Special Situations Real Money Port Update

Last year, I discovered an opportunity for small investors to participate in “special situations”. Special situations occur when corporate events such as tend offers, liquidations, and going private transactions establish a fixed payout for a stock. Profit can be made by buying stocks that are selling below the fixed payout that a special situation has generated and then capturing that difference in these fairly low risk situations. Benjamin Graham invested in these opportunities and Warren Buffett has utilized arbitrage and special situations to invest his cash hoard while waiting for the next fat pitch on a wide moat company.

My discovery involved investing in public companies that want to become private companies in order to avoid the substantial accounting costs associated with the . These often restrict the number of shares you can own to qualify for a cash payment for your shares. Because of these restrictions, large investors such hedge funds are often not interested in these transactions because they cannot generate enough profit to effect the performance of their portfolios.

I decided to experiment with these going private transactions. Since I was already considering opening a (ESA) for my toddler, I decided that with the tax free nature of these accounts and my desire to maintain a low risk portfolio for my son’s educational account, since I may need to tap these funds for education expenses even before he is old enough to go to college, that this would be the ideal account for me to try investing in going private transactions. (By the way, I also have a significant 529 account for my son in case you were worried about me experimenting with his college fund.) The only major disadvantage with using a Coverdell ESA is that I cannot take receipt of stock certificates in this account, since it would be considered a withdrawl of funds. Some going private transactions require you to request that stock certificates be transfered to your name in order to be cashed out. Thankfully, this is currently not a common requirement.

I deposited $2,000 into the Coverdell ESA on October 19, 2004 and I purchased my first going private stock on October 22, 2004. In order to document my experiment with going private transactions, I decided to document all the transactions I make in my son’s Coverdell ESA. The following table includes all the activity that has occurred in this real money portfolio:


Date

Action

Quant.

Description

Symbol

Price

Amount

09/01/05

Interest

Money Market Fund

$2.19

08/29/05

SOLD

1,700

REFOCUS GROUP INC

RFCG

$0.35

$587.02

08/23/05

BOUGHT

300

MERCURY AIR GROUP

MAX

$3.45

-$1,042.95

08/02/05

Cashout

99

BESTWAY INC

BSTW

$13.00

$1,287.00

08/01/05

Interest

 

Money Market Fund

 

 

$0.45

07/22/05

BOUGHT

1,700

REFOCUS GROUP INC

RFCG

$0.25

-$432.95

07/18/05

Dividend

 

CENTRAL FEDERAL

GCFC

 

$18.00

07/12/05

Cashout

1,990

CAPITOL FIRST CORP

CFRC

$0.18

$355.41

07/01/05

Interest

 

Money Market Fund

 

 

$0.03

06/24/05

Interest

 

Money Market Fund

 

 

$0.03

06/16/05

Interest

 

Money Market Fund

 

 

$0.51

06/13/05

Interest

 

Money Market Fund

 

 

$0.03

06/07/05

BOUGHT

499

FRAGRANCENET COM

FRGN

$0.58

-$297.37

05/16/05

Interest

 

Money Market Fund

 

 

$0.50

04/18/05

Interest

 

Money Market Fund

 

 

$0.44

04/15/05

Dividend

 

CENTRAL FEDERAL

GCFC

 

$18.00

03/16/05

Interest

 

Money Market Fund

 

 

$0.44

02/16/05

Interest

 

Money Market Fund

 

 

$3.45

02/14/05

BOUGHT

200

CENTRAL FEDERAL

GCFC

$12.39

-$2,485.95

02/07/05

BOUGHT

99

BESTWAY INC

BSTW

$11.01

-$1,102.94

02/01/05

BOUGHT

1,990

CAPITOL FIRST CORP

CFRC

$0.12

-$251.75

01/21/05

Deposit

 

CONTRIBUTION 2005

 

 

$2,000.00

01/18/05

Interest

 

Money Market Fund

 

 

$0.96

01/03/05

Interest

 

Money Market Fund

 

 

$1.38

12/08/04

Cashout

425

ASA INTERNATIONAL

ASAA

$5.00

$2,125.00

11/16/04

Interest

 

Money Market Fund

 

 

$0.27

10/22/04

BOUGHT

425

ASA INTERNATIONAL

ASAA

$4.55

-$1,946.70

10/19/04

Deposit

 

CONTRIBUTION 2004

 

 

$2,000.00

Let’s see how I have done so far. The only going private transaction that has not gone well has been Central Federal Corp. The board of directors at Central Federal decided that their going private transaction was costing too much so they canceled it. The stock price dropped after this announcement. I decided to hold on to this stock for a bit since it pays a nice dividend. I assumed after several months that the price of the stock would return to its pre-going private transaction level. This hasn’t happened yet but my son’s account hasn’t been substantially impacted.

According to my online broker, the current total account value was $4,045.10 at the close of business on September 2, 2005. My son’s Coverdell ESA account currently holds:

  • $840.50 in a money market fund
  • 499 shares of Fragrancenet.com currently quoted as $0.40 a share for a total of $199.60 (or at $0.97 a share the total is $484.03)
  • 300 Mercury Air Group at $3.35 a share for a total of $1,005.00
  • 200 Central Federal Corp. at $10.00 a share for a total of $2,000.00

Since the Fragrancenet.com reverse split was approved and it is in the final process of being completed, I think it is fair to value this position at $484.03. In that case, my son’s Coverdell ESA is currently worth $4,329.53. That is roughly an 8.2 percent gain on my investment of $4,000. That total gain is not great but it is not bad either. I plan on continuing to pursue special situations and arbitrage opportunities in this account.

I will soon be putting the $840.50 cash position to work and I plan on addressing my Central Federal Corp. position within a month or two. You can follow my activity in the Special Situations Real Money Port (AKA my son’s Coverdell ESA) here. I also plan on posting more frequent updates like this one, so you can better follow my activity and performance in this account.

Comments

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