The Rundown – Your weekly SPAC Deep Dive (09/12/21)
There’s been a lot of buzz surrounding the SPAC merger between VPC Impact Acquisition Holdings (VIH) and Bakkt Holdings. The deal was announced earlier this year, with the transaction valuing the combined firm at $2.6 billion and providing $574 million in gross proceeds. Bakkt enables customers to store and trade digital assets like cryptocurrencies, loyalty points, gift cards, in-game assets and digital currencies.
Bakkt is hoping to differentiate itself from other fintech platforms that have gone public recently like Robinhood and Coinbase by showing that is backed by experienced leadership. Intercontinental Exchange is the primary backer of Bakkt, with an 80% stake in the platform. For those unfamiliar, Intercontinental Exchange is a behemoth and operates 12 regulated exchanges around the world including the New York Stock Exchange, ICE Futures Exchange and OTC energy, credit and equity markets.
Despite details continuing to trickle out, there are several lingering questions that remain unanswered. What led to a 30% spike in the stock price earlier this week? Is there potential to make a risk-free bet in the short term? What’s the long term value of the stock, given that there is significant cut-throat competition? Let’s look at it one step at a time.
Earlier this week, a Reddit post reported that the total short interest for VIH was exceedingly high, given that the current shares outstanding are substantially low. Bears shorted the stock successfully from $22 earlier this year to under $10 recently. With a recent post on r/Wallstreetbets, traders have speculated about a substantial opportunity to reap profits through a short squeeze before deSpac and also estimate substantial value creation in the long run through solid underling fundamentals.
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Short Squeeze Opportunity
A SPAC redemption process involves shareholders/PIPE investors redeeming their shares for their full Net Asset Value (NAV), which is $10 in this case before the General/Special meeting is conducted. The VIH-Bakkt general meeting is now only a few weeks away and will likely happen by the end of September/Early October.
VIH stock only has a float of 19.5 million shares but is one of the most heavily shorted stocks with 7 million shares currently shorted (40% of Float). Furthermore, the short isn’t hedging activity from current PIPE investors as they are barred from shorting. Shorts have done well so far as the shares have sunk from $22 to close to $10 currently. Bears continue to bet against the company and believe that once Bakkt completes its deSPAC, the shares would face pressure from PIPE holders hedging to mitigate any potential losses from the transaction.
But the problem with shorting after a deSPAC is that short interest is then a larger pool of the shares that are left after redemption since some investors will choose not to redeem. If there’s buying pressure around the stock, it can trigger a technical short squeeze, where shorts will have to scramble to cover, resulting in a massive spike in price due to the low float. But on the other hand, if shares are trading substantially above the $10 price, redemptions will likely be lower, resulting in lower absolute returns. Despite this, the momentum in the current stock may result in shorts getting squeezed out the old fashioned way.
There are two key indicators that investors should be aware of to take advantage of the situation. First, if shares fall below $10 before the redemption date, its a strong buy as shares can be redeemed for NAV even if there is no short squeeze, resulting in a risk-free transaction. Second, if large quantities of shares are redeemed by investors, the float will substantially shrink, resulting in higher short interest and shorts being squeezed out. In this case, potential investors should look at redemption data before piling onto the short squeeze.
Redefining the Future of Commerce
Looking at the long term opportunity for the stock, we should look at Bakkt’s core business to understand the value drivers. With the recent advancements in decentralisation, it is now more feasible than ever before to turn things into a trustable digital assets. The trend has sparked the creation of hundreds of utility tokens, meme coins, digital art and NFTs. Bakkt may be a key player in the Defi revolution moving forward by monetising all forms of digital assets. Management believes that the future of commerce will involve all forms of digital payment, which includes traditional fiat currencies, cryptocurrencies, digital assets like NFTs & in-game assets and reward points.
A key strategy for building stickiness into the product offering involves various loyalty programs that will play a big role in consumer spending. Digital loyalty programs ensure that users end up spending more and strengthen the trust between merchants and customers. For consumers, this will be an opportunity to earn crypto as well as merchant offers, loyalty points and gift cards. Expanding the definition of loyalty programs and going digital will further benefit the entire ecosystem as plastic gift cards can go unused, resulting in liabilities on the balance sheet of merchants for years.
Part of the company’s goal is to monetise the potential $2 trillion crypto capital into spendable assets. While there is regulatory uncertainty around lending crypto for interest with the recent Coinbase-SEC feud, it certainly remains in the realm of possibility in the future. For now, Bakkt is prioritising cryptocurrency transactions and storage and may introduce other features later. Apart from cryptocurrencies, the company wants to be a one-stop solution for all digital assets, including loyalty points, reward points, on-chain assets, NFTs, gift cards and digital currency. This can be a virtuous cycle, as merchants adopt more forms of digital assets, they expand their customer’s spending power, which in turn helps power commerce itself.
Value Proposition Hangs in the Balance
While the transaction values the firm at $2.6 billion, movement in the stock will primarily be determined by the execution of the team. Management has set out lofty projections, with $515 million in revenue and more than 30 million active users by 2025. While these targets are attainable, there are a few key assumptions that need to fall into place for the numbers to make any sense at all.
Bakkt is assuming that the Average Revenue Per User (ARPU) will go up from $10 in 2020 to $210 by 2025 (After Accounting for Transaction-Based Expenses). Given that the company already undercuts Coinbase and Square when it comes to cryptocurrency transaction fees, it might be difficult to active such high ARPUs over the next five years.
Based on the revenue projections, Bakkt stock is currently trading at 5.2x FY25 revenue multiples, which is quite steep compared to the established competition. By comparison, Square is trading at 10x FY21 revenue, while Robinhood is trading at 25x FY21 revenue. Both companies also have a substantially larger active user base. (Robinhood – 21 million, Square – 36 million).
Bakkt is assuming aggressive user acquisition growth, with estimated active users rising from less than a million in 2020 to 31 million users. While this is possible, the company faces steep competition from Square, Robinhood and Coinbase, who will all aim to capture a larger piece of the pie of a hotly contested market. The data indicates that it will be a challenging task for Bakkt to become the market leader any time soon.
There are both short and long term Opportunities for investors who are looking at the current VIH-Bakkt deal. In the short term, as a result of the massive short interest and relatively small float, there’s a high probability of a short squeeze after share redemption numbers are out. Furthermore, Bakkt has several good ideas to redefine the future of money and the long term value of the stock will firmly depend upon the company’s ability to execute its ambitious targets.