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SPAC + Meme Stock = A Dangerous Combination

When my five-year old attends a birthday party, she brings a present, then often leaves with a bag of token gifts from the host. The exchange happens even if she doesn’t stick around for long.

Special purpose acquisition companies offer a similar incentive to attract capital, but the division of spoils can be more unbalanced. 

Take Getty Images Holdings Inc., which briefly became a meme-stock — rocketing fourfold after its July SPAC listing. The image and video content company was able to cancel the financial party bags normally reserved for the hedge funds who provide the capital (and the retail investors who trade it), while corporate insiders were rewarded with a sackful of extra gifts.   

It’s a convoluted tale of financial engineering highlighting the perverse consequences of a stock being hyped online. It shows the importance of studying disclosures and paying attention to skewed financial incentives. 

To recap, in return for seeding a SPAC with cash, investors (often hedge funds) are given warrants granting them the right to purchase additional shares in the merged company for $11.50, or slightly higher than the $10 price at which SPACs sell their stock.

The warrants provide extra financial upside, and they can be retained even if the investor chooses not to fund the merger and asks for their money back, which happens a lot now that SPACs have become the most reviled Wall Street invention since the collateralized debt obligation.

Getty Images’s revenue exceeded $900 million last year and it is profitable, yet more than 99% of the investors in its $828 million SPAC — CC Neuberger Principal Holdings II  —  opted out. The deal still closed in July as planned, thanks to additional funds supplied by affiliates of the SPAC sponsor.  

Initially, there was a tiny float of shares available to trade and, as often happens in these situations, retail investors piled in hoping to squeeze the price higher. It worked. The stock went from less than $9 to a peak of almost $38. 

In theory, this should have been great news for holders of the more than 20 million Getty Images warrants because their right to purchase shares at $11.50 was potentially quite valuable.

But in reality they couldn’t take immediate advantage: The warrants could only be exercised once the target company has an effective S-1 registration statement. So instead Getty Images now had the upper hand: That’s because former SPACs have the right to force warrant holders to exercise if the stock price exceeds $18 for a few weeks or else have those securities canceled for a token amount.

When it announced the redemption of the warrants almost concurrently with the S-1 being declared effective earlier this month, the stock plunged back below $11.50 (because some corporate insiders and institutional investors were now able to sell).Hence, it no longer made financial sense for holders to exercise their warrants and these were likely be worthless unless the stock price rebounds. “The warrant structure and details were established prior to the merger and fully disclosed in connection with the merger transaction,” the company said in an emailed statement.

Getty Images certainly didn’t play nice by burning warrant holders but this was only possible because 99% of SPAC shareholders weren’t keen to fund its merger. To better protect their warrant investment, more of them should have supported the deal.

Wiping them out benefits other stockholders by minimizing potential dilution. It isn’t the first former SPAC to try the maneuver. Private stock market Forge Global Holdings Inc. did something similar in June. Removing the warrant liability “reduces potential dilution and decreases our fully diluted shares,” Forge told investors back then.So all’s fair in love, war and SPAC-land then? Indeed, it’s caveat emptor, as Getty Images did accommodate other sources of dilution. SPAC founders receive warrants in return for the money they use to set up the blank-check firm, and these so-called “private warrants” can’t be forcibly redeemed. In this instance, the sponsors were able to exercise their warrants in August, thus netting them a chunk of additional stock, which is nice for them.Adding insult to retail and hedge funds’ injury, the unexpected share price jump triggered several “earn-out” clauses, meaning tens of millions of additional shares were issued to Getty family members, and a few million to the SPAC sponsors. Plus about 6 million employee share awards were unlocked by the gyrating stock price. And naturally this added dilution caused the stock to sink even further.  

Fortunately, the SPAC’s share investors weren’t harmed because almost all of them cashed out. Warrant holders’ losses might also have been worse: Normally the warrants and shares move in tandem, but in this instance the warrants trailed far behind, indicating investors didn’t think the squeeze would be sustained. I tip my hat to this SPAC investor and Twitter user who foresaw exactly what would happen.

So what have we learned? Getty’s earn-out clauses were poorly designed — the share price triggers were deemed met after just 20 days. As I’ve noted before, a temporary jump in the stock shouldn’t result in a payday for corporate insiders, yet somehow this keeps happening. 

To prevent warrant holders being kneecapped in future transactions, the SPAC rulebook should be revised so the redemption price trigger starts after the S1 is declared effective, by which time the share price should have settled down.Given such misaligned financial incentives and volatile post-merger trading, no wonder nobody wants to join the SPAC party anymore.

More From Bloomberg Opinion:

• Bill Ackman’s SPAC Is Dead. Long Live the SPARC?: Chris Bryant

• Matt Levine’s Money Stuff: Trump SPAC Doesn’t Have the Votes

• Stock Market’s Summer Fling Wasn’t Real Thing: Jonathan Levin

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Bryant is a Bloomberg Opinion columnist covering industrial companies in Europe. Previously, he was a reporter for the Financial Times.

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