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Feb
6
In Workouts Work Out In Down Markets — Part 3, I discussed another workout opportunity in the acquisition of Radiation Therapy Services (RTSX) by Vestar Capital Partners in a going-private transaction. The deal was pending shareholder approval and customary closing conditions. Since that post on January 21, 2008, the price fluctuated quite considerably and shook the nerves of a lot of holders.
This is a prime example of why you should use price as a tool, not a guide.
In the eleven trading days since I wrote that story, the price of RTSX has fluctuated wildly — from as high as $30.02 on the 22nd to as low as $26.58 a week later. This 11% drop shook holders and many people began second-guessing their positions. To truly understand this psychology, one need not look much further than the Yahoo! Finance message boards for RTSX. Some visitors were steadfast; some were terrified because the price was moving for no "apparent" reason.
In reading the merger agreements and SEC filings, we found that management controlled more than 40% of the outstanding shares (and had committed to voting in favor of the transaction), that financing was all but guaranteed, and that little stood in the way of this transaction, save the customary class action lawsuits and final shareholder approval.
At today's special meeting to approve or dismiss the transaction, 99.7% of the outstanding shares voted in favor of the merger, and it is now expected to close on February 21, 2008. Of course, that sort of super-majority wasn't required; we needed just 10% of the outstanding votes to agree with management's 40+% affirmative vote.
Today's Price and Tomorrow's Expectations
The above announcement was made at 5:55pm EST, nearly two hours after RTSX closed today around $28. It will likely open and trade close to $32.50 until the close on the 21st, and the premium will probably remain gone throughout (though I'll be watching it to double-dip).
Use Price as a Tool, Not a Guide
What happened when the price kept dropping? I bought more, even buying some shares on margin. Why? Simple — I used price as a tool to profit, not as a guide to influence my decisions. Regardless of whether RTSX was trading at $30 or $25 this morning, the terms of the deal were the same, and were contingent on a small number of shareholders voting for the transaction.
What happened to the price of RTSX over the past two weeks as this shareholder meeting approached? A slew of people (and likely a number of hedge funds) used price as a guide and began panicking when the price dropped. The more RTSX fell, the more they panicked. It happens all the time.
You must use price as a tool, not a guide, in your investment decisions. In this case, there was no insider selling, no hints of a failing deal, and no news or reason to believe that anything was wrong with the transaction. Instead, sellers lost money and/or opportunity because other investors were panicking. They traded on noise and emotion, not news.
On a short-term basis, emotion and noise drive the markets. On a long-term basis, enterprising, non-conventionalist investors stand to profit greatly from this inefficiency.
Efficient Market people: If all information is immediately priced into every security, how do you explain when no information and 100% emotion is priced into a security like RTSX?
It Ain't Always Money In The Bank
Why do we engage in workouts? Because it beats the pants off of leaving idle cash in a money market and it helps smooth out down markets. Lest you think every old workout deal is money in the bank, let me assure you that they are not always so — and they require some in-depth research and monitoring (though not necessarily a ton; if it doesn't jump out at you, pass).
Once you've analyzed the deal, considered the possible risks, and determined the attractiveness and relative safety of a particular workout, you need to check in on it every day until the deal is done. I'm not talking about sweating over the price; you need to stay on top of the SEC filings to see if anyone close to the deal is selling (or buying). You have to be prepared to react, and even take the occasional (perhaps substantial) loss, if the deal is falling apart; you must be able to hold strong when there is nothing but price movement. Finally, you must remember that thousands of investors full of emotion — both fear and greed — are trying to make more and lose less than you and that you can not let these speculators influence your decisions.
Time Spent vs. Reward of Transaction
In the end, I spent about an hour or so ripping apart the RTSX deal. (Of course, I've analyzed thousands of these deals so I knew what to look for and what to avoid.) Once I invested, I'd be shocked if I spent more than 2 minutes a day looking at the EDGAR filings, press releases (or lack thereof), and price. In total, less than an hour and a half were spent on finding, understanding, and staying on top of this workout. The net result should be about a 24% gain in four weeks, keeping in mind a few things:
- this return depends on whether or not I hold until the end (depending on how quickly the premium dries up over the next few days); and,
- I used margin to double my position when the premium widened with no news or signs of trouble; and,
- nothing upsets the applecart while I still hold my position.
You Don't Need a Ton of Ideas!
Buffett has been known for saying he just needs one or two great ideas a year. You are no different (except that smaller investors can find many more; Buffett couldn't put any real money to work in RTSX). If you could find one practically-cash-in-the-bank workout every two or three months, and earn just 10% on each (assuming you don't use margin), you are looking at a 32% annual return after paying 30% in taxes (46% if done in a tax-free account).
Don't salivate just yet; you will get caught with your hand in the cookie jar from time to time! Still, your results can be quite satisfactory.
And the question naturally follows, "How much of my portfolio should I allocate to workouts?" On Friday, we'll take a look at asset allocation for conservative, non-conventionalist investors.
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by George on February 6, 2008 at 10:27 PM