Breaking down the ridiculously complex $PSTH / $UMG transaction

It’s happening.

A few days ago, I called UMG my #3 most likely deal target for PSTH. When I wrote that article, a lot of the pieces for a UMG deal fit with what Ackman was saying in interviews, but the potential for a UMG / PSTH deal still left me kind of cold.

Last night, news broke that PSTH was in late stage talks to take Universal Music Group (UMG) public by buying a 10% stake from Vivendi (VIV). They confirmed those talks this morning, while also announcing that the deal would take place in one of the most complicated transactions I’ve ever seen.

Right on the heels of the UMG / PSTH news breaking last night, I hosted a space with Sleepwell Capital and Steven Wood from Greenwood. Both of them know tons more about UMG and the music industry than me (check out Sleepwell’s piece on music royalties, and Steven’s fantastic BOL / ODET note is what first put the tea leaves together for me that UMG might be the deal), so I learned a ton from that space (honestly, the biggest takeaway from the UMG / PSTH deal for me might be the reinforcement of how valuable Twitter is / how much upside the company has as they continue to execute on products like Spaces that tap into the power of Twitter’s network!).

I’m going to do a blog post summarizing a lot of the thoughts and takeaways from that space in the near future, though I will give you a quick summary: I think this is a good, not great, deal for VIV and PSTH; I think it’s a grand slam for Pershing (PSH, the sponsor / Ackman’s fund) and particularly Ackman. Why?

  • For Vivendi: Their minority shareholders were going to get hit with a huge tax from spinning off UMG; selling a portion to PSTH lets shareholders dodge some of that tax while also fueling Vivendi with a lot of cash to buyback their shares post-spin. In addition, having Ackman on board means the stock will probably trade better post spin, as all of the Ackman copycats pay extra attention to UMG.

  • For PSTH: this is a reasonably attractive deal. They’re buying UMG for ~21x EBITDA. WMG, their best comp, trades for ~20x. However, UMG is a better business than WMG (UMG is a bigger label with a better catalogue and it’s growing faster), so it probably deserves a premium to WMG. In addition, WMG is a controlled company with a dual share class structure (only ~25% of their shares float, and the float is entirely the low vote shares), so WMG probably trades with a couple of turns of multiple discount due to their governance. Put the two together, and I think you could easily argue that if WMG is trading for 20x a fair multiple for UMG is in the 25-28x EBITDA range. Ackman / PSTH are buying UMG at 21x, so they’re getting a nice discount to fair value in exchange for helping solve VIV’s tax problem and lending Ackman’s shine to the deal.

    • That’s just relative valuation of UMG versus WMG. You can make a similar argument on absolute valuation. UMG is a dominant business with great revenue visibility, very long lived cash flows, and basically no capital intensity. They also have a tailwind from most of the trends in society / markets right now (as streaming music proliferates more, UMG benefits, and they get paid every time someone puts one of their songs into a Tik-Tok video!). To pay ~20x EBITDA for a business with those characteristics seems like a very good deal in an absolute sense!

  • For PSH / Ackman: I think it’s pretty clear what happened with PSTH. Remember that Ackman filed to raise PSTH in late May 2020 and they IPO’d in July 2020. At the time, Ackman was on the heels of having absolutely nailed the COVID trade (buying credit swaps when the market wasn’t prepped for COVID, then selling them at a mammoth profit at the peak of fear). While the market wasn’t in full panic mode in late May 2020, the future was still incredibly uncertain; plenty of people still thought we were going to go into a depression from COVID, and many people thought getting a vaccine by the end of 2021 would be optimistic. So Ackman raised that money at an absolute high, thinking he could go after a unicorn that had been hit by COVID (AirBNB was his first target and hits that thesis perfectly). But then the market rallied furiously, and cheap cash was available in near unlimited quantities to basically every company. No one wanted to take Ackman’s money; there was cheaper money with less strings attached floating around everywhere. It’s now been ~a year since PSTH IPO’d; PSTH had a two year life, so if Ackman couldn’t find a deal within the next year all of PSTH would liquidate. This UMG deal solves all of Ackman / PSTH’s problems. He’s getting UMG at a good price, and the business is likely to do well over time, so he’s not destroying his reputation doing this (remember, one of the unique thing about PSTH is they have no traditional promote; Ackman / PSH can only make money if the stock goes up over time. Buying UMG positions him for that and doesn’t burn any of his credibility like buying a super hyped EV company and hoping for a quick pop would). More importantly, PSTH will have some cash left over, which will go to PSTH remainco. PSTH remainco will effectively be a cash shell with no liquidation date. That’s incredible for Ackman; he can keep this cash shell in reserve and pounce when a big opportunity comes up. Remember that Ackman made some of the literal greatest investments in history during the last two crisises (GGP during the financial crisis and the credit swap trade during the pandemic); PSTH remainco guarantees Ackman will have cash available to deploy during the next crisis, whenever it may be. (PS I enjoyed Matt Levine’s take on this as well).

    • I think this deal is also good for Ackman because it partially proves out his SPAC franchise. UMG is a giant company, and PSTH / VIV worked together to strike a deal that worked for everyone. Going forward, Ackman can go to any seller who has really complex tax / ownership structure issues and say, “I worked with VIV for 7 months to unlock UMG. I’m willing to work with you as long as it takes; we’ll find a deal that works and creates value for both of us.” He’ll still have issues putting money to work, but at least now he’s partially proven out the PSTH SPAC thesis and has increased his optionality for raising a chain of SPACs in the future.

Anyway, those are my initial thoughts on the deal. They may change over the weekend or as I digest the deal more.

But, for now, I just wanted to get a quick post down discussing the deal’s structure. Why?

This is one of the most complicated deals I’ve ever seen. Between PSTH’s options chain and the fact VIV (which owns UMG) is publicly traded, I am positive there are some really interesting trades that could be made from the first people to figure out the complexities of this trade. If you’ve thought through the trade and have any differing or quirky views and want to swap thoughts, please feel free to reach out.

Let’s start with the basics of the deal; I’d encourage you to check out the press release and verify the facts for yourself, but the headline for the deal is:

  • PSH will buy $1.6B of PSTH. PSTH has $4B in trust, so their cash balance goes to $5.6B

  • PSTH will use $4.1B of that cash to buy 10% of UMG for €35B

    • Just to make the math simpler later, that’s ~73% of PSTH’s $5.6B in cash. So PSH’s share of that $4.1B is ~$1.2B, while minority / core PSTH’s share was ~$2.9B.

  • PSTH will hold on to those UMG shares; after VIV lists / spins of UMG to their shareholders (on the Euronext), PSTH will similarly distribute its UMG shares to PSTH shareholders.

  • PSTH has ~$20/share in trust; shareholders will be given the option to redeem their shares and get $20/share back.

  • The UMG deal will cost ~$14.75/share in cash, so shareholders who do not redeem will receive their shares of UMG (which cost $14.75/share) plus have an interest in the remainco with $5.25/share left in trust.

  • If you don’t redeem, you will also get a 5-year right (a “SPAR”) that will trade on the NYSE

  • If you don’t redeem, you will also get your tontine warrants plus you and anyone else who doesn’t redeem will get to split up the tontine warrants from the shareholders who do redeem (I tweeted out last night how tontine warrants work, but I’d encourage you to read the prospectus to see the exact mechanism for yourself!). Importantly, the deal will be structured so that the tontine warrants (and the sponsor warrants) do not have any claims on UMG (per the PR: “As the Transaction is structured as a stock purchase and not as a merger, the Redeemable Warrants and the Director and Sponsor Warrants (collectively, the “PSTH Warrants”) will not become exercisable for shares of UMG.”).

  • If you hold the non-tontine warrants (the warrants that are freely tradeable right now), PSTH will hold an exchange offer for them.

  • PSTH will also distribute a “SPARC” to each PSTH shareholder who doesn’t redeem. Basically, a SPARC is a right that will trade on the NYSE. Ackman will try to find a deal, and he’ll bring the deal to SPARC shareholders. If they like it, they can exercise their right and buy into the deal effectively at cost. If they don’t like the deal, they can sell their rights or just let them expire worthless. If all SPARCs are exercised, the SPARC would raise $5.6B, plus Pershing (PSH, Ackman’s investment vehicle) has committed to buy $1-5B of whatever deal SPARC announces. So, assuming all SPARCs exercise (a big assumption I’ll address in a second), SPARC will have $6.6-$10.6B to offer a potential merger partner.

Whew, that’s a lot. It speaks to how crazy this deal is that I did 9 bullet points above and I’m worried I missed something! Again, it’s probably the most complicated transaction I’ve ever seen; in fact, it’s so complicated that I wonder if the SEC is going to be cool with this structure or if they’ve already blessed it. The SEC rejected a somewhat similar structure earlier this year when they turned down a “Spinning Eagle” SPAC. I asked Bill on Twitter; I’ll let you know what he says!

Anyway, there are a lot of complexities to this, but a few immediately jump off the page. The main one is the treatment and valuation of the SPARC right.

Obviously, a right has value. If Ackman manages to find a homerun of a transaction, the rights could be incredibly valuable. For example, say he announced a deal to buy Bloomberg for a $20B EV. Bloomberg’s probably worth $100B, so that deal would be a homerun and the rights would be incredibly valuable.

But if we’ve learned anything from original PSTH, it’s that finding a multi-multi billion dollar transaction that you can create value from is difficult. There are a lot of investors looking to put big checks to work in the world’s best businesses; given Ackman’s return criteria it’s unlikely he’s going to be the lowest cost dollar for any of the potential companies he’s looking for. That makes finding a deal really difficult.

Plus, SPARC is going to be negotiating with an unknown cash balance. How does SPARC go to someone and say “hey, do a deal with us, we’ll deliver an unknown quantity of cash to you depending on how many of our shareholders redeem?” That’s a tough deal to structure; I guess the solution is PSH just backstops the whole thing (i.e. PSH will write up to a $5B check, and if all SPARC options are exercised SPARC would raise $5.6B, so PSTH could just structure a deal around delivering $5B minimum and then upside from low redemptions is a cherry on top). Still, it’s a strange structure. The time Bill is most likely to find a really good deal is during a period of distress; given SPARC will not have any actual cash but just a call to shareholders to exercise their rights for cash, he might find it difficult to structure a deal in times of distress since the ultimate cash level is unknowable.

So SPARC is one weird thing about this deal…. but trust me, there are plenty of others.

A relatively simple one to start: the PR makes clear that VIV is spinning / listing UMG on the Euronext. PSTH spins their shares after UMG is listed on Euronext…. so where will those spun off shares trade? PSTH trades in the U.S. (obviously), so will the spun shares trade in the U.S.? Or will they be spinning off UMG’s European shares to a largely domestic shareholder base? That later seems like a recipe for a lot of confused shareholders and forced selling, while the former is…. just strange? UMG is choosing to list in Europe; why would PSTH force a domestic listing on them and why would UMG agree to that?

Let’s talk about the tontine warrants. The press release makes clear that the warrants will not apply to UMG. What happens to them post deal? I guess the company is going to restrike them to a more reasonable level (they’re currently at $23.50, and remainco will have $5.25 in cash, so they need to come down a lot on the strike or they’re worthless). But it’s still pretty strange; it’s not what shareholders signed up for.

There are a lot of other weird things here. For example, the language on the warrant conversion seems almost intentionally confusing. But I think I’ve hit the main ones.

I want to turn to a few other lingering questions I have on the heels of this deal.

First, I tweeted this out, but an original version of the FT article on PSTH / UMG said that Ackman raised his bid for UMG on Weds. The updated version dropped that language. I will be very curious to read the proxy background; remember that in his WSJ interview Ackman said he’d been in talks since November and valuation was not the hold up. Either FT had bad sourcing and pulled it, or Ackman was lying. The implications of either is interesting, but I’ll hold judgement until the proxy comes out.

Speaking of proxy, I don’t know if there will be one. The UMG deal was structured to take place without a vote. I’m really confused by the entire set up of this deal. It’s very different than a typical SPAC structure, and it seems to take a lot of liberties with the structure. A SPAC is supposed to raise a bunch of cash, look for a deal, and then complete a deal or liquidate. In this case, Ackman is using a SPAC to turn into a permeant cash shell. I’m curious if this whole structure has been blessed by the SEC already, or if Ackman is just assuming anything goes after Elon completely defanged them. I’m also just curious about that warrants: the warrants are given to SPAC shareholders to give them upside in a good deal, but they will get no access to UMG. How is that right? Yes, the distributable warrants can be exchanged as part of this deal, but ~75% of PSTH (the original SPAC’s) value is going to buying UMG shares, and all of those tontine warrants have no upside from UMG. I’m not sure how anything about that structure is ok; it seems ripe for a shareholder lawsuit (not legal advice; pretty much everything is ripe for a shareholder lawsuit these days!).

The last thing I want to discuss is opportunities on the heels of this deal. I’ve been saying for a long time PSTH’s options chain was wildly mispriced given the potential to “get reverse DVMT’d” as well the incredibly high volatility. The market appears to have picked up on that today, as volatility across the board for PSTH has collapsed. Still, I wonder if there’s some opportunity in the options chain as it’s hard for me to imagine the chain can adjust for a transaction this insane / complex (i.e. how will call options pick up SPARC, the tontine warrants adjustment, etc).

But the real opportunity here might be in PSTH remainco and PSTH SPARC. Remember, Ackman has an absolutely incredible track record of deploying cash in times of a crisis, and both remainco (which seems to have no end / liquidation date) and SPARC (a five year SPARC with the potential for extensions) give him a bunch of permanent cash to deploy into a crisis. It also appears that Ackman’s incentives will be tilting a little heaving to remainco than to UMG; PSH will own 29% of Remainco (remainco will have $1.5b in cash, so PSH’s share is ~$435m) as well as a forward purchase agreement that gives them the right to buy another $1.4B of remainco, PSH will be committing at least $1B to SPARC plus getting convertible prefs that will give them more upside, and the treatment of the Sponsor/Director Warrants on original PSTH is unclear but might just transfer to remainco. I’m not saying PSH isn’t incentivized to do a good deal w/ UMG, but overall PSH is investing ~$1.17B into UMG (see math in bullets above). UMG is a reasonably steady business with great cash flows. PSH can put ~$1.2B into them and sleep really well at night, and then they can go look for even better deals with the rest of their remainco / SPARC exposure (where they’ll get more of the economics and have bigger upside).

Anyway, I think I’m going to wrap this article up here. I’ll probably do another article in the near future building off why I think the UMG deal is a good transaction for everyone (and building off some of the knowledge Sleepwell Capital and Steven Wood dropped in our space last night!), but I wanted to get this out there since the deal is insanely complex and I’d love feedback if anyone is looking at / thinking about this differently.