SVFA: A Low Risk SPAC Arbitrage Play

Summary

• Pre-merger SPACs offer features that present an arbitrage opportunity for SPAC common shareholders.
• SPAC shareholders have a full redemption right to their share of the collateral trust account that is typically invested in short-term US government securities.
• There is virtually no downside risk if you purchase a SPAC common below the trust value and exit before a business combination is formed.
• SVFA is an example of a SPAC common trading below trust value with a maturity of less than one year.
• This idea was discussed in more depth with members of my private investing community, Yield Hunting: Alt Inc Opps. Learn More »

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Written by George Spritzer, co-produced by Alpha Gen Capital

A Good Way To Invest Your "Safe" Money in SPACs

SPACs are structured to offer almost no downside risk as long as you sell before a business combination is actually finalized. And there is sometimes upside "optionality" potential from the more successful deals.

SPAC arbitrage may be viewed as an option to potentially benefit from a successful merger of the SPAC with a company. The option is not only free, but a return is generated when you buy the SPAC below its trust value.

One reason why the big institutional money may not be more involved with SPAC arbitrage is because SPAC arbitrageurs have limited liquidity. The average daily trading volumes per SPAC are often very low. But there can be short windows of opportunity when volumes multiply and an acquisition target is announced or when discounts to NAV increase sharply which brings in bargain hunters.

During difficult market periods, SPAC common share prices may decrease slightly. But the potential loss is limited because you can always redeem the SPAC for the trust value. For many investors, the main risks are operational. If you miss an important deadline, such as filing for a redemption, a SPAC investment can quickly change from an ultra-safe position to a highly risky small cap bet.

Back in the 1990s, SPACs were structured differently, and there was some small risk of fraud around SPAC trust accounts. But since 2003, there have not been any cases where the trust account's capital was not guaranteed contractually and redemptions were paid in full. There is complete segregation of the trust accounts from other assets, and well-established brokerage houses such as JPMorgan and Goldman Sachs maintain these trust accounts.

What is the basic approach?

The goal of the strategy is to purchase shares of common stock or units of SPACs that trade below the value in the SPAC trust account. The plan is to sell the shares before a business combination is reached. You definitely would not want to remain an equity investor once a business combination is formed.

ETFs That Use the SPAC Arbitrage Approach

There are many hedge funds that have used SPAC arbitrage for a portion of their portfolio over the years. More recently, several ETFs have been formed that use a lower risk SPAC strategy. They are now available to retail investors.

There is useful information on ETF websites that explain the SPAC arbitrage strategy in more detail.

1) Robinson Alternative Yield Pre-Merger SPAC ETF (SPAX)

Assets Under Management: $20 Million

Expense Ratio: 0.50%

2) CrossingBridge Pre-Merger SPAC ETF (SPC)

Assets Under Management: $58 Million

Expense Ratio: 0.80%

3) Morgan Creek - Exos Active SPAC Arbitrage ETF (CSH)

Assets Under Management: $7 Million

Expense Ratio: 1.25%

4) The SPAC and New Issue ETF (SPCX)

Assets Under Management: $45 Million

Expense Ratio: 0.95%

SPAC Arbitrage Pick - SVF Investment Corp (NASDAQ:SVFA)

Note that SVF stands for "SoftBank Vision Fund". SoftBank has issued three SPACs - SVFA, SVFB and SVFC.

IPO Date: January 8, 2021

Gross Proceeds: $603.75 Million

Initial Trust Value Per Share: $10.00

Estimated Completion Deadline Date: January 8, 2023

Unit Composition: 1 share of common plus 1/5 redeemable warrant. A full warrant entitles the holder to purchase one share of common stock at $11.50. The units trade with the ticker SVFAU. For purposes of the SPAC arbitrage, I would recommend keeping it simple and avoid the units and just purchase the common.

Business Target: Technology sector.

We seek to partner with IPO-ready technology companies that are operating in a large and growing market, with proven unit economics, next-generation technology, and world-class management teams. We believe our global reach, unparalleled ecosystem, and patient capital can help founders build transformative businesses through an IPO and beyond.

Underwriter: Citigroup. Citigroup is considered a "top-tier" SPAC underwriter.

SPAC Management Team: Led by Rajeev Misra who is the CEO of SoftBank Investment Advisers, the investment manager of the SoftBank Vision Funds. Previously, he was a Senior Managing Director and Partner at Fortress Investment Group, and has also held senior positions at UBS and Deutsche Bank.

SVFA Has Very Good Sponsorship

SoftBank is a very well connected sponsor with plenty of additional capital available as needed whenever they want to close a good deal. The SPAC market seems quite dead right now, but this could easily change in the future. An announced deal that the market favors could easily produce an excellent return for investors while your downside is limited by the protection of the $10.00 trust account.

Capital Gain Opportunities/ Optionality

1) Most SPAC deals are consummated before the completion deadline date. When a deal closes sooner than anticipated, you receive a higher yield, because the spread below the trust value is earned in a shorter time period. You can still cash in your shares for the trust value before the shareholder vote, even when the business combination is approved by shareholders.

2) Another way you can benefit is if SVFA announces a target that the market really likes. In that case, the common can trade well above the trust value. Recently, this has not been happening much, but there have been a few exceptions like DWAC and FRGE.

Data by YCharts

Note the big price surge in SVFA that occurred late last year. On November 15, 2021, the price traded as high as $10.88 on a huge volume of over 6 million shares. These price surges are often caused by rumors on a potential company that SVFA may be acquiring. In this case, the rumor did not pan out and the price fell back within a week or so.

It pays to be alert for these price surges which can be hard to predict, but could happen at any time. For those using the conservative SPAC arbitrage strategy, you would exit or trim your position when the price trades above trust value.

What is a Good Exit Strategy?

It is important to monitor the progress of the SPAC management team, since shareholder votes can occur well before the SPAC termination date. You will see press releases announcing any letter of intents or definitive agreements before the shareholder vote. This gives you time to exit the SPAC common shares well before the shareholder vote while you still have the protection of the $10 Trust value floor.

In some cases, for smaller positions, you can exit by selling your shares in the secondary market at or just below trust value. For larger positions, it is usually easier to tender your shares for the trust value, assuming you do not have to pay a high corporate action fee to your broker.

What About the SVFA Warrants?

The SVFA warrants are currently trading around $0.53 and will give you a 5-year warrant on the common exercisable at $11.50, if/when a business combination is formed. I think it is fairly valued at current levels, but it clearly has nothing to do with the low risk SPAC arbitrage strategy because:

• If SVFA cannot find a business partner before the expiration date, the warrants can go to zero. This recently happened with another SPAC warrant MACAW which ran out of time before they could find a deal.
• I believe it is very unlikely that the SoftBank people will not find ANY deal, which explains why the warrant is still trading above $0.50. But as the time limit approaches, they may feel pressured to accept a less than optimal deal with not much upside.
• SPAC warrants have not been trading well lately even in cases where the business combination is formed. Most of this is due to poor market sentiment, since the majority of de-SPACs have been trading well below $10, and quite a few have dropped 70% or more from the SPAC IPO price.

Concluding Remarks

I believe that SVFA is a relatively safe way to park money in the current turbulent market environment. As of Friday's close, SVFA closed at $9.86, and with some patience, it may be possible to buy shares at $9.85 or a little lower. Remember that even in the worst case scenario, you can always recover $10.00 a share in around 8 months.

SVFA has a daily average trading volume of 196,000 shares and usually trades with a one cent spread. I generally recommend using smaller limit orders, but you should also do fine with smaller market orders, since you often can get price improvement where SVFA trades between the bid and asked price.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of SVFA 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.