Warrant Conversion

Yesterday evening, RMG Acquisition Corp. III (RMGC) filed their documents in regards to their announced combination with H2B2 Electrolysis Technologies, Inc., but also included was that they intend to do a warrant conversion for shares for both the public and private warrants.

We’ve recently seen an uptick in de-SPAC’d companies calling their warrants in an attempt to clean up their cap tables, but RMG III’s warrant conversion harkens back to SPAC’s of old which wanted to clean up their warrants at closing, not after.  Meaning, RMG III will include the warrant conversion as a proposal for warrant holders to vote on at the completion vote for the combination.

For SPAC veterans that have been around since 2019, you might remember the Trinity Merger Corp./Broadmark deal where they offered warrant holders $1.60 in cash for their warrants, plus they got to keep a 1/4 warrant as a sweetener.  However, Broadmark was especially motivated at that time due to it being a REIT, which issues dividends by nature.  And the problem with SPAC warrants in that scenario is that the warrants include anti-dilution adjustments which go into effect when dividends are paid in an amount that exceeds $0.50 per share.

So, if Broadmark couldn’t clean up their warrants ahead of closing, what would happen is, every time Broadmark were to issue a dividend, the warrant would need to be re-struck (also included in the warrant holder vote was a waiver to remove the anti-dilution provisions). Hence the need to include the warrant amendment upfront in the completion vote rather than do it post de-SPAC’ing.

However, now in today’s current market environment where we’ve seen much, much higher redemption rates at shareholder votes, there is also a need to address the SPAC warrants, but for different reasons.  That’s because the cap tables look pretty wonky post-close.  By way of example, if you originally had a $300 million SPAC, with a 1/3 warrant, that suffered 90% redemptions, you would end up post-vote with 3 million public SPAC shares, but 10 million public warrants outstanding. If you also include the private warrants that the sponsor purchases at IPO, that could be an additional 8 to 9 million warrants if the sponsors bought them at $1.00. That’s a BIG warrant overhang if the size of the company the SPAC is buying isn’t massive.

We’re starting to see de-SPAC’d companies address this by calling their warrants back. In the past two weeks alone both the Biote/Haymaker III deal and Cartesian Growth/AlTi deals have announced warrant calls and this trend should continue.  RMG III is just getting ahead of it by trying to clean up the warrants a little earlier.

As for the specifics on RMG III’s conversion, they are proposing to convert each warrant at a ratio of 0.075x in common stock of the surviving corporation. If we assume a $10.00 price of the surviving company for easy math, that means warrant holders would receive $0.75 worth of the share. Furthermore, in order for this to be approved at the completion vote, 65% of warrant holders need to vote “yes”.

Will $0.75 be enough? Well, the trading value of SPAC warrants is drastically different today than it was at the time of the Trinity/Broadmark deal, which is why Trinity/Broadmark’s offer of $1.60 + 1/4 warrant looks so juicy right now.  Naturally, the RMG III warrants currently are not worth something similar. Having said that, warrant holders will most likely push back a little because that’s part of “the dance” in these things. Warrant holders would much rather keep their warrants and in order to get holders to part with them, warrant holders want the company to pay up. Plus, these are five-year warrants and there’s value in that.

What complicates things in these matters is that warrant holders get to vote on it and so they do have some leverage, but given where warrants have been trading recently, which the average for all de-SPACs that have closed since January 1, 2022, is $0.57, with a median of $0.40,  a 0.075x conversion price looks to be in the ballpark.