then, investors were caught up in a crazy (unwarranted) hype cycle, leading shares to trade at a 50%+ premium to NAV in early 2021, prompting me to write that investors were better off buying Ackman's hedge fund OTCPK:PSHZF at a discount than PSTH at a crazy premium.

In early to mid 2021, Ackman, at last, revealed his target: PSTH would be merging with Universal Music Group in a *ridiculously* complicated transaction. This prompted me to write an article asking, well, Bill, what the heck are you doing?

Interestingly, I had some fairly prescient words in that article:

Unless Bill has it in writing somewhere that the SEC plans to approve this bad boy… ummm… I would be concerned. Seriously. He is treating the SPAC structure like his personal whipping boy, and he completely jackhammered anyone holding a sizable load of the outstanding warrants.

Right around then, I again wrote that investors were better off investing in PSHZF, Ackman's hedge fund, than PSTH. Simply put, it had more to gain from the transaction and, again, was at a discount.

Shortly after, the SEC did, in fact, veto the complicated PSTH/SPARC/UMG transaction, and Bill took the UMG piece over with his hedge fund and a sidecar.

Since then, PSTH shares have been brutally punished and now trade at a 1-2% discount to NAV. They have done a whole lot of nothing and don't look like they are preparing to do a whole lot of anything any time soon. Worse, frivolous lawsuits have been piled onto PSTH, prompting Ackman to attempt to pivot the purchasing power of PSTH, a SPAC, into a SPARC.

The short version of SPARC is that it would not be an actively traded cash pile like PSTH and other SPACs are. Instead, the rights would be publicly traded and would offer investors the opportunity to contribute capital into a merger when one is identified and announced.

The advantages of a SPARC would include not having a pile of capital locked up and enduring the swings and moods of Mr. Market (remember the PSTH chart above?). Instead, holders of SPARC rights/warrants could patiently wait for a deal to be announced, review the deal, and then decide whether or not to contribute capital.

Ackman's plan for a SPARC is currently awaiting SEC review, although Ackman has advised that he continues to actively pursue a merger for PSTH.

This is a very, very messy history for a cash pile looking for a deal, and shares have been punished for this history.

The only thing is... they have been punished too much.

Today, PSTH shares trade at a discount to NAV despite the SPAC having a top tier sponsor and Ackman having actually done what he told you he was going to do by bringing home a "mature unicorn" (even if that deal was ultimately killed by the SEC).

So, let's take a look at the investment case. Here, I will try to convince you that 1.) shares have been punished too much and 2.) PSTH presents a compelling risk/reward.

Bill Brought Us a Good Deal

Before we go any farther into discussing PSTH, we have to be clear on one thing: Bill brought PSTH shareholders a good deal.

Ackman brought PSTH holders exactly what he said he would when he landed a deal with Universal Music Group. While this company may have disappointed the Reddit army (Stripe to the moon!!!!), it was an attractive investment. In fact, UMG shares are currently sitting a happy ~40% above the pre-IPO price of $21.70 per share.

Data by YCharts

He got shareholders a mature unicorn with positive cash flows and exciting business prospects, a company that functionally serves as a royalty on the world's music listening. He cut the deal at a reasonable valuation, and he did it in such a way as to leave himself and his hedge fund Pershing Square aligned with general shareholders and without any outsized sponsor shares.

So, whatever else I say about PSTH and Ackman for the rest of this article, I want you to remember this: Ackman is a strong capital allocator. He is still sitting on top of a $4 billion cash pile, and he is still looking for a deal. He has an excellent track record with his prior SPAC producing a >20% CAGR, and the deal he set up for PSTH already would have been accretive.

Maybe UMG wasn't as exciting as Stripe. Maybe the market was upset about the deal's complicated structure. Maybe part of the carnage in PSTH shares has to do with the more general carnage in the SPAC market as a whole. But, at the end of the day, Ackman's first deal for PSTH was precisely what he promised investors it would be. If anything this should increase our confidence in his ability to find good business combinations, allowing for some loss of negotiating leverage and the shot clock decay after having lost about a year of PSTH's lifespan.

PSTH's Range of Outcomes

With the stage set, we arrive at the range of outcomes on the table for anyone buying PSTH here:

1.) Ackman finds a strong merger of UMG quality. Personally, I am still hoping for Fidelity or Bloomberg, but there are many good candidates. PSTH shareholders get a pop on merger and a long-term positive IRR. In this scenario, let's not forget that PSTH shares today still trade with (at least) 2/9ths of Tontine Warrants attached. With warrants trading at $1.23 today, this adds an additional $0.27 per share and significant upside in the event of an attractive merger.

2.) Ackman finds a mediocre merger. Shares trade at or near trust value. Some investors may redeem and get a 1-2% IRR from a purchase price today; those that buy into the deal get the redeemers' tontine warrants for slightly enhanced upside.

3.) SPARC is approved in the near future, PSTH's trust cash is returned to shareholders who then hold SPARC warrants. PSTH shareholders get a 3-4% IRR (depending on return time frame) and a SPARC right that has some value and may be subject to value appreciation in hype cycles (just imagine what happens if Ackman is seen anywhere near Patrick Collison or Elon Musk, for example). Again, you have the benefit of the 2/9ths of Tontine warrants per share which would in theory benefit shareholders when a merger is found.

4.) SPARC is not approved, Ackman never finds a merger candidate, and PSTH cash is returned to shareholders. PSTH shareholders get a ~1-2% yield to maturity on a pseudo-treasury bond equivalent, beating the heck out of the average savings account.

The first two cases really speak for themselves. This is standard SPAC stuff with a Tontine twist. Obviously, anyone buying PSTH today should be hoping for the first case.

The third and fourth cases revolve around the "SPARC" concept, which we should dig into for a moment here.

The SPARC is Ackman's creation that would function sort of like a private SPAC. Investors would have the $4 billion in PSTH's trust returned to them and would be given a publicly tradeable SPARC right that would offer them access to the SPARC's future deal. This would remove the shot clock element that PSTH is currently facing and would additionally allow capital locked up in PSTH to be sent off to potentially higher short-term IRR opportunities. What's more, the rights would be publicly tradeable, and it is not hard to imagine the rights appreciating by 50-200% on a semi-annual basis, according to hype cycles and rumors and etc. When Ackman finds a deal, rights holders would then have the ability to contribute some amount of capital (not to exceed $20 per right) to the deal to consummate a merger.

The downside?

Well, it's a new structure, and if Ackman's recent track record getting new SPAC-adjacent structures through the SEC is any indication... it's not going to happen.

Frankly, of the 4 cases above, I think SPARC is the least likely.

Do you really think the SEC will offer carte blanche to SPAC sponsors to create pseudo-rights to piles of non-existent but potential SPAC capital pools that basically anyone can create to hunt for deals for? And these pseudo-rights will be publicly traded?

If the SEC approved SPARC for PSTH, it would be very difficult to imagine them not approving it for anyone else. This would open up something of a Wild West in SPAC-land, which... is already a bit of a Wild West and which is already due to be placed under increased regulatory scrutiny.

I don't know about that. I don't know that anyone looks at the murky depths and skewed incentives of SPAC-land and thinks... yeah, let's make this crazier. That said... in terms of the 4 outcomes for PSTH today, I actually see the SPARC case as the second most attractive behind option 1. Thus, I would not be upset to be proven wrong on this.

Downside Protection

Although I have already mentioned case #4, it is worth really bringing this back into focus: PSTH's downside right now is a positive 1-2% gain in the event the SPAC is dissolved and capital is returned.

In a zero percent interest rate world... this is nothing.

You know the "heads I win, tails I don't lose much" investing line? Well, outside of a fraud scenario, PSTH is actually "heads I win, tails I still win but less" situation.

Ackman Remains Heavily Incentivized to Find a Great Deal

Let's apply a little game theory for a moment: how bad do you think Bill Ackman wants to get a deal done?

Let me clear that up for you: bad.

Very bad.

Ackman has a significant amount of reputation tied up in PSTH, and this is a reputation that has recently recovered from the 2014-2018 underperformance. He has his ability to raise PSTH 2 tied up in this. Oh, and he quite literally has $65 million in his fund's capital piled into PSTH's risk capital tied up in this. $65 million is not a killer, but you can bet Ackman wouldn't exactly be thrilled to see that money simply drift away into the ethers.

Not only is Ackman incentivized to find a deal (all SPAC sponsors are), but he is incentivized to find a good deal due to PSTH's forward purchase agreement. The forward purchase agreement mandates Pershing to invest at least $1 billion in any deal that is found, ensuring Ackman is aligned with PSTH shareholders.

Does this mean he is guaranteed to get a deal done?

I mean, of course, not. Time is against him and the world's mature unicorns have ready sources of capital available to them. Many of them might be thrilled to have Ackman onboard, but some might not. It is clear the warrants were a big hangup for the UMG deal, and most mature unicorns probably don't want a warrant overhang complicating their cap structures.

I could see a deal happening... and I could see one not happening. It is hard to know. But, again, "heads I win, tails I still win but less."

Where Does This Belong in a Portfolio?

In my mind the question isn't really whether or not PSTH presents a compelling risk/reward. The question is where this belongs in a portfolio.

Does PSTH deserve the capital I use to try to beat the market with my risk on equity positions? Probably not. Given how long the UMG deal took, you can comfortably bet that PSTH is going to be dead money for several months even if a deal is in the works. Also, in the SPARC and/or return of capital cases, the IRR is going to be somewhere in the realm of 1-4%. This isn't exactly world beating.

This IRR looks marginally more attractive when compared to the projected negative real return of stocks over the next 5-10 years, but, still, it is nothing to get excited about.

But... is PSTH better than cash, which yields nothing, bonds that yield next to nothing, and tremendously low risk barring a massive fraud, while having far more upside than either of those and good liquidity (outside of market crashes)? Well, yeah.

Personally, I have increased my exposure to PSTH, although I have done so by treating it as a pseudo-cash equivalent in my broader investment portfolio and outside of my more active and aggressive trading portfolio.

Conclusion

At the end of the day, PSTH is an attractive pre-deal SPAC. With this SPAC, we get a top tier sponsor with a strong history of finding attractive SPAC deals (including the recent, failed UMG deal) at a discount. This discount will produce a cash beating, low risk 1-2% IRR in a return of capital scenario and a somewhat higher, 2-4% IRR in a SPARC scenario with a tradeable right as a bonus. On the upside, Ackman remains a top tier sponsor and remains heavily incentivized to consummate a highly accretive SPAC deal, offering investors the opportunity for significant upside (plus 2/9ths of Tontine warrants per share!). With PSTH shares trading at a discount of 1-2% to NAV, PSTH represents a highly compelling risk/reward.

Disclosure: I/we have a beneficial long position in the shares of PSTH, PSHZF either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.