Nikola's surge puts power in company to force warrant call
As Nikola Corp. watchers wait to see how many pre-orders the company can rack up for its Badger pickup truck, a different countdown is set to begin for investors.
The upstart company trying to compete with the likes of Tesla Inc. filed a registration statement with the Securities and Exchange Commission early last week. When that filing is declared effective, a timeline will be set in motion that would allow Nikola to force investors to redeem outstanding public warrants early. The registration, declaration of effectiveness and forced early redemption are events with the potential to weigh on shares -- building tension between the company and warrant holders, and drawing a taut line between Nikola fans and short-sellers.
Attention on Nikola has been intense with its stock more than doubling since its merger with blank-check acquisition vehicle VectoIQ on June 4. The shares are a particular darling of the commission-free day-trading set, raising questions about how much of its quirky structure is understood by newly minted retail stock dabblers.
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Shares of Nikola have “taken on a life of their own," said George Kaufman, investment banking head at Chardan Capital Markets. “Volatility in the shares isn’t related to fundamental changes in the business."
One lens into the pressures surrounding the stock focuses on publicly traded warrants that were a part of equity units sold at VectoIQ’s public debut. Once a registration statement governing the warrants is declared effective, it becomes possible for holders to give the company $11.50 to get one Nikola share.
Both Nikola’s stock and warrants fell roughly 11% on Friday as of 3:45 p.m. in New York. Still, with warrants trading freely at $32, and incorporating the $11.50 exercise price, owning a warrant would seem to leave a lot of potential profit with shares currently trading at around $64. The gap between the two shows the stock’s stomach-churning volatility and the risk something happens to it between now and when the warrants are exercised.
The prospect of the warrants being declared effective may be one of the factors behind that gap. Already skittish after such a powerful rally, Nikola holders have shown themselves sensitive to the potential for fresh stock to hit the market.
Investors should expect a “near-term pull-back," as the price discovery process is underway and the volatility seen in shares following its SPAC merger is “illustrative of the challenges involved," JPMorgan analyst Paul Coster said in an initiation report earlier this week. Coster has a neutral rating on shares and a price target of $45.
“In the very short term, we believe registration of the SPAC Warrants could lead to sale of about 30 million shares, and share registration should enable shorts to borrow stock, countering the effect of recent retail accumulation," he said.
Wariness of that risk was on display in after-hours trading on June 15 when the registration statement was filed and shares fell as much as 12%, prompting founder and CEO Trevor Milton to explain on Twitter. That selloff was immediately reversed, with shares trading higher again within an hour.
As of Thursday, the registration statement had not been declared effective. The prospectus registered up to 23,890,000 shares of common stock underlying both public and private warrants. Nikola currently has 360.9 million shares outstanding, with about a third of that freely available to trade.
In response to queries about the possibility of forced warrant redemption, a company spokeswoman in an email sent Friday morning said: “Any such announcements will be made public when appropriate."
While bears have spent a lot of ink warning of the implicit danger of the warrant exercise, the possibility of it happening has never been a secret. Nikola’s shares have sat securely above $60 for nearly three weeks, even as discussion of possible dilution became common in chatrooms and other places where retail investors congregate.
Complicating matters, when the registration is declared effective, an event called a forced cash call can come into play, Chardan’s Kaufman said. If common shares close above $18 for 20 days within a 30-day period, Nikola can force warrant holders to pay $11.50 in cash per warrant in exchange for one share of common stock or surrender their warrants for essentially nothing.
“Short-sellers saw some relief and long-only investors saw some potential risk in the S-1 filing, believing the SEC would declare it effective quickly," Kaufman said. “In most cases, the filing and the effectiveness of said filing can put downward pressure on shares, which may not be temporary." Chardan was among the underwriters of the VectoIQ SPAC IPO that resulted in Nikola.
In effect, the sustained rally in Nikola shares puts power in the company’s hands to call the warrants once the SEC green-lights its registration statement and hurdles are met.
“Generally, a holder would want to hang onto the warrant rather than exercising it, so the ability to force the exercise is a pro-issuer provision," Carol Anne Huff, co-head of Arnold & Porter’s capital markets transactions practice, said.
From Nikola’s perspective, a forced cash warrant exercise would give the company an injection of additional capital, but a short squeeze could make that kind of forced redemption trickier to pull off. Stock borrow fees spiked to a high of more than 700% last week due to a lack of shares to loan out, S3 Partners’ Ihor Dusaniwsky said. And shares remain at lofty levels. Those who are hedging their warrants would be short the underlying common shares.
If shares continue to run, the company could alternatively force holders to exchange the warrants for a reduced number of shares without requiring a cash payment, or just leave the warrants out there. Richard Branson’s Virgin Galactic Holdings Inc., whose shares also shot skyward after its public debut via a SPAC merger, did a cashless redemption. Virgin’s warrant holders received 0.5073 of a common share for each warrant surrendered.
Nikola can decide to take the dilution for no cash, which could result in warrant holders who fully hedged their position being short more shares than they would receive upon a cashless exercise. This could result in them having to top up in the public markets, exacerbating any short-squeeze, Kaufman said.
That would also open up the possibility for an additional equity offering, which, assuming shares stay aloft, could fetch more cash per share.
“Why use the cash call when there is a battleground between the shorts and longs, with the shorts losing? That’s a fair question," Kaufman said. “This could be one of the instances where not forcing the cash out of these warrants has merit, but that would be a middle finger to warrant holders, many of whom are or were regular shareholders before the run-up."