- You need to do your own research. Analysts often drop coverage when special situations/corporate actions arise and they do not cover smaller market cap names
- In the stock market invest in only what you know best. The penalty you pay for having a focused portfolio (slight increase in annual volatility) should be outweighed by your increased long term returns
- Past price movements are not an accurate representation of a stock’s true risk
- “Look down, not up” when making an investment decision because if you’re not losing money the alternative is attractive (making money)
- Corporate actions are usually short term events and there could/will be tax implications when making short-term investments
Spinoffs and Rights Offerings
- Historically spun-off companies have outperformed their peers by over 10%.
- Spinoffs can qualify as a tax free transactions for businesses with low cost basis
- The spun-off stock is given for free to existing shareholders and these shareholders usually sell, depressing the price resulting in attractive investment opportunities. Many entrepreneurial changes kick in and both the parent and spinoff see market appreciation by the second year
- Spinoff’s with large debt loads offer attractive leverage opportunities if their assets begin to appreciate
- Proxy material and Form 10 (small spinoffs) provide material like pro forma financials and management compensation for companies to be spun off.
- Investing in parent companies that are free of complicated divisions can be successful and lead to other investment opportunities
- Partial spinoffs occur when only a portion of a specific division is sold to the public. The rest of the ownership is retained by the parent company.
- There are better opportunities investing in partial spinoffs when stock is given to current shareholders than when the partial spinoff is distributed via an IPO. This is because investors must bid for IPO share while they are often distributed for free to existing shareholders
- When a parent retains partial ownership this allows investors to assign a value on the partial spinoff and parent company (spinoff – parent market cap = core business)
- Investors can purchase the parent while simultaneously going short the partial spinoff to directly invest in the part of the business they want to
- Knowing when and where management incentives are priced (strike of stock options) can help uncover value in spinoffs and determine the amount of publicity given to a spinoff
- Whenever a rights offering is used to distribute shares in a spinoff this is usually a good investment. This is because unlike a normal rights offering there is no guarantee the spinoff will trade above or below the purchase price set in the rights offering. Management does not need to guarantee the highest price for the spinoff as it is fairly distributing the shares to rights holders
- Oversubscription privileges allow rights holders who purchase rights in an offering to buy additional shares on a pro rata basis.
- If a rights offering is structured properly shareholders are only taxed based on the value of the rights received
- Firms can choose to limit the number of shares in the spinoff effectively creating a higher share price in an attempt to dissuade certain investors (Liberty Media). The remaining rights not exercised by investors would be purchased by TCI as preferred stock at a low interest rate and with terms very attractive to Liberty Media. This allowed them to lever-up at a very low cost and made the deal even more attractive for investors. Executive ended up exercising all of their available rights, the stock split a year later which increased liquidity. Investors who exercised their rights made a fortune.
Merger Arb and Merger Securities
- Often the risk-reward profile of merger arb does not make it an attractive investment. Timing is very important and competition in the space is fierce. Arbitrageurs attempt to lock in their spread by shorting the purchasers price by the amount of the offer and then covering their short with the shares received from the merger. However a number of factors can cause this trade to sour.
- Investing in other merger securities like preferred stock and warrants can be a solid investment. These securities are often sold immediately by skittish investors creating buying opportunities for the diligent investor. Read the proxy material in order to understand the different payout features of merger securities.
Bankrupt securities
- The risk reward payoff does not make sense when investing in the common stock of bankrupt companies. However other bankrupt securities, like bonds, bank debt, and trade claims could be wise investments.
- Bargains appear in the newly issued stock of companies emerging from bankruptcy as investors who held more senior securities sell-off the equity they were given
- Always invest in companies with attractive businesses. This will provide a sort of margin of safety when investing in post-bankrupt securities
Selling
- Trade the bad ones, invest in the good ones
Restructuring
- Look for situations with limited downside, attractive businesses to restructure around, and an incentivized management team
- Make sure the magnitude of the restructuring is significant relative to the size of the total company
Recapitalizations
- Companies lever-up their balance sheet in order to make a tax-friendly distribution to shareholders
- Stub stock refers to the common stock of a corporation trading after a recapitalization. Although the debt-load increases risk for investors the combined value of the new security from the debt-load and the stub stock is usually more than the market value of the equity pre-recapitalization
- Investing in stub stocks can provide very generous returns. More profit is distributed to shareholders as fewer taxes are paid (interest on recap securities is tax deductible) the result is any incremental operating profits provide a leveraged increase in payout to shareholders.
LEAPS
- Long expiration option contracts allow investors to make a leveraged bet on an underlying security
- Sometimes LEAPS don’t initially price in special situation events which leads to extraordinary returns when these events occur
- Warrants are issued by the underlying company and have even more time to expiration than LEAPS
SEC Filings
- 8K – filed after a material event occurs
- S1, S2, S3,and S4 – filed when company issues new securities
- Form 10 – Spinoff distribution
- Form 13D and 13G – Owners of 5% or more must disclose holdings and intentions with stake
- Form 14D-1 – Tender offer statement
- Schedule 13E3 and 13E4 – Going private transaction
Related Book Notes
