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SPAC warrants

SPACs raise capital from the public by issuing units of shares with attached warrants, which can subsequently trade on their own.  These warrants are worthless if the SPAC doesn't do a deal, but can potentially be cheap when the SPAC has identified a deal and is close to completing it. 

At that time, there is uncertainty surrounding the success of the deal, because the SPAC's shareholders have the option of voting it down and taking their cash back out of the trust account.  However, SPACs have certain mechanisms to get their deals to go through, especially if they can find investors that believe in them and are willing to buy out dissenting shareholders. 

A current example of such a situation is DSP's warrants.

DSP is a SPAC -- sponsored in part by Steel Partners -- that has an agreement to acquire Frontier Bank (OTCPK:FTBK), a $4.0bn asset bank.  The bank had a lot of problems with 43% of its portfolio in construction and land loans, but it has recently changed management and will use the SPAC's cash as a capital infusion to prepare for growth and potentially FDIC-assisted deals in its region. 

As part of the transaction and in accordance with purchase accounting, FTBK's loan portfolio will be written down to fair value.  Pro forma for the recapitalization by the SPAC, the bank will have $10.24 in tangible book value per share.  The warrants, that were originally issued as part of the units that DSP floated to the public, will be amended to have an $11.50 exercise price and a 7 year life. 

The warrants, trading at $0.40, are long-term call options on (1) the transaction going through, and (2) a fair-valued bank balance sheet that was earning $100mm a couple of years ago and can go back to very profitable underwriting in its markets.  Of course, if the deal doesn't go through, the warrants will be worthless, but it seems likely that the deal will happen. 

What is the potential upside?  Comparable companies have historically traded around 2x book value, so in the next 3-4 years the company could be trading somewhere in the low/mid-twenties, which would make the warrants very valuable.

The downside, obviously, is zero, and there is a definite chance that the deal may not go through.

Maybe this is pie-in-the-sky dreaming, but some might find this an interesting and relatively cheap option to play financials.

Disclosure: staff is long DSP warrants