There have been a lot of great questions regarding workouts over the past week of the Workouts Work Out In Down Markets series (beginning here). Some visitors jumped into the comments and posted free resources to track upcoming mergers, acquisitions, and going private transactions.
We all have that looming question in the back of our heads: Can I really make low-risk money when all these smart people are seeing the same deals and passing?
The Risks
First off, there is no such thing as “risk-free” – only risky or intelligent. (U.S. Treasuries are intelligent if they provide the best value for your money. They aren’t risk-free if the U.S. falls.) Intelligent investors, like smart poker players, bet big when the odds are in their favor, regardless of the actual outcome of any single move. How can you ignore a single loss and move on? Simple – only put your money in when the odds are in your favor. In the short-term, anything can happen; in the long-run, the odds say that you will make money.
That’s the point, right?
All Those Smart People
There are a lot of smart people putting money into the markets. Wall Street’s ultimate goal: make you feel stupid or scared so you feel compelled to give them your money to manage. And what have all of these smart people accomplished? When you consider that the large majority (upwards of 80% or 90%) have lost to the markets over time, it’s not necessarily a smart move to listen to them or follow them into and out of positions.
You don’t have to engage in workouts – especially if you are not comfortable with (or don’t have the time to invest in) ripping apart deals, reading reports and proxy statements, etc. That said, you are certainly smart enough to do so – and beat Wall Street in the process.
So, Why Don’t I Just Engage In Workouts?
Simple: Low-risk workouts, like underpriced, wonderful companies (Buffett calls these “generals”), are few and far between. When your generals are running up in price, your workout positions often struggle (or fail) to keep up. When your generals or the markets are dropping or doing nothing, workouts can help keep your portfolio afloat and compound your returns.
Engaging in workouts, however, is very time-intensive for a moderately small payoff. Add taxes into the mix, and you are getting very little for a considerable amount of work. So, is the payoff worth it? Well, if your job is to analyze thousands of deals and hundreds of annual reports each year, workouts are often worth the effort.
If you are casually investing for your own portfolio and only intend to spend a few hours a year on your investments, workouts may not be for you. (And don’t feel bad about it. Intelligent investing does not imply investing in ever deal available.)
Should I Use Margin On My Workouts?
Buffett has said:
When you combine ignorance with leverage you get some pretty interesting results.
If you are blindly speculating on workouts, you most certainly should not use margin. If, however, you are approaching each workout in a rational, well-researched manner, you may consider using leverage like Buffett mentioned in his January 1962 letter to partners:
I believe in using borrowed money to offset a portion of our workâout portfolio since there is a high degree of safety in this category in terms of both even results and intermediate market behavior…Oftentimes we owe no money and when we do borrow, it is only as an offset against work-outs.
A prime example of this (in my recent use) was the Tribune workout. On December 19, 2007 – just two days before the going private transaction was complete – Tribune’s CEO, Dennis FitzSimons, resigned. The market took that as bad news and pummeled the stock from $33 and change to $30 and change.
Had these “investors” bothered to read the details of the deal rather than look at price alone, they would have known that the CEO intended to step down when Zell took over. While the smart people were seeing turbulence and an upset applecart, I saw the tell-tale sign that the transaction was done and Zell was stepping in.
I tripled my position on Tribune using nothing but margin (though it still worked out to be less than 20% of the entire portfolio) and we were able to turn a 10% gain into a 30% gain.
So, should you use margin? Only if you know the deals inside and out and can act quickly and decisively when noise creates opportunities.
There’s A Class Action Lawsuit Against On Behalf Of The Shareholders!
There’s almost always a class action lawsuit filed the second a workout transaction is announced. That’s why companies cover their bases by bringing in outside analysts to determine a price and by shopping the deal to a number of buyers.
If the steps are followed properly (they often are) and a majority of shareholders approve, the class action lawsuit is little more than a shot-in-the-dark advertisement for the filing attorneys.
Why Do I Keep Missing Out? The Premium Dries Up Too Quickly!
When looking for workouts, look to find deals that were announced more than six months ago. Recently announced workouts have a long way to go before closing. The “older” ones are approaching their closing dates and, as often happens, have likely been forgotten by Wall Street.
Remember, on Wall Street, yesterday’s news is old news.
Is This Deal Too Good To Be True?
From time to time, the markets overlook a “done deal” and you have the opportunity to make a handsome return. You simply need to know why the deal might be grossly mispriced. Is the transaction too small for people to notice? Is there something hiding in the deal that adds risk?
Though the majority of workouts have the potential to provide a consistent return, you may run across a grossly mispriced workout from time to time. Remember: the transaction, not the price, is the tool.
Well, that’s the skinny on workouts. I know – there are a ton of unanswered questions looming out there. You have to remember that investing is both art and science. There is no universal checklist to analyze all workouts, just like there is no universal spreadsheet to analyze all companies (even though they may be floating around).
You have to look at each company and opportunity. The formula is always the same; still, the input will greatly affect the output.
Filed under: Workouts, Arbitrage, & Hedges
I read here that RTSX was valued at 1.1 billion, which would be about $46.43/share:
http://www.news-press.com/apps/pbcs.dll/article?AID=/20080106/NEWS01/801060351/1002
So Vestar should be incentivized to complete the deal.
Anyone know if Vestar is likely to experience problems with financing?
It seems like the recent .75% rate cut would increase the attractiveness of completing this transaction to Vesmark.
I also read (in the NYTimes) they they have a $40 million reverse termination fee. It sounds like these Reverse termination fees are standard fare, and this would not portend anything negative about the likelihook that Vestar would back out.
What’s your take on that Joe?
( REPLY )
Marc: I owe you an e-mail and I promise I’ll get it out this week.
david: The financing was already arranged and the termination fees are significant compared to the size of RTSX. Vestar may back out (that’s the risk of the arbitrage), but there have been no reports of sales from RTSX insiders, Vestar people, or other major holders since the regulatory approval.
RTSX wants this deal to go through. As such, the backing out would likely come from Vestar, if at all. In that case, RTSX would be entitiled to the termination fee – a significant amount of money considering the company’s size.
( REPLY )
Joe,
I’m learning, so please excuse the question if the answer is common knowledge. It seems like pre-merger regulations address large deals more aggresssively than small deals. I am wondering if small companies and buyout firms are sometimes motivated to keep the stock price low until shortly before the deal closes. Wouldn’t it be advantageous for the buyout firm and employees of the acquisition target to buy up cheap shares so: 1) The buyout firm spends less (fewer outstanding shares to buy) at the closing and 2) employees of the acquisition target benefit from arbitrage spread. Next, since this is a small company: most of the news / press about the deal comes from the buyout firm and / or the acquisition target. Aren’t these companies motivated to deliver the worst pre-merger news possible: thus scaring other investors to sell cheap before the deal closes?
I’m asking these questions based upon a current example: Image / BTP / CT1.
Since Friday I’ve seen a bunch of “he said / she said” press releases about pre-merger information exchange disputes and other items that I doubt these companies are required to report. Neither firm has announced the deal is definitely off, but these press release have driven shares down ~60%. What else, besides buying up cheap shares, motivates professionals to air their playground disputes in public?
( REPLY )
Personally, I would look at these public disputes as more of a problem than just noise. If these companies are, in fact, trying to publicly manipulate the price lower so they can aquire more shares, the SEC will gladly throw the executives in the clink. Though there is a small minority of people that might try this, the large majority of public disputes are more of a sign of a failing deal than a market manipulation.
Taking a look at the filings for Image and BTP, I see no buying or selling. Because of BTP’s stake/control in the company – 41% – BTP would have to announce any purchases or sales within two business days. The fact that they haven’t means one of two things:
- They are trying to get financing and still want the deal to go through; or,
- They are going to breach, pay the fine, and move on.
One of the problems with this workout is the following, taken from SECTION 5.13(a) of the AMENDED AND RESTATED AGREEMENT AND PLAN OF MERGER:
Parent shall use its commercially reasonable best efforts to obtain the full amount of the Financing on the terms and conditions described in the Revised Financing Commitments delivered to the Company by Parent; provided, however, that in the event that any portion of the Financing becomes unavailable on the terms and conditions of the Revised Financing Commitments, Parent shall use its commercially reasonable best efforts to obtain alternative financing…
I have a problem with this language simply because it says, “Hey, we’ll try and get financing for this, but no promises.” There is also the question of a weak termination fee. The $1.5 million termination fee says, “We don’t have any financing in place, and we can’t promise anything. If we can’t get the deal done, we’ll compensate you for your time. Otherwise, we don’t want to be on the hook for anything.”
Why would they air their dirty laundry in public? By law, they have to keep shareholders informed of any material changes in their business, in the agreement, or in the transaction. Though they do not have to tell you what is happening every day, they do have to inform you of any material matters that might affect your decision to remain or become a shareholder. A failing merger would be considered material.
( REPLY )
Hello,
Looking at the Nokia-Navteq deal, I’m wondering what’s left to be done before the deal closes? Shareholders of both companies agreed with the $78 per share offer, the CFO of Nokia said the financing has been secured (noting that Nokia has enough cash to get the deal completely done without financing), the FTC approved, the deal is expected to close in Q1/08, and the shares of navteq are still trading at around $74… Done deal? Can we know the exact closing date?
Regards,
Math
( REPLY )
Night:
I’m pretty new to the value investing game, but I think I really get it.
You want to thoroughly review the investment. Then, if you look at the price and it seems like the price is low to the point where you really can’t see how it could be so low, then you a) thoroughly review your investment again, and then b) buy.
Example:
I bought RTSX at 27.00, which would give me almost exactly a 20% return if the deal goes through.
If the stock were to hit 30.87 (5% from the takeover price) and we were still more than 1 week from the deal, I would probably sell. Even if I wouldn’t sell, I definately woulnd’t buy more at that price.
( REPLY )
Hmmm..awesome! *heads to the gym to make some money*
I will definately be keeping an eye out for good workout opportunities with the resources people linked to & wherever else I might find a deal. I’m excited.
Thanks for the posts, keep more good stuff coming!
( REPLY )