Why PIPES are So Important for SPACs

My uncle smoked a pipe that he filled with cherry tobacco, and while I can’t stand the smell of cigarette smoke, that pipe actually smelled nice…oh, sorry, not that kind of pipe.

When I’m looking at buying into a SPAC warrant that has not yet announced a deal, from a big picture perspective, I look at two things…management, and the price I have to pay for that management.

If you’re the founder of a company, you want capital, but most of the time (if you’re not using this as an exit) you also want good, experienced management to work with to help you to continue to grow after the merger.

That should be pretty obvious…you want to work with someone who’s grown a business from $50M to a billion, as opposed to a pure financial manager who is good at putting deals together…or an athlete…or actor…or whoever else has a SPAC as a calling card.

But, there’s another reason you want good management in place if you’re buying warrants, and that has to do with the PIPE we’re here to talk about today.

What is a PIPE? It’s a private investment in public equity. 

What you may, or may not know, is that most SPACs complete deals with companies that are MORE valuable than the money the SPAC has in its trust account. 

So, a SPAC that has raised $300 million, may do a deal with a company that values the company at $1 billion. Where does the other $700 million come from?

Mostly from large investors and funds who like the deal, and decide they would like to be involved early on. And, the SPAC founders, and target company insiders can also provide additional funding.

So, who do you think the PIPE investors, large money managers, who invest in businesses for a living, like to give money to? Actors, athletes, and other money managers…or people who have turned $50M companies into $1B companies before…right.

Now, a few months ago (and all of last year) this wasn’t an issue, because anything SPAC related was the best thing since sliced bread. PIPE investors were more than happy to kick in to the pot, when most SPAC common shares were trading above trust value. 

Fast forward to today. Many SPAC management teams, when they are seeking out PIPE investors, show up hat in hand. And then have the pleasure of telling the people they are asking for money, that their common stock is trading BELOW the amount of cash they have in the bank. 

Let’s think about this in every day terms. You show up at the bank and ask for a mortgage. The loan officer asks how much you would like to borrow, and you say $100,000. Sweet. How much have the houses around you, that are exactly like yours been selling for…uhm, $80,000. (Maybe you want to do some fixing up of the house with the extra money.)

Not to be deterred, and wanting the fees, the loan officer says, “OK, well, mortgages are averaging 3% right now…if you want more than the value of your home, we may be able to do it, but it’s probably gonna be more in the 4-5% range.” OK, done.

PIPE investors, much like the loan officer, are money guys and gals. The deal can, almost, always be done, the terms just have to be, shall we say, appropriate. 

This is the environment we are currently in.

Which, isn’t a “bad” environment for getting deals done, but it is more “appropriate” than last year, or even a few months ago…which means it is a little more difficult to negotiate, as SPAC founders and target founders accept a little lower valuation…or kick in more of their own money.

In this environment, it is more important than ever to focus on quality business managers, who are trusted by PIPE investors, and can get deals done in today’s market.

Having said all that, I’ve been pouring over SPAC filings this week, looking for those I think can thrive even now. A few warrants we’ve added to our SPACfolio recently include Authentic Equity Acquisition (AEACW) and Mason Industrial Technology (MITW). Both led by great management teams.

For more info join us at The Warrant Observer.