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"Honestly it would be weird if there wasn’t insider trading in this SPAC."

https://www.bloomberg.com/opinion/articles/2021-12-13/the-trump-spac-pipe-is-free-money?utm_source=twitter&utm_medium=social&utm_campaign=socialflow-organic&utm_content=view&cmpid%3D=socialflow-twitter-view&sref=TBDibEcD

The Trump SPAC PIPE Is Free Money
Also Peloton and a Bored Ape fat finger.

By Matt Levine +Sign Up
December 13, 2021, 10:50 AM MST

We talked last week about the Trump SPAC PIPE. A quick recap: Donald Trump has a vague sketch of a media company called Trump Media & Technology Group (TMTG). TMTG is a private company and there is almost no public information about its business, finances, executives, etc. In October, TMTG announced a merger with a special purpose acquisition company (SPAC) called Digital World Acquisition Corp. (DWAC), which will contribute about $293 million of cash to TMTG in exchange for TMTG stock. DWAC is currently a public company; it raised stock from the public by selling shares at $10 each, and upon the announcement of the TMTG deal its stock shot up. It closed at $56.02 on Friday.

Traditionally SPAC deals are accompanied by private investments in public equity (PIPEs), in which big institutional investors agree to buy stock in the combined company at the time of the SPAC merger. Often the PIPE investors invest on the same terms as the SPAC investors, buying stock in the new company at $10 per share, but where (as here) the stock is up a lot in anticipation of the merger, the PIPE investors might agree to a higher price.

TMTG and DWAC announced a $1 billion PIPE on Saturday, Dec. 4. The price was a bit weird. Nominally it is $33.60 per share: The PIPE investors put in $1 billion and get back 29.8 million shares ($1,000,000,000 divided by $33.60). But it is subject to downward adjustment: The actual number of shares that the PIPE investors get is only fixed after the SPAC merger closes.

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A lot will happen between now and when the SPAC merger closes. TMTG and DWAC will have to file a merger proxy with extensive financial and business information about TMTG. Perhaps that information will be, you know, bad. Perhaps investors will read the proxy and say “huh this company has no real business plan” and the stock will drop. Or not, I don’t know, I am not sure I’d bet on the stock dropping due to a lack of business plan; you can read TMTG’s current investor deck here, and it is not exactly replete with business planning. Still the point is that there is some risk of the stock dropping.

But the PIPE investors are protected against this in two ways. First, TMTG and DWAC have promised the PIPE investors that they’ll be able to sell the stock the minute the merger closes. Ordinarily in SPAC deals, the company agrees to file a registration statement with the Securities and Exchange Commission and work to get the SEC to approve it, so that the PIPE investors can legally resell their shares. But usually that happens after closing, and you can't count on rushing the SEC. In this deal, TMTG and DWAC have promised to get the registration statement effective before closing, and in fact it is a condition to the closing of the PIPE. The PIPE investors only have to put up their money if they can immediately turn around and resell their shares.

The second protection is that the price of the PIPE is “subject to downward adjustment.” When the merger closes and TMTG is public, it will look at the average closing price over the next 10 trading days, and use that to compute the final price of the PIPE. If the stock trades at $56 or above after closing, there will be no adjustment, and the PIPE investors will buy stock at $33.60 per share. If it trades below $56, though, the PIPE investors will buy stock at a 40% discount to whatever the average price is: If it trades at $45, they’ll pay $27 per share. (Effectively, they'll get more shares — 37 million, at $27 per share — for their billion dollars.) But this is floored at $10: If the stock trades at $16.67 or below (including if it trades below $10), the PIPE investors will buy at $10 per share.

The result is that the PIPE investors are committing $1 billion of money, but taking very little risk and getting very richly rewarded. They can — and, I expect, will — sell their stock as soon as the merger closes and TMTG is public, and they’ll sell at a huge guaranteed profit because they will buy their stock at a 40% discount to the stock price at the time they pay for it. Still, some risk: If the stock is below $10 by the time the deal closes, they will lose money on the trade.

Or that is what I said last week, but the trade is actually even better for the PIPE investors? Because here is the trade they can do:

Short DWAC stock now, locking in a sale price of about $56 per share.
Buy back the stock at closing, from TMTG/DWAC, at a maximum purchase price of $33.60.
Make $22.40 per share guaranteed.
Ordinarily, if you short stock in Trump’s thing at $56, you run the risk that it will go up to $100 and you’ll lose a ton of money. But if you have committed to the PIPE, TMTG and DWAC have agreed to sell you shares at $33.60 (subject to downward adjustment), so that risk is off the table. If the stock goes up, you buy at $33.60. If the stock stays flat, you buy at $33.60. If the stock goes down, you buy at a 40% discount to the market price. If it goes down to $20, you buy at $12. If it goes down to $16.67, your price is floored and you buy at $10, but that’s fine if you already sold at $56.

Let’s say you have committed $100 million to the PIPE. At the cap price, this means you will get about 3 million shares ($100 million divided by $33.60). So you sell all those shares today, at about $56 per share, for $167 million. Then at the closing of the PIPE you put in your $100 million, get back at least 3 million shares, and deliver them to your stock lenders to close out your short position. You are left with a $67 million profit. If the stock goes down, and is below $56 after the merger closes, you will get more shares — as many as 10 million, if the stock is at $16.67 or below — and then you can sell those too for some extra cash. 1 But the $67 million is guaranteed no matter what the stock does.

I want to point out that this is explicitly contemplated by the deal documents. Here is Section 3.1(bb) of the Securities Purchase Agreement that the PIPE investors signed with DWAC (emphasis added):

Acknowledgment Regarding Purchaser’s Trading Activity. Anything in this Agreement or elsewhere herein to the contrary notwithstanding (except for Sections 3.2(g), 4.12 and 4.15 hereof), it is understood and acknowledged by the Company that: (i) none of the Purchasers has been asked by the Company to agree, nor, to the knowledge of the Company, has any Purchaser agreed, to desist from purchasing or selling, long and/or short, securities of the Company, or “derivative” securities based on securities issued by the Company or to hold the Securities for any specified term, (ii) past or future open market or other transactions by any Purchaser, specifically including, without limitation, Short Sales or “derivative” transactions, before or after the closing of this or future private placement transactions, may negatively impact the market price of the Company’s publicly-traded securities, (iii) after the execution of this Agreement, any Purchaser, and counter-parties in “derivative” transactions to which any such Purchaser is a party, directly or indirectly, may have a “short” position in the Common Stock and (iv) each Purchaser shall not be deemed to have any affiliation with or control over any arm’s length counter-party in any “derivative” transaction.

That is, DWAC agreed that the PIPE investors can short DWAC stock right now. 2 This is a very unusual provision in SPAC PIPEs; most purchase agreements specifically say that the investors are not allowed to short. 3 In the Trump SPAC PIPE, they specifically are allowed to.

Now! A couple of things. First, there are risks to this trade. One risk is that it might be expensive to borrow DWAC stock, it’s a meme stock, the price could go up, borrow could be recalled, and you could be forced to cover your short at a loss before the merger closes. If you make it to closing, you’re guaranteed to be able to buy the stock for $33.60 for a risk-free profit, but you had better be sure that your stock borrow is locked up until then. And closing — which requires writing a public disclosure document that satisfies SEC rules — could be a long way away.

Another risk is, I say “you’re guaranteed to be able to buy the stock for $33.60,” but that depends on DWAC and TMTG honoring the commitments in the contract and, you know, who knows. Donald Trump has been known to re-trade on deals. 4

Beyond the risk of perhaps getting short a meme stock and then being forced to cover prematurely, there are legal risks. The main one is: If TMTG hired an investment bank to sell $1 billion of stock into the market right now, today, with the extremely limited public information about TMTG’s business and finances that is currently available, that investment bank would definitely be breaking the law. (Specifically it would be violating Section 5 of the Securities Act of 1933, which requires sales of stock to be registered.) If this transaction consists effectively of TMTG hiring a bunch of PIPE investors to sell $1 billion of stock into the market right now, with the delivery of the stock to the investors in a few months, there is a risk that those investors are also legally underwriters of unregistered stock, and will get in trouble. (Not legal advice!) The fact that the transaction explicitly acknowledges that they might be doing this suggests that they’re not too worried about the legal risk, but the SEC — which doesn’t like SPACs anyway — might disagree.

And in fact short interest in DWAC stock does not seem to be especially high — certainly not the full 29.8 million shares underlying the PIPE — and the volume over the past week also does not suggest that the PIPE investors have been selling all that heavily.

Still! It seems like they could; it seems like the deal was specifically set up so they could. It was specifically set up to let them buy stock at $33.60 and lock in a sales price, today, in the $40s or $50s. It was specifically set up to be guaranteed free money for the PIPE investors.

There has been a lot of writing about the Trump SPAC PIPE that suggests that the investors in this PIPE are somehow doing Donald Trump an under-the-table favor, that this is a story about secret money in politics. For instance:

Not only was a big PIPE investment not announced when the partnership with Trump was revealed, now that it has been announced, the names of the investors have not been made public. That’s because each investor has been limited to controlling no more than 4.99 percent of the voting stock, just under the Securities and Exchange Commission’s threshold requiring anyone controlling 5 percent or more to be identified publicly in filings.

“This PIPE is structured so that the identity of the PIPE investors may not be known for a long time, if ever,” Rodrigues says.

While the public and general shareholders don’t know who the PIPE investors are, Trump apparently does. In fact, Reuters reported last week that Trump has been personally calling certain potential PIPE investors, trying to get them to commit to a $100 million investment, which heightens a potential for a conflict of interest—only Trump would know what other interests he might have to serve.

“Are they individuals or companies or countries that have a stake in something that he could affect as president?” Kathleen Clark, a professor of legal ethics at Washington University in St. Louis says. “Yes, of course they are, whoever they are, but I think the bigger question right now, is: Will we ever know their identities?”

Well, first of all, yes, of course we will know their identities: The PIPE investors will all be listed as selling shareholders in the registration statement, which will be filed before the merger closes. 5

But second, I think the whole premise here is wrong. If you agreed to invest in Donald Trump’s $1 billion SPAC PIPE, it is not because you want to donate money to Donald Trump, to do him a favor. It is because, in exchange for your investment, you will get Donald Trump meme stock that you can immediately sell to retail investors at a huge guaranteed profit. He is doing you a favor! I assume that the PIPE investors include a lot of Trump friends who are very grateful to be in the deal. Because it’s free money!

Meanwhile the warrants
Because DWAC is a SPAC, it has warrants outstanding. Each warrant represents the right to buy one share of stock, after the merger with TMTG closes, for $11.50. The warrants (ticker DWACW) closed on Friday at $18.35. The stock (DWAC) closed at $56.02.

Some simple arithmetic reveals that $11.50 + $18.35 = $29.85, and $29.85 < $56.02. If you want to get exposure to DWAC/TMTG, you can buy one share for $56.02, or you can buy one warrant (to buy one share for $11.50) for $18.35. The total per-share cost of the warrant, $29.85, is $26.17 lower than the going price of the stock.

This is anomalous! But not that anomalous, for meme-y SPAC warrants. (We talked about a similar situation in Nikola Corp. warrants last year.) The basic situation is that the stock is meme-y, salient, beloved by retail investors, and high, while the warrants are a bit weirder, more niche, traded by hedge funds, and lower. You’d think that there'd be an arbitrage between them, but it’s imperfect. You can’t exercise the warrants now — you have to wait until after closing — so you can’t just capture the $26.17 difference now. The classic way to capture the difference is to buy a warrant and short a share of stock, 6 but that is risky for the reasons it’s risky for the PIPE investors (limited expensive stock borrow that might be recalled, etc.). I suppose the point is that there are lots of Trump-SPAC trades that look like free money, but be careful with them.

Elsewhere in Trump-SPAC warrant trades that look like free money, but be careful:

A few weeks before Digital World Acquisition announced a deal to merge with a fledgling social media company backed by former President Donald J. Trump, it was at the center of a sudden trading frenzy. ...

About 350,000 warrants of Digital World traded in the first two days. But on the third day — Oct. 4, a week after Digital World and Trump Media & Technology Group entered into formal talks that were not disclosed at the time — trading in the warrants exploded. More than 2.5 million changed hands that day.

The surge was unusual, especially for a little-known SPAC that hadn’t publicly identified a merger target, experts said. And with the Financial Industry Regulatory Authority now scrutinizing the merger deal — particularly trading activity that took place before the companies announced their agreement on Oct. 20 — warrants could be under a microscope.

Honestly it would be weird if there wasn’t insider trading in this SPAC.