[This is a new one for StockWarrantsHQ.com, a guest post. I was in email contact with this fellow trader throughout the recent Phunware saga, so I know this isn’t an after the fact story. When they asked me if they could write-up their experience with the warrants, my reply was sure, why not. This shows exactly what any trader can do if they put in just a tiny bit of elbow grease. Low risk, potential high reward trades. This one happens to be in one of my preferred vehicles, warrants.

The only caveat is that they wanted to remain anonymous, which again works for me since I know the major facts / timing are correct from my emails. (Can you tell I used to be a securities regulator? After the dotcom bust, I was on a regulatory team that read through the private emails of the investment bankers who had been touting the dotcoms. Buy me a Glenmorangie sometime…but be forewarned you’ll close all of your investment accounts afterward, LOL. )

My few comments in the article are in italics. So, without further adieu, the first guest post on StockWarrantsHQ from an Anonymous Phunware Warrant Trader.]

How a quirky path to the public markets, and a partial government shutdown, yielded an opportunity for the ordinary investor

“Read every word.  Opportunity is buried in the footnotes.”

I still remember the conversation.  We were waiting out a delay, sharing a
row on a full flight to nowhere particularly important.  He was a fund
manager and we started talking about how anyone can go through the
financials of a filing, but the best opportunities are often found in the
parts that almost nobody bothers to read.

Skip ahead to Phunware’s entry to the public markets through a merger with a SPAC (Special Purpose Acquisition Company).  This quirky method resulted in a very low float through Phunware’s first 97 days as a public company.

The float was somewhere between 49,000 and 114,000 shares through this
period, while companies are typically required to offer at least a million
shares when going public.  The Wall Street Journal published an excellent
analysis covering this topic in February.

Phunware jumped to an intraday high of $550 per share on January 10.
During this rapid rise, Phunware’s public warrants moved from $0.15 to
$0.99, before settling to around $0.50. 

Why would someone pay hundreds for a stock when they could pay $12 instead ($0.50 for the warrant plus $11.50 to exercise).  I decided to do some research.

If you’ve been reading Steven’s blog, you already know where this is
going.  The warrants (PHUNW) could not be exercised because Phunware had not yet registered the shares (PHUN) they would issue at exercise. 

Here’s where the part about “Read every word” comes in.  The warrant agreement contains some interesting language about this registration process.  You can find similar language in the filings of other blank-check companies.

The company would try to file the registration within 30 days of the
merger.  There was also a 90-day deadline for the registration becoming
effective.  If the company missed this deadline, warrant holders were
entitled to a cashless exchange (spoiler alert: this is exactly what
happened).

With a very low float, Phunware was maintaining a price well above the
strike price of the warrants.  The danger with buying the warrants was that
the float was likely to increase suddenly when the registration became
effective, which had the potential to drive the stock price down. 

Once the stock price goes below $11.50, the warrants are underwater.  Even worse, you could find yourself in a situation where the company redeems the warrants (on 30-days notice) based on the high previous share price, making the warrants effectively worthless if the price of the common fell.

A cashless exchange is a completely different animal.  The high share price
results in a better conversion rate from the warrants to the common stock
(the conversion rate is basically the difference between the market price
and strike price, divided by the market price). 

Doing a little math, if the stock stayed around $50, you could get 0.77 shares of PHUN for each PHUNW.  Buying the warrants at $0.50, you would own PHUN at a cost basis of only $0.65 (the real math is a little more complex and involves the trailing volume-weighted average price, but you get the picture). [The formula, copied from the Phunware prospectus, is in a post I did here.]

They couldn’t possibly let that happen. Phunware would miss out on about
$75 million in proceeds from the exercise of the warrants if all PHUNW went through a cashless exchange.

Around this same time, the news was dominated by a single story — the US
partial government shutdown.  At the time, you could read the FAQ from the SEC.  It was clear that nobody at the SEC was going to be working on a new S-1 during the shutdown.

While the odds of the cashless exchange opportunity were still low, I
figured that the government shutdown had the potential to slow the
process.  I also guessed that the low float would help keep the stock price
high enough to make a cashless exchange a good option.  That was enough for me and I bought PHUNW on January 25 for $0.49.

March 27 was the 91st day after Phunware’s merger.  The registration
deadline was missed.  Cashless exercise was now possible…  in theory.
Getting my broker to affect the transaction took more effort than it should
have, but they eventually got it done.  I received just over half a share
of PHUN for each PHUNW.

Unfortunately, I didn’t receive my shares until April 4.  The previous day,
PHUN lost 60% of its value in a single trading session.  In spite of my
terrible timing, the trade netted a 487% profit.  In the same timeframe
(Jan 25 – April 4), Phunware stock declined by 94%. [I started talking about this one in January. So it wasn’t a big surprise when this happened. Told ya, told ya, told ya…OK, back from 2nd grade now.)

With the decline in PHUN below the warrant strike price, the window for a
profitable cashless exercise from PHUNW to PHUN was only a few days long. [The exchange rate is a rolling rate which has declined as the stock has declined. ALWAYS, ALWAYS, ALWAYS, check with your broker for the exact exchange details on any warrant you trade BEFORE you put on a position. Warrant terms can and DO change.]

Once Phunware’s S-1 becomes effective, the cashless exchange option will no longer be available to holders of the public warrants.

I don’t know if I will find such an “opportunity in the footnotes” again,
but I’m going to keep looking.  This trade was one heck of a ride.