Special Situations
A special situation is an unusual, temporary event that allows you to buy a share in circumstances with a high probability of appreciation.
It has little to do with usual fundamental analysis: it is about capturing an inefficiency created by the situation, which can deliver significant extra return.
The most common: spin-offs, M&A, bankruptcies, arbitrage (especially takeover bids), tender offers / share buybacks.
Spin-offs
When part of a parent company is separated and its shares are distributed to shareholders, creating a new listed company, we speak of a spin-off (also spin-out or starburst).
Shareholders of the parent become shareholders of the spin-off in the proportion determined in each case. It is a form of divestment by the parent; the idea is that the spin-off operates as an independent business.
Reasons and source of the inefficiency
The parent usually aims to unlock value or divest a business in which it has had little interest. The inefficiency arises because: the new company has no track record and is seen as the “black sheep”; there are forced institutional sellers (they sell by mandate); the spin-off is often loaded with debt that does not belong to it; the parent usually presents it as a victory and the figures are often incomplete.
Is it profitable to invest in spin-offs today?
The US ETF that tracks spin-offs outperformed the S&P 500 until mid-2019; since then it has delivered fairly poor returns. It is “fashionable” for large companies to spin off the bad business (especially in the US); the parent often loads the spin-off with debt to pay a special dividend or to take advantage of “hot” market moments.
Only ~42% of spin-offs have beaten the market; so it pays to be very selective.
What to look for in a spin-off
| Area | What to review |
|---|---|
| Team and governance | Management heavily involved in the spin-off and aligned with creating value (not overvaluing to enrich themselves and exit). Shareholding, stock options and strike price. Useful question: do parent executives move to the spin-off? |
| Origin and sector | Preference for European spin-offs (in the US there are many from weak businesses). Parent and spin-off business model; sector and growth guidance. |
| Structure and balance sheet | Debt: levels at the parent and what is transferred to the spin-off. Historical investments by the parent in the spin-off. Size of the spin-off (forced selling by institutions). |
| Communication and value | Official presentation, reason for the spin-off. Analyst coverage. Hidden assets. |
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Takeover arbitrage
Takeover arbitrage consists of earning a return on shares that have received a takeover bid (friendly or hostile), by buying at a discount to the final acquisition price.
It is a risky strategy, generally only recommended for professionals because of information asymmetry. Do not invest when there is high risk and limited upside.
Look for asymmetric situations: lose little, gain a lot. If the bid is certain, these assets can be used as a “safe haven”.
What to analyse
- Valuation of the bid: does it reflect the real value of the company?
- Trading price: preferably above the bid price (possible improved offer).
- Preference for hostile bids (board in disagreement). If friendly: look for rejection by major shareholders.
- Stock options and incentives of the board (strike price; they benefit from selling above it).
- Fine print of the bid: risk of cancellation. Possible white knights (competing offers at a better price).
Odd lot arbitrage
What is an odd lot
An odd lot is a parcel of fewer than 100 shares. The opportunity arises when a company announces a buyback of a block of shares through a tender offer: in many offers, shareholders with fewer than 100 shares have priority in the buyback (the tender announcement must be checked).
The broker and the market handle odd lots in a transparent way.
Risks
- Trading: the company may cancel if the share price trades % below the minimum buyback price
- Funding: if the buyback is funded with debt and funding is not secured.
- Regulatory: an investigation that forces the offer to be withdrawn.
- Changes to the terms of the tender offer.
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