SPAC vs SPARC - the Ackman difference

Pershing Square Tontine (PSTH) – Bill Ackman’s SPAC, finally announced a deal post market close on June 4, 2021 - to acquire 10% of Universal Music Group from Vivendi. The CNBC discussions I saw described the deal as "confusing", "complex" and couldn’t figure out if value had been created. Online articles and Twitter comments I saw were all shades of negative to downright uglgy. The market reaction was poor with PSTH share price falling from $25.05 at close of market June 4th to $22.06 by the end of day June 5th (-12%).

I think the market had expected a SPAC - a quick, one-off exciting deal e.g. Bloomberg, instead they got something else. That something else is actually very good in my view. Firstly the terms:

Ackman is no Chamath (a hypocrite and snake oil salesman in my view). Ackman wants to create long term value rather than just generating one-off massive commissions from pitching the latest hot technology turd to gullible investors. My speculation on the reason for the UMG deal and post PSTH structure is:

1. There is too much capital fighting for returns in today's market to find a large quality business at a reasonable price. So Ackman wanted to recycle his capital and extend the duration of PSTH. UMG is a high certainty deal which helps achieve this objective

2. This furthers Ackman’s goal of creating a permanent capital structure

Point 2 warrants further explanation. Just a few years ago Perishing Square (PSH) was suffering 4yrs of negative returns due to the disastrous back to back losses from Herbalife (-$1bn loss) and Valeant Pharmaceuticals (-$4bn loss). This large under-performance period led to huge outflows in Ackman's funds only limited by onerous redemption terms (e.g. only1/8 redeemable each quarter). The survival of PSH/Ackman was due to his realisation early on that he needed long-term capital to match his long-term investment objectives – a learning he took from Buffet’s closure of his partnership in 1969. Ackman had started the transition from private redeemable capital to permanent listed capital in 2014 with a publicly listed version of his fund raising $3bn in its IPO. The transition resumed and re-accelerated the last few years helped by his strong performance in 2019 and 2020.

So what is PSTH Remainco and SPARC? I think they should be thought of as extremely attractive private equity (PE) funds. The benefits over traditional PE funds are:

• No ongoing base and performance fees

• The sponsor is heavily aligned by ownership and further capital commitments

• Immediate conversion from private to public for targets greatly increases success rate and returns – cheaper funding (banks, public markets), day 1 liquidity revaluation

• Liquidity (even pre-deal)

• PSH is a top tier investment manager

SPARC is especially attractive as it has no upfront capital commitment and optional buy-in. This is essentially a put option on a liquidity pullback/market crash.

Valuation

With these points in mind, it becomes easy to value PSTH. I think the capital return occurs soon after the date of UMG’s listing (even with the unknown delay in units being distributed) since one can just short UMG if required.

*Vivendi said 5/2021 that UMG would list on Euronext Amsterdam exchange before 27/9/2021

UMG: 10% of UMG with implied valuation EV=EUR35bn (US$42bn). Uses up $14.75/share of cash from PSTH. UMG shares will be distributed to PSTH shareholders post UMG’s listing

• Low: based on PWC/Ernst & Young’s valuation of EV=EUR33bn

• Base: valuation based on Warner Music (no 3 player) of EV=EUR40bn

• High: GS 5/2021 valuation @ EV=$53bn

PSTH Remainco: represents the $1.5bn cash remaining ($5.25 cash/share). Perishing Square (PSH) owns 29% of Remainco and holds rights to purchase $1.4bn to fund future acquisition

• Low: face value of remaining cash

• Base: 10% premium to cash/share

• High: 20% premium to cash/share

SPARC: 5yr listed right exercisable @ $20/share (post deal announcement) in new entity SPARC. Fully exercised rights represent $5.6bn cash. Additionally PSH has forward funding agreement for $1-5bn giving SPARC total financial firepower of $6.6-10.6bn

• Low: 2% x 5yrs x $20 (exercise value per share)

• Base: 3% x 5yrs x $20

• High: 4% x 5yrs x $20

The UMG valuation seems pretty straightforward. My base expectation (14% above PSTH’s purchase price) based off Warner Music’s valuation seems reasonable given UMG's lower gearing and larger market share. It’s unlikely Ackman made a deal where he would lose money.

For PSTH Remainco and SPARC, the valuation is based off PE fund fees. A normal PE fund charges 2% pa on committed capital and 20% of all returns (generally subject to a hurdle rate ~8%). So given all the benefits that PSTH Remainco and SPARC have over the typical PE fund, assigning a 2%, 3% and 4% pa for a 5yr duration (10%, 15%, 20% premium) for the Low, Base and High valuation scenarios seems very reasonable. Additionally PSTH’s premium for its ~1yr listed history was well above 20%.

Conclusion

The market doesn’t understand the PSTH deal because it’s thinking through the lens of 1st degree and short-termism.

I see PSTH as a better version of cash with components of a market crash hedge and non-systematic returns upside built in. My simple valuation table shows a very asymmetric returns profile. I bought further PSTH units on Friday at low $22s price and closed out my short $25 18/6/2021 PSTH Calls. It seems sensible to convert at least 1/3 of my 30% portfolio cash position to PSTH units around these prices.