On Babies And Bathwater
Summary I like distressed investments, but love distressed investors. Confusion and cross ownership can drive down prices. Sometimes this happens in perfectly healthy securities. Risk I’m a complete and utter coward. I have always thought that the typical mutual fund company investor surveys were utterly inane to ask “how much risk” you want. I despise risk. I want no, or as close as possible to no, risk in the portfolio ever if one means the risk of overpaying. I want risk like I want a masseuse with leprosy. Instead of risk, I want free money or at least want reward that’s uncoupled with commensurate risk. Distressed Investors When it comes to market upheaval, there are often opportunities in distressed investments where one can scoop up assets at 10 or 20 cents on the dollar. However, while these can be rewarding, they are often messy situations. A lot can go wrong. Instead of diving head first into a distressed situation, one opportunity can be to seek out distressed investors and then to see what else they own and where they will be forced to liquidate. Hedge Fund Concentration As discussed in M&A Daily , high hedge fund cross ownership can drive down prices when there’s a market dislocation. In a recent example, there was a utility deal blocked by a regulator. When the deal target’s stock plummeted, unrelated utility deal targets traded off. These other companies had only the most tangential relationship to the blocked deal target. Cleco (NYSE: CNL ) in particular is a safe exposure with little regulatory risk. What’s the connection with Pepco (NYSE: POM )? Mostly, the connection is the shareholder cross ownership. Subjective dread associated with large drawdowns just leads many investors to lighten up elsewhere. In extreme cases, investors hit with large drawdowns may reduce other position to make up for their newly lower asset base. Drawdowns lead to redemptions, redemptions lead to selling liquid names, and the cycle continues. Ticker Confusion I have always thought that ticker confusion makes for a particularly hard case for proponents of the strong form of the efficient market theory. I have lived through many cases of dramatic ticker confusion where a company’s news directly impacts the stock price of similarly named but substantively irrelevant companies. These cases are sometimes lucrative but always hilarious. Many have involved companies too small and illiquid to exploit, but occasionally, they are actionable. When Twitter (NYSE: TWTR ) released its IPO plans, Tweeter (then TWTRQ)’s stock jumped 700% the next day. Tweeter was a consumer electronics chain from Boston. In its heyday, the center now named after Comcast’s (NASDAQ: CMCSA ) (NASDAQ: CMCSK ) Xfinity was the “Tweeter Center.” Tweeter filed for Chapter 11 in 2007 and liquidated in 2008. The equity was worthless but still traded over the counter by the time stock traders got so hot and bothered to buy Twitter shares that they could not even wait for the IPO. This one was particularly amusing in that the “I” of “IPO stands for “initial,” meaning that one would be hard pressed to find a publicly traded Twitter stock before its IPO. When Google ( GOOG / GOOGL ) announced that it was buying thermostat maker Nest Labs for $3.2 billion, unrelated Nestor (then NEST) popped by 1,900%. When Rubbermaid’s (NYSE: NWL ) Graco Children’s Products was hit by a product recall, shares of unrelated Graco Inc (NYSE: GGG ) took a hit. In terms of dollars, the biggest opportunity was between MCI (then MCIC) and the unrelated Massmutual Corporate Investors, now Babson Capital Corporate Investors, (NYSE: MCI ). Whenever MCI would have good news such as a potential buyout, Massmutual would race and whenever MCI had problems, Massmutual would fall. Unlike the others, these were liquid, tradable names with a statistically significant correlation on substantively unrelated news items. Conclusion One can occasionally exploit such ridiculous failures in the price system by tracking who owns what and reacting to cross correlations that lack a substantive business rationale. Last year, when AbbVie (NYSE: ABBV ) abandoned their acquisition of Shire (NASDAQ: SHPG ) due to political harassment, similar tax inversion deal targets imploded… but so did other popular event driven hedge fund holdings, even ones without any substantive connections to tax inversion. Eventually, SHPG fully recovered, many other tax inversions succeeded , and the unrelated selloffs recovered by the year end. This year, there are a number of deals with serious antitrust issues, none more serious than the Ball (NYSE: BLL ) acquisition of Rexam (OTCQX: REXMD ). It appears highly probable that the antitrust enforcers will bring at least one high profile antitrust suit this year against the BLL deal or one of the others. When it happens, it will probably pay to have a shopping list ready. Even safer deal targets and other securities owned by major REXMD holders will sell off without sensitivity to price, risk or even relevance to the news. Be prepared. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks. Disclosure: I am/we are long CNL. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital. Rangeley invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our investors, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.
