In 2020, SPACs (special purpose acquisition companies) emerged as an attractive way to go public. The SPAC mania continued in 2021. Lately, investors have been wary of investing in SPACs and many of them are trading below the IPO price of $10. As the SPAC industry matures, investors also start familiarizing themselves with several terms including the De-SPAC process and redemptions.
We saw a strange situation when Locust Walk Acquisition Corp. (LWAC) stock more than tripled intraday on Aug. 25 after shareholders approved the merger with eFFECTOR. More than fundamentals, the spike was related to a short squeeze following the SPAC redemption. Before we discuss what SPAC redemption is, it's important to familiarize ourselves with the De-SPAC process.
What is the De-SPAC process?
Simply put, De-SPAC is the process between the signing of the definitive merger agreement between the SPAC and the target company and the final listing. Usually, SPACs keep a three-to-six-month window for the De-SPAC process.
As part of the De-SPAC process, the SPAC has to get the merger approved. On a regulatory level, the company has to file the documents with the SEC. The SEC can ask for more information related to the merger.
The regulator has been active lately and Bill Ackman’s plans to take partial ownership in Universal Music through a complicated structure were thwarted by the SEC. The SEC imposed a fine in the Stable Road Acquisition (SRAC) on Momentus for making misleading claims. It has also changed the warrant accounting rules.
The next step in the De-SPAC process is to get shareholder approval for the merger. If shareholders vote against the merger, the deal wouldn't go through.
While most SPAC shareholders approve the merger, there have been instances when they voted against it. Thanks to the recent crash in growth stocks, many SPACs have renegotiated the terms with the merger target before the final merger.
Now, as part of the De-SPAC transaction, the company has to offer stockholders an option to redeem their shares. The redemption happens on a pro-rata basis based on the total funds with the SPAC. Most SPAC IPOs are at $10. This would mean that stockholders who redeem will get $10 plus any interest that the money earned.
You wouldn't expect many redemptions if the SPAC IPO price is comfortably above the IPO price. After all, who would want to get their shares redeemed at a lower price than the stock’s market price?
Redemptions have become pretty normal in 2021 since many SPACs are trading below the IPO price. It’s a simple arbitrage for stockholders. They can redeem their shares for a higher price than the market price. If investors are bullish on the merger target, they still have the option of buying back the stock at a lower price from the open markets.
Also, ahead of the voting and redemption, an investor can buy the SPAC from the open markets below the IPO price and then redeem them at a higher price during the redemption process.
LWAC stock’s rise, explained
What we saw with LWAC exemplified the issues with SPAC redemptions. While the stockholders approved the merger, most of them opted for a redemption. As a result, 97 percent of LWAC stockholders opted for redemption.
This meant that the outstanding shares of the SPAC fell to about half a million from 17 million. The move caught short sellers on the wrong foot and there weren't many outstanding shares available now for them to cover their positions.
This was the case of an epic short squeeze where the reduction in outstanding shares triggered a squeeze in the stock. While LWAC stock soared to a high of $29.20 intraday on Aug. 25, it eventually closed at only about $16.98. It was still a rise of almost 93 percent from the previous day.
To sum it up, LWAC would go down in books as a perfect example of what could go wrong in a SPAC redemption. Watch out for more redemptions since there are still plenty of SPACs trading below the $10 price level.