Yesterday I wrote about the ongoing trend in ESG/sustainable investing and how we can try to profit from it via spacs. Today I’ll present the first spac company which I believe will do well in the future.
But first, I received some basic questions about spacs so I thought I would take a short moment to discuss the basics of these things. I’ll keep it simple. Spacs are Special Purpose Acquisition Companies: Public companies (i.c. you can buy shares on an exchange) with no commercial operations. The only thing these companies have is cash. It’s basically a publicly traded bag of cash. A spac’s only purpose in life is to go out and find private companies to buy. Once they’ve found one, they merge together, the spac changes its name and the private company now becomes a public one. After that, if you’ve owned the spac, now you own the old private company.
Normally when a company goes public it’s shares can be traded on some exchange. When a spac goes public, it does not sell shares but units. A unit normally consists of one share and (a fraction of) a warrant. After a short period, the unit will split into a share and warrant and both will trade separately. Now what is a warrant? Warrants are long-term options. With a spac-warrant you can buy (but don’t have the obligation) a spac-share at a certain price (for spac-warrants normally $11.5). So if a share is worth say $10, your warrants are worth zero, as $10 – $11.5 < 0. If spac-shares are worth $20, your warrant is now worth $20 – $11.5 = $8.5. Now, if you bought the warrant for $2, you made more than 4x your money. So you see, if you can find a good spac deal and cheap warrants, it can be highly profitable.
Let me repeat what I wrote in yesterday’s blog:
I have found spacs, and particularly spac-warrants, to be good vehicles to play trends/hypes:
- Spacs can move very quickly, closing a business combination in 2,3 months compared to >6 months for a regular IPO [during an IPO a company goes public], and are thus able to play into trends more quickly.
- Regular IPO trajectories have a SEC (the US stock market police) mandated silent period prior to listing. In contrast, spacs able to sell their business combination before the closing of the business combination (and do so).
- Many funds cannot or will not buy into spacs prior to the closing of the business combination due to a variety of reasons, such as uncertainty regarding the closing of the business combination, low liquidity of the spac, or general antagonism/aversion towards spacs.
- As a consequence of the silent period, lock-up and the banks in the syndicate (the group of banks that bring the company to the market), regular IPOs have new analyst coverage only after a specific period, generally a month or so. Today, we are starting to see new analyst coverage of new spac business combinations even before closing of the business combination.
For each new spac deal I try to assess how quickly the share price can reach $18 and how ‘easy it is to sell the particular ESG story’ (remember, ‘ESG’ and ‘sustainability’ are all about ‘being good companies’). The $18 is because that’s when you might be forced to convert of the warrants. At an $18 share price, the warrants are worth ~$6.5. With respect to how ‘easy it is to sell the story’, I mainly look at how ESG/sustainable/green the story is, the valuation and similar companies.
The first company I’ll present is Live Oak Acquisition Corp, or ‘LOAK’. LOAK recently announced a merger with Danimer Scientific. Danimer already produces PLA, but the company’s main product is PHA, “a 100% biodegradable, renewable and sustainable plastic feedstock alternative for usage in a wide variety of plastic applications…”. According to the company, its PHA polymer is the first commercially available PHA in the world to be certified as marine degradable.
This is very interesting for the ‘easy to sell’ story. To give you an idea of the industry certifications of (bio)plastics:
- Industrially compostable. First step above all that doesn’t go away. It is the easiest standard to achieve. Biodegradation takes place in an controlled, industrial facility to produce compost. The process requires very high temperatures.
- Home compostable. More or less like 1, though the process of making it disappear requires less work (heat generally), but processed volumes are very low and it can take a long, long time.
- Soil degradable. Here you start using (mainly) bacteria to process the plastics. Soil degradability can take a long time though.
- Fresh water degradable. Very difficult to achieve as less and less micro-organisms are present.
- Marine degradable. The most difficult and highest standard to achieve. The cold sea water with low population of micro-organisms makes it hard for materials to decompose.
Danimer PHA products are certified as marine degradable. Now that’s a story you can sell!
What makes it more interesting compared to some of its peers is that Danimer appears to already have achieved some level of scale (a higher level of productivity): Phase I of the Kentucky plant expansion was finished this year (20m pounds production capacity). The plan now is to move to phase II, which adds another 45m pounds, and break ground on the new greenfield facility (Q1 2022) that is expected to add an additional 125m pounds of finished product when finished (Q4 2023).
Most investments will be in the period 2021-2023 for phase II and the greenfield facility (~$400m). According to Danimer, after the business combination it will be fully financed for the entire project.
Danimer expects all this to lead to the earnings picture below. PHA resins are expected to be the main revenue stream. The company claims high visibility as capacity has been fully sold-out through 2022 with the phase II capacity buildout; all contracts are take-or-pay with large customers such as Nestle and Pepsi. As demand is much higher than supply, Danimer expects to be quickly sold-out again in 2024 as the greenfield facility is expected to approach full utilization. Target ebitda margin is ca 30% upon the full utilization of the Kentucky facility in 2023 and are supposed to continue to expand thereafter given operating leverage from the greenfield facility ramp-up.
The bear case of this story is arguably an Avantium scenario: A company with a promising bioplastics technology, nice partnerships with big names and a conviction that it will be able to scale, but eventually fails to do and as such the story is over. However I believe the story with Danimer to be less risky; the company has already achieved some non-negligible level of scale and revenue visibility seems indeed high until 2022 given their take-or-pay contracts. Also, growth financing seems secures after the deal. Delays are always a risk (and probable), but I don’t believe that to be an issue now to ‘sell the story’.
The bull case is the company being able to scale and ramp up properly (and on time). As demand is currently much, much higher than supply, the company will have no problems selling out its capacity early, which massively increases visibility (2027+). End markets are huge, and as the greenfield facility construction progresses, the company will start talking about additional greenfield opportunities. Given the extreme green character of the firm and the clear intention of selling itself as an ESG leader, I would not be surprised should multiples expand quickly and the shares sky-rocket.
Danimer mentioned the best direct peers to be private companies, some European and other Asian. Kaneka is apparently the only other company that’s actually selling PHA, however according to the company there’s limited market overlap. In addition, Kaneka does not appear to have reached commercial scale in its PHA production.
Assuming a $18 share price, 103m shares (89m + 11.5m warrants + 2.5m 1st earn-out at $15) and ~$500m net cash (incl. ‘cash’ warrant conversion), Danimer will trade at ~25x 2022e ebitda of $54m (ebitda are earnings of the company, i.c. what the company makes after deducting fixed and variable expenses).
You might think that 25 times the earnings (ebitda) in 2022 is a lot, but if the company pulls it off, these earnings can grow >50% per year after that and the company will be worth much more than 25x. Given the very sustainable character of Danimer, its revenue visibility up 2022 and strong expected growth thereafter, I believe Danimer to be an easy sell and I’m betting LOAK/Danimer will reach $18 sooner rather than later.
With LOAK warrants currently trading at ~$2 (at the time of writing), there’s plenty of room to $6.5 or more in the near term. The business combination is expected to close “end of Q4, early Q1”.
Click here for the Danimer presentation.