First depicted by Maurece Shiller (not to be confused with Robert Shiller) in his 1955 book: 𝙎𝙥𝙚𝙘𝙞𝙖𝙡 𝙎𝙞𝙩𝙪𝙖𝙩𝙞𝙤𝙣𝙨 𝙞𝙣 𝙎𝙩𝙤𝙘𝙠𝙨 𝙖𝙣𝙙 𝘽𝙤𝙣𝙙𝙨, Special Situation Investing (SSI) is the process of investing in companies involved in unusual events on the expectation of future price increases.
SSI takes many forms and can involve a number of different assets classes. They usual present themselves in the form of spinoffs, tender offers, mergers, acquisitions, bankruptcy, litigations, capital restructurings, shareholder activism, and the list goes on.
Whilst SSI is a very well known form of value investing it does carry higher than normal risk. Generally speaking most SSI opportunities arise from news stories and rumour of news about to break. Whilst, however, this is the case, SSI does not sit in the same camp as pure speculation as thorough research and due diligence is required.
Beyond Shiller's origin book the most detailed account of SSI is Joel Greenblatt's 1997 book: 𝙔𝙤𝙪 𝘾𝙖𝙣 𝘽𝙚 𝘼 𝙎𝙩𝙤𝙘𝙠 𝙈𝙖𝙧𝙠𝙚𝙩 𝙂𝙚𝙣𝙞𝙪𝙨, which is seen to be the most comprehensive book on the subject.
In this book Joel explains the principles, risks and potential rewards from different types of SSI, however, the key focus is Spinoff Investing.
Spinoff Investing is the process of investing in new businesses that have been separated from another company as the services/products offered from this division/department was not in keeping with the originating company. For example, the spin off of WarnerMedia (media and entertainment) from AT&T a telecommunications company. (Note: WarnerMedia immediately merged with Discover Inc. to form Warner Bros. Discovery - another special situation in its own right).What to look for
Whilst there are a number of types of SSI processes including risk arbitrage (the process of buying at a lower share price than it is due to be sold - for example buying Twitter shares for $45/share before it sold to Elon Musk for the pre-agreed price of $54/share) there are significant risks associated.
On the other hand Spinoff Investing has been well researched to provide a few simple rules for investment:
- The number of outstanding shares after the spinoff event should be low (this encourages institutional investors to sell their newly acquired shares in the new company soon after receipt to avoid liquidity issues for their fund)
- The market capitalisation of the new spinoff company should be low (ideally small-cap) as fund managers, managing millions or even billions of dollars in assets, will not want to hold positions in companies that limit their ability to increase stake without taking significant ownership of the company (fund managers are unable to hold positions of significant control for the companies they invest in)
- Insiders (CEOs, CFOs, etc) should be holding/increasing their own personal stake in the spinoff company. Indicating confidence in the future of the business
- Insiders should have share-based incentives to increase their own desire to ensure the spinoff company's future success
- The spin off company should have a high volume of debt (received as part of the spinoff) with low interest payments, or even a line of credit from the originating company. This will make the business unattractive to investors after spinoff but not determent the spinoff company in the long-term
With the above spinoff companies will see a sell off after the spinoff event as institutional investors look to get ride of their shares (providing a buying opportunity to value investors).
Whilst all SSI opportunities carry higher than normal risk, Spinoff Investing (if followed correctly with the proper due diligence) can be highly lucrative.How does this fit into the AVI Strategy
Due to the high risk nature of SSI, its weighting within the AVI Strategy has been kept to 5% only (positions of 1-5% per stock being held).
As SSI opportunities, worth exploring, arise as little as once or twice per year this weighting is well balanced against the Traditional Value Stocks that are held.