Experiments in Finance put some real money to work in two recent tender offers. These included the Fidelity National Services (FIS) and WebMD Health (WBMD) tender offers. Fidelity National Services had announced back in May that it was buying back $2.5B shares via a dutch auction, with a tender prices range set from $29 to $31 per share. The offer included a preference for odd-lots (holders of less than 100 shares) and was set to expire on August 3, 2010. WebMD Health also had a recent tender offer that expired September 8, 2010 to purchase properly tendered shares at $52. This offer for WBMD also included an odd-lot provision.

Experiments in Finance decided to buy 99 shares of FIS for $27.75 on July 15th.  She then reported on her results by posting, “On August 3rd, the results of the dutch auction were announced, and the tender price was set at the lowest end of $29. Even so, this allowed me to earn $115 in a couple of weeks’ time, or a return of about 4% after fees.”

She then went on to buy 99 shares of WBMD on August 26, 2010 for $50.70.  She was a bit nervous about provision of the tender offer that indicated that the tender offer could be canceled or modified if  “a decrease of more than 10% in the market price for the shares, the Dow Jones Industrial Average, the NASDAQ Composite Index or the S&P 500 Composite Index since the date of the Offer.”  She reported back that this provision was waived on August 30th. Given that the deal went through as planned, Experiments in Finance should have grossed a 2.6% return on that investment.  I’m sure she’ll be reporting her final results on this deal shortly. I received cash in my own account this past Wednesday for the WebMD shares I tendered in the Special Situations Real Money Portfolio.

Where did Experiments in Finance find out about these deals? She wrote the following:

In case you’re wondering, I actually find out about all of my special situations investing opportunities through a subscription to Fat Pitch Financials’ Contributors Corner and have been pleased with the service (and no, I unfortunately don’t receive any benefits from referring to them in this post!) Check it out if you’re curious to learn more. The subscribers there are pretty helpful in offering their experiences, any opportunities they find, and answering questions (such as whether there’s an advantage to tendering early, or at a higher price, or trying to purchase from multiple accounts).

I’m pretty proud of that recommendation. Consider trying Fat Pitch Financials Contributors Corner yourself for a month. Use the discount code FPF5 in order to get a one month subscription for just $10 (it’s normally $15 per month).

However, the first thing I thought of was would this potentially present a fat pitch special situation opportunity. Warren Buffett always keeps his word on merger deals. Could the Burlington Northern offer create another Constellation Energy Group (CEG) opportunity?

As you might recall, last year I made some significant profits from the Constellation Energy Group merger arbitrage. Berkshire Hathaway’s MidAmerican Energy Holdings offered $26.50 per share in cash for Constellation Energy. After the deal was announced, the price of CEG shares drift down to as low as $15 and then up to $30 last year. Mr. Market sure got moody, even with Mr. Buffett at the helm of that deal. Could the same thing happen again with BNI?

I decided to ask my Twitter followers. Here’s my question and their responses:

FatPitch: I’m hoping $BNI will dip down to $90 in the coming weeks. Do you think it will happen? Lower?

rationalwalk: @FatPitch Can’t see BNI slipping to $90…. would require crash in BRK shares well below $80K to do that.  Very, very unlikely.

marketfolly: @FatPitch could happen if market dives as many predict. at same time, few merger/arb plays out there right now; funds swarm to same plays

ModernGraham: @FatPitch If it does, it would be Mr. Market at his finest – there’s no reason for it to be anything but $100 now

MrMarketBlog: @FatPitch I doubt it. I don’t think anyone is going to doubt Warren getting this deal done

vlad0: don’t underestimate irrationality

What are your thoughts on the potential for arbitrage profits with the Burlington Northern Santa Fe deal? Share them in the comments section below or follow me on Twitter.

What are special situations?

I first learned about special situations while reading Joel Greenblatt’s book, You Can Be a Stock Market Genius. Here’s how Mr. Greenblatt describes special situations:

“Something out of the ordinary course of business is taking place that creates an investment opportunity. The list of corporate events that can result in big profits for you runs the gamut — spinoffs, mergers, restructurings, rights offerings, bankruptcies, liquidations, asset sales, distributions.”

These special situations typically come about when there is a change in a corporation’s ownership structure. Often this involves mergers, buybacks or new offerings, but in some situations it is just the disposal of assets.

Greenblatt describes these opportunities as the secret hiding places of stock market profits. At first I just thought these special situations were just low return arbitrage opportunities to park cash while looking for value. However, over the years I’ve come to realize that special situations can often be very profitable.

What are workouts?

“Workouts” – these are the securities with a timetable. They arise from corporate activity – sell-outs, mergers, reorganizations, spin-offs, etc. In this category we are not talking about rumors or “inside information” pertaining to such developments, but to publicly announced activities of this sort. We wait until we can read it in the paper.

This definition comes straight out of the January 18, 1965 letter Warren Buffett wrote to partners of the Buffett Partnership, Ltd. The key element of this definition is that workouts have a specific timetable. I consider workouts to be a subset of special situations given that not all special situations have a defined timeline. For example, liquidations can drag on for quite some time and there can be parts of the liquidation contingent on when buyers are found for some of the company’s assets.

However, many consider special situations and workouts to be synonymous. In fact, when Benjamin Graham wrote about these opportunities in The Intelligent Investor, he named the heading of that section, Special Situations or “Workouts“. In that section of Chapter 15 – Stock Selection for the Enterprising Investor, Graham describes three special situations. The first one is a corporate acquisition involving a stock for stock exchange where shares of the purchased company are exchanged for a specific ratio of shares of the buyer. The second example is an all cash buyout of a company’s shares. Finally, the third example is a liquidation. Graham goes on to note that these three examples are fairly representative of “workout or arbitrage” opportunities.

Notice that Graham uses the term “arbitrage” in conjuction with workout. In addition to the use of the terms special situations or workouts, you might also see investors referring to investments in these areas as arbitrage. However, arbitrage has a wider meaning that encompasses all sorts of activities that take advantage of price differentials between different markets. Also, when specifically talking about mergers and acquisitions, the terms merger arbitrage and risk arbitrage also used interchangeably. As is typical in the English language, there are lots of terms that mean more or less the same thing.

I hope you found these definitions helpful. How would you define special situations and workouts?

This morning the Special Situations Real Money Portfolio account showed $7,000 in cash had arrived for the hundred shares of BUD that I had acquired back on October 6, 2008. I originally purchased these 100 shares for a total cost of $6,309.95. Therefore, my total profit on this trade comes out to $690.05,  a 10.9% total return. If I annualize that return for the 45 days I was invested in BUD, the average annualized rate of return is an amazing 89%!

BUD was a great win for the Special Situations Port. Now I just need to temper my enthusiasm for merger arbitrage opportunities, since this unusually generous return for a large cap merger arbitrage play is not the norm. I believe this opportunity was only available as a result of the deleveraging of hedge funds and institutional investors during this market crisis. It goes to show you how important it is to adapt and remain flexible given the rapidly changing market environment. These opportunities in the often dull field of special situations are often only truly profitable when the markets get out of equilibrium and become irrational.

The closing of this Anheuser-Busch position frees up a lot of cash for new opportunities in the Special Situations Real Money Portfolio. I already put a portion of the cash to work in a classic going private transaction that I revealed to subscribers of Fat Pitch Financials Contributor’s Corner.

The Special Situations Real Money Portfolio ended the day with a balance of $18,763.44. I’m proud to say that this portfolio is up 17.64% for the year and currently sports a 25% IRR since inception. There are not too many other portfolios out there outperforming the indexes by this amount. My goal now is to try and maintain this level of performance by continuing to focus this portfolio on relatively low risk workouts.

Disclosure: I do not currently own shares of Anheuser-Busch (BUD) or InBev.

I sold my original position in CEG, but last Friday I couldn’t resist buying CEG at $22.30. After I bought the position, I decided to put a good-until-canceled (GTC) limit order in at $26.30. How did I come up with $26.30? I figured it was less greedy than my last limit order sale of CEG at $26.40.

This morning, the market roared back to life. Constellation shares jumped up to $26.26 while I was away from a computer. By just 4 cents, I missed profiting from CEG again in a very short period of time. Was it worth holding out for 4 more cents given the risk of having to wait a while for MidAmerican to close the deal, which is still quite a ways off? What limit price should I have placed? What criteria do you use to determine what price to sell a merger arbitrage opportunity early?

Disclosure: I own shares of CEG. No other shares mentioned in this article are owned at the time of this was posted.

On the way up to $26.50, all 470 shares in the Special Situations Real Money Portfolio were sold. I placed a limit order of $26.40 yesterday to sell my CEG shares, because I was going to be tied up in meetings all day today. I wanted to make sure I didn’t miss any wild positive swings in Constellation share prices if Mr. Market got giddy with any positive news. As I guess, the good news today did drive CEG shares up and over the buyout price.

Do I regret selling today at 26.40 even though CEG shares closed the day at 27.23? I have no regrets, even though a potential $35 per share offer by EDF appears to still be alive. I was only interested in the certain offer by Warren Buffett’s Berkshire Hathaway subsidiary. Once that price was acheived, no margin of safety remained. I’ve also spotted another attractive merger arbitrage opportunity I might exploit tomorrow if there is a delay or failure of the House vote on the bailout package.

So how did I do? I bought 470 shares of CEG on September 29, 2008 for an average price of $22.38 per share. The total cost of those shares was $10,517.87. Today, four days later, I sold the 470 shares for $26.40 a share, for a total payout of $12,400.97 after costs. My total profit came to $1,883.10, a 17.9% return. It is very rare that you can get a total return of almost 18% for a merger arbitrage opportunity. It’s even rarer to realize that gain in just four days. The average annualized return for annualized return of 1,634%! That trade helped push the Special Situations Real Money Portfolio up to year-to-date return of 24.36%.

Disclosure: I own shares of CEG but no holdings of any other stocks mentioned.

About a week ago, I was kicking myself for missing a great arbitrage opportunity. Berkshire Hathaway’s MidAmerican Energy Holding Company announced on September 18th that it was buying out Constellation Energy Group (CEG) for $26.50 per share in cash. I follow Warren Buffett’s Berkshire Hathaway (BRKa) pretty closely, so the buyout headline stuck in my head.

The next day I once again spotted Constellation Energy Group in my feed reader, but this time it was for a blog post by Derek at Stableboy Selections. He noted that CEG was trading at 18% below the $26.50 buyout price. That caught my attention. It is very rare for a company that is being bought for cash to trade for a discount of less than 10% unless something is wrong.

I started searching around for any potential issues with the CEG deal for about a half hour. I couldn’t find anything, so I went to place an order for CEG in my Special Situations Real Money Portfolio account. As I was placing the order, CEG jumped up to $26.50 and then traded slightly above even the buyout price. I missed the 18% potential profit by just minutes. As members of Fat Pitch Financials Contributor’s Corner know from my comment to premium subscribers, I was very disappointed. I missed that fat pitch, but at least no strikes are called in investing.

Fast forward to today. After my lunch, I checked my newly created list of merger arbitrage opportunities that I’m maintaining at Contributor’s Corner. I noticed that CEG was down over 10%. I looked for news about the deal and I didn’t see anything new. Given a second chance to swing at this fat pitch, I purchase 400 shares of CEG at 23.51.

Shortly after my order was filled, I decided to check CEG again. The price dropped to 22. Then I made the mistake of refreshing my browser again. This time it showed 20, and on a subsequent quote the price was 19. The blood started draining from my head. I started to really doubt myself. Did I make a mistake? Should I quickly sell? Thankfully, I held it together.

I scrambled to find out what was going on to cause this massive price drop. I couldn’t find anything on Yahoo! Finance, MarketWatch, Bloomberg, Reuters, Google News, the Wall Street Journal or the Financial Times. The news was just dominated by today’s failed Congressional vote for the financial bailout plan. Finally, I check the Yahoo Message Board for Constellation Energy Group. There I spotted a post that caused me to panic, “Headline – Constellation seen considering Chapter 11 filing.” By this point, CEG dropped to 18, 17, and finally 15 in just moments! I quickly checked the above news sources again and then searched for the term “Constellation Chapter 11″ on Google News. Nothing came up.

By this point, my senses thankfully returned. Why didn’t the author of the message board post include a link? That was suspicious. Then someone else asked for the source, but the only response included a domain name, www.sparkspread.com. The site wouldn’t load for me after several frantic attempts. Then I pulled up a cached version of the site and it didn’t appear very authoritative and no CEG headline appeared. Now, I suspected this whole bankruptcy scare was likely a hoax, to put it nicely. I hope the SEC looks into this, but given all the other market insanity I’m not counting on it.

At this point, Constellation Energy Group started to climb again back to 19 and then 20. At twenty, I decided that I should really average down my position, so I picked up more shares at $20.30. Mr. Market still seemed a bit unconvinced, so CEG dropped back below 20 briefly, but I was out of cash at this point.

The drama came to a conclusion at around 3:30 PM this afternoon when MidAmerican issued a press release confirming that the merger was still on track. Surprisingly, shares of Constellation Energy Group only ended the day at 23. I’m pretty confident that Warren Buffett’s MidAmerican subsidiary will stick to its offer. Mr. Buffett is known for being honorable and holding firm on his offers. Financing is not an issue here, since parent company Berkshire Hathaway definitely has the cash pay for this buyout.

I learned several lessons from today’s activity. First, Mr. Market can be completely irrational and lead others to do crazy and even irresponsible things. The price swings associated with CEG today were simply crazy. When no one could explain the initial price drop, a nasty rumor was posted to fill the void created by the uncertainty. Second, major market turmoil can open up opportunities in merger arbitrage for individual investors, where normally the profit margins are too slim. I normally avoid merger arbitrage, but this market crisis has caused institutional investors to sell off their holdings and some hedge funds are closing down and unwinding their positions. This basically takes the professionals in arbitrage out of the game and allows us amateurs to get a chance at bat. Finally, trust your own research and always confirm rumors before even considering acting on them. I wish I had tried to call Constellation Energy Group right away when I first learned of the rumor. A simple phone call to someone in the know could have cleared up my uncertainties immediately. I wonder if the folks who bought CEG between 15 and 16 today were in that position, or just had major cajones and bought low.

I’m just happy that I’ll likely be able to make a nice return on this relatively low risk position. The Special Situations Real Money Portfolio is likely one of the few portfolios you’ll read about that is still up 14.7% this year and generating a 25% compound rate of return since inception. Now I just need to get my value plays in the Fat Pitch Financials Portfolio to perform half as well. Fat pitches are flying and I need to start swinging.

Disclosure: I own shares of CEG. No other stocks mentioned are owned at the time of the post.

It’s been a while since I’ve shared with you the details of a stock tender offer. Stock tender offers with an odd lot provision are particularly attractive for individual investors since they allow holders of less than 100 shares to avoid proration that often occurs when tender offers are oversubscribed. Therefore, if you own less than 100 shares of a company that is tendering their shares, you know that you can receive a price between a certain range for all the shares you own. If you bought the shares below the minimum tender offer, you can be fairly certain that you will earn some profit from tendering your odd lot holding. These tender offers can be some of the lowest risk deals you can find in the stock market. Recently, United Rentals (URI) conducted such a tender offer.

I didn’t participate in the United Rentals (URI) tender offer (don’t ask me why), but Jonathan at My Money Blog did. Jonathan learned about the United Rentals tender offer in early July from my Fat Pitch Financials Contributor’s Corner premium service. Jonathan is a full paying member of Contributor’s Corner and did not receive any compensation or direct guidance from me on his articles about his experience with this tender offer. Nevertheless, I highly recommend his two articles on the United Rentals tender offer, especially if you have never experienced one of these transactions.

In his first article, Jonathan tells his readers about his purchase of 99 shares of United Rentals for $19.81 per share on July 9th. He then details the background of this deal. The key point is that United Rentals wanted to buy back 27 million shares using a Dutch auction with a range of $22 to $25 per share. While Jonathan admits he is a novice at these deals, he did a great job detailing the risks associated with the tender offer. He notes that too many people might tender their shares, and therefore URI might only buy a partial amount of your shares unless you own an odd lot. The other big risk is that the company might cancel or amend the tender offer. Jonathan does a great job assessing the risks and explaining his thought process. While Jonathan is primarily a passive index fund investor, he has realized that these unique special situation opportunities can help juice his portfolio. He sums up the potential of the URI tender offer by stating:

“Basically I’m trying to make $200 while putting up $2,000. That is a return of 10% over what should take a few months.”

Jonathan then followed up on July 20th with his results from the URI tender offer. It was a successful trade for him. He made $191.91 (9.8%) in less than a month, which comes out to over a 100% annualized rate of return. Jonathan notes, “Even after taxes, that will be buy me over 25 meals from the lunch carts.” That a good way to think about it. Let’s just hope he doesn’t eat all those meals at one time.

I’m just happy to know that Jonathan more than recouped the cost of his Contributor’s Corner membership. Jonathan makes an important point to note that larger shareholders didn’t do nearly as well on this deal. This is just one of those rare cases on Wall Street where the little guys have the advantage. I think Jonathan would agree that in addition to the small amount of cash he made, he also learned a lot about how special situations work. Participating in these small tender offers can help you work through many of your questions regarding tender offers, so you can gain the experience and confidence needed for much larger deals. There are only a few tender offers occurring at this time, but I suggest you review Jonathan’s experience and my past experience with tender offers so you can be ready for the next fat pitch.

Disclosure: I do not own shares of United Rentals (URI).

Jaclyn proposed to go private by conducting a reverse split where 250 shares would become one share. This was then to be immediately followed by a forward split where each share would again become 250 shares. Holders of less than 250 shares before the split were to receive $10.21 in cash per share. The goal of this transaction was to reduce the total number of shareholders of record to less than 300, a requirement for taking a public company private. Since this was a classic going private transaction, I think it makes for good learning example. It’s been a while since I’ve detailed my experience with one of these going private transactions, so for many of my newer readers this will be informative.

I first started tracking Jaclyn after it made its initial going private transaction filing and preliminary proxy on December 21, 2007. The first thing I looked for in those filings was how the company planned on treating holders of shares in street name (shares held at a broker). Companies are not required to reduce the number of street name holders when going private, they only need to have less than 300 holders of record (where the shareholder’s name is actually on the stock certificate). The Special Situations Real Money Portfolio is a Coverdell Educational Savings Account and many of the members of Contributor’s Corner also trade in IRA accounts. These custodial accounts for tax purposes cannot take physical delivery of shares. Thankfully, Jaclyn stated in their preliminary proxy that they intend to treat stockholders holding their common stock in street name in the same manner as record holders. This alone increased the attractiveness of this opportunity, since I would be able to take advantage of this opportunity in a tax efficient way and with lower expenses (no costly stock certificate mailing needed).

Jaclyn was trading at just above $6 on December 21st. On the next trading day, December 24, 2007, shares of Jaclyn had jumped to $6.75. Given the turmoil in the credit markets and my past experience with going private transactions, I decided to not rush into this opportunity. Jaclyn was going to need credit to complete this transaction and it often seems that these companies underestimate the potential number of shares they will have to cash out. I find that the risk that the going private transaction will be cancelled is somewhat reduced if you wait until an actual vote date is announced for the proposed going private transaction. This usually occurs during the next phase of the going private transaction when the definitive proxy is filed.

There were some early positive signs that this going private transaction would go through smoothly. A comment left by member of Contributor’s Corner early on noted that the executive chairman, chairman, president, and vice chairman, who combined control 50.9% of the stock, intend to vote FOR this deal. He also noted that the company estimated it would cost approximately $1,916,000 to complete the transaction, so with $769,000 on the balance sheet at the time, Jaclyn would only need a bit over $1 million in credit. Given that their bank increased their credit line to $3 million in order to purchase shares, it looked like Jaclyn had both the votes and money to complete this going private transaction.

Then in February, Jaclyn issued another preliminary proxy. At this point I thought the rewards were starting to outweigh the risks associated with this going private transaction. The market also was thinking the same thing, and the price of shares climbed from below $7 to over $8.

Members of Contributor’s Corner were getting pretty excited about this deal. In total, there were 33 comments regarding Jaclyn in Contributor’s Corner. Some of the newer members were concerned that this deal looked too good and might contain risks that they weren’t considering. Some of the more experienced members and myself noted that it would probably take 6 months or longer for this transaction to complete. I personally use 6 months as a rule of thumb for most of these going private transactions from the date of first filing. The main risks for me at this point concerned whether Jaclyn might decide not to treat street holders the same as record holders or even decide to shelf the deal due to the market environment at the time.

Several more weeks followed before I took any action. On April 3th, the price of Jaclyn shares declined by 15%. Members of Contributor’s Corner wanted to know if anything had happened. I researched various sources and found no news. It was just Mr. Market getting nervous that there hadn’t been any news. I decided it was time to act. I put in a limit order and bought 200 shares. I got the shares for $7.65 per share, and my total cost was $1,536.95.  Normally, I would buy 249 shares in this situation, but I didn’t have enough cash in the account at the time to do that.

Then just a few days later, Jaclyn issued a definitive proxy for the going private transaction. The proxy indicated that the vote date would be May 7, 2008. This was very good news and shares of Jaclyn promptly climbed back to over $8 per share as the risk associated with this transaction went down.

The next question I started to receive was about when the last possible date would be to aquire shares and still get cashed out.  My personal rule is to buy shares at least a week before the vote date, since shares take a few days to settle and sometimes the effective date for a reverse split can occur on the same day as the shareholder vote if management is real quick. Buying shares after the vote date can be a real gamble unless the company clearly indicates what the exact effective date will be. I’ve heard a few reports of individuals not being cashed out for the Jaclyn deal because they bought too late. Thankfully, none of the members of Contributor’s Corner reported this problem (probably since I warned them).

On May 7th, positive signs started appearing. A delisting noticed appeared in the SEC filings for Jaclyn. By May 9th, most members noticed that the Jaclyn entry at their brokerage accounts changed. The ticker symbol was replaced by a number or other symbol and some even noted that their brokerage entry for Jaclyn stated “contracts”, reorg, or “for cash out $10.21/sh.” The one thing we did not see was the results of the vote, but with these small companies it can take a few days for the voting results to be reported. The company finally reported the results of the vote on May 12th in a release.

In just over two weeks after the vote date (May 22, 2008 to be exact), I received $2042 automatically in my account for the 200 shares of Jaclyn I had. In total, I held these shares for just 49 days. For my initial $1,536.95 investment, I made $505.05. This come out to a total return of 32.9%. The real performance number to focus on is that this little workout produced a 245% average annualized rate of return! Now you know why I like going private transactions so much. If you also find yourself attracted to these type of opportunities, consider joining Fat Pitch Financials Contributor’s Corner where you can review current opportunities and study past deals.

Disclosure: I no longer hold a position in Jaclyn (JCLY).

When acquiring an odd-lot following the announcement of a tender offer, what must be done next to ensure participation in the tender?

You need to contact your broker to let them know you want to tender your shares.

Do you receive a form in the mail which must be completed to indicate your desire to participate in the tender?

Not usually.

Do you mail this form to the company doing the tender or to your brokerage?

No, unless you hold the physical stock certificates. Normally, you should just work with your broker.

How do you ensure that you will receive the form in time to participate in the tender?

There is no need to wait for forms.

Some forms mailed to me via my broker seem to take some time to reach me. Is there often a way to find the relevant forms online?

Go to SEC EDGAR and review all the current filings for the company. You can also check the company’s investor relations webpage if they have one.

If you mail the form to the company doing the tender, do you need to notify your broker that you will be participating?

Contact the broker first, since rarely do you need any forms.

Does a broker typically charge you a commission when the tender is completed and your shares exchanged for cash?

It depends on the broker, but many discount brokers do charge a fee for tender offers. It is higher than the typical commission. I pay $25 to tender but I’ve heard of others paying as high as $50.

What do you see as the main risks to this “arbitrage”, are they simply that the tender will be called off and the stock will then trade down?

The tender price is not usually fixed, so there is the danger that the tender offer will come in at the low end of the range. There is also the risk that the tender offer could be called off or modified (lower offer). There is also the potential that the odd-lot provision is removed at the last second.

What is a company’s ability to rescind a tender once it is announced?

Corporations have great lawyers so they always leave a loop hole in so they can easily rescind a tender offer.

I know this is a lot of questions. If you have the chance to answer some I would greatly appreciate it. Once I get a little more comfortable with some of the details, I look forward to joining the Contributor’s Corner. Thanks again for maintaining the site!

We talk about a lot more than odd lot tender offers at Contributor’s Corner. We also look at going private transactions, spinoffs, and other unique opportunities that come up. The archives are also a great resource since you can read over all the questions and comments provided by other investors on deals. There are a lot of lessons learned in the over 1700 entries.

The author of these questions joined Contributor’s Corner the day after I answered his questions. If you have any additional questions about tender offers, please feel free to post them in the comments section below.

  Cash and Equivalents: $3,853,000
  Restricted Cash: $6,200,000
  Short-term Investments: $30,475,000
  Accounts Receivable, net: $10,702,000
  Inventories: $15,806,000
+Prepaid Expenses & Other: $1,401,000

= Total Current Assets: $68,437,000
- Total Liabilities: $30,860,000
Net Current Asset Value: $37,577,000

Shares Outstanding: 5,847,408 shares

NCAV on Shares Outstanding: $6.42/share

NCAV appears to have dropped about forty cents per share over this past quarter.  The main cause of this reduction came from an increase in total liabilities. 

LENS closed today at 2.96.  This means this stock is still trading below Graham’s criteria of 2/3 of NCAV.  Heck, Concord Camera stock is trading at 46% of NCAV!

On a positive note, at least sales were up this quarter.  Revenues were $16.4 million in the third quarter and have now climbed to $22.1 million in the fourth quarter.  The loss per share has gone from $0.57 per share to $0.54 per share.  This comes from an almost doubling of gross profits from $1.1 million in the third quarter to $2.1 million in the fourth quarter.  Of course this improvement is probably due to a seasonal trend associated with summer vacations.

I was hoping to hear of other new product initiatives beyond the OnGuard Kids product.  However, nothing else was mentioned as being in development in this 10-K.  I think we can probably expect another rough year ahead for Concord Camera.  They really need to start getting creative.  However, CEO Ira Lampert doesn’t appear to be too motivated to turn this around.  Hopefully, the cheap assets of this company will attract some interest.

Full Disclosure: I own shares of Concord Camera (LENS).

I closed July out with $12,044.13 in the Special Situations Real Money Port.  Back in May, the account was worth $12,239.27.  As you can see, I’ve lost a little bit of ground over the past two months. The account is down about $200 since May. However, that’s not too bad considering how the indexes have been dropping.

The good news is that I am still up 26.4% for the year.  My internal rate of return (IRR or APY) is an impressive 24.2% since inception, which is exceeding my expectations for this account.  To put it in simple terms, I’m up 50.6% on my investment of $8,000 ($2,000 each year since 2004).

Now let’s get to the details about what’s happened this month.  In June, I was cashed out of Tribune (TRB) in a tender offer.  That deal netted me $90.81 or a 2.8% return after all commissions and fees we taken into consideration.  On an average annualized basis, that comes out to 26% for the the 39 days that I held Tribune.  This is above my target annualized rate of return, so I was happy.

I took those proceeds from Tribune to purchase 199 shares of BNS Holding Inc. (BNSIA) for $11.75 per share.  This position climbed up to $12.75 at one point as a lot of other individual investors started taking advantage of this opportunity.  However, BNS Holding pulled a fast one on us.  On July 27th, the company issued a press release indicating that it was instructing brokers to not provide for cash payouts to any stockholders holding shares of common stock in street name.  Street name is the way shares are typically held if you are using a broker.  I was totally caught off guard.  I thought this was a done deal since the vote for the going private transaction was already successful and only a few days remained until the August 2nd date to effect the 1 for 200 reverse split. Since the Special Situations Real Money Port is a Coverdell ESA and only a few days remained before the reverse split was to occur, there was no way for me to register these shares in my son’s name in time. Shares of BNSIA plunged as all the street holders tried to sell.  I ran into trouble selling my shares due to a technical issue and my busy schedule.  I finally was able to sell some of my shares yesterday for $10.75 and I hope the remaining shares get sold for as much soon.

The Special Situations Real Money Port also had a position in Navigant Consulting (NCI).  Navigant Consulting was conducting a dutch tender offer that gave preference to odd lot holders before any prorating if the deal was oversubscribed.  I estimated that the Navigant Consulting tender would come in somewhere around the midpoint of the offer range of between $19.50 and $22.50.  I bought my shares for $20.65, but I only picked up 85 shares on May 10th because the account ran out of cash.  I made my tender conditional on the offer being greater than $20.75.  Well, the deal came in at $20.50 so my shares weren’t tendered.  Then the stock began to sink.  By the time I realized that I didn’t want to be a long term holder of NCI I was only able to sell out at $19.50 per share.  I lost $111.68 on that trade for being stupid.  If I had been smart, I would not have made my tender offer conditional and I would have lost a lot less.

Now that I’ve gotten all that bad news out of the way, I have some excellent results to report about my investment in the Halliburton Co. (HAL) split-off of KBR Inc. (KBR).  As you might remember, I bought 99 shares of Halliburton on March 13, 2007 for a total of $3,174.95.  I opted to convert these shares to KBR shares in the split-off tender offer made at the time.  On April 16th, I received 157 KBR shares for my Halliburton shares.  I decided to hold on to this position for a bit since it seemed that the market was mispricing KBR.  Sure enough, KBR shares climbed from the low twenties to a high of $36.  I placed a stop order at $31 to lock in my gains.  Last week when the market tumbled, my shares were sold for $30.90.  The total proceeds from that sale were $4,843.80 after commissions.  I had a net gain of $1,643.85 (adjust for a $25 tender fee).  That’s a 51.8% return on my original investment!  Given that it only took 135 days to earn this return, this comes out to a 139% average annualized rate of return for my Halliburton to KBR split-off investment.  I can’t wait to find my next split-off opportunity.

If you too are looking for the next split-off opportunity, consider joining Fat Pitch Financials Contributor’s Corner.  At Contributor’s Corner you will have access to the latest trades and holdings of the Special Situations Real Money Port.  You’ll also have access to the latest going private transactions, odd-lot tender offers, spinoffs, and other special situation opportunities.  The members of Contributor’s Corner are very active in the forum where the discussion even includes more traditional value plays in microcaps and Graham net-net stocks.  Contributor’s Corner is so active because I reward members with 3 additional days of credit on their subscriptions for the latest updates on special situation opportunities.  I’m amazed at how fast members of Contributor’s Corner report on changes and updates to special situation opportunities.  It’s hard to beat the collective research of this motivated group for such a reasonable price.

I turned to the presentations given at the June 19th Tyco Investor Meeting.  I find the slide presentation given at these meetings to be particularly helpful when trying to understand what is going to happen after a spinoff.  Sadly, I can’t seem to find links to these presentations anymore on the Tyco website. However, using one of my handy investor hacks, I located this link to the Tyco Investor Meeting presentations and webcasts. (Hack: I used the cache links in Google to help find what was on the Tyco corporate website a few weeks earlier. This trick comes in handy on occasion.)

Let’s start by looking at Tyco Electronics.  My gut sense tells me that Tyco Electronics likely has the smallest economic moat of the three companies.  Tyco Electronics is in the industrial electronic components industry. My experience with the electronics industry leads me to think there is heavy price competition and intense creative destruction due to innovation. However, according to Tyco Electronics they derive approximately 70% of their sales from products that are number one in the industry. These products include connectors, cable assemblies, heat shrink tubing, touchscreens, and undersea telecom systems. Their operating margins are above 15%. However, revenue growth has only been about 5-7%.  ROIC has been about 8% over the past three years.  Given lack of direct knowledge regarding Tyco Electronics products I am not prepared to declare that Tyco Electronics has a wide eoncomic moat.

Regardless, it might still be worth looking at the intrinsic value of Tyco Electronics.  Tyco Electronics reported free cash flows (FCF) of between $1.068 billion in 2004 and $1.122 billion in 2006. The capital expenditures component of FCF has been fairly consistently between 4 and 5% of revenues (about $600 million). The company reported a goal of achieving organic growth of 5 to 7%.  Free cash flows have been fairly close to net income.  Therefore, I’m estimating the growth rate of FCF to be about 6%.  Given that we are well into 2007, I’m estimating 2007 free cash flow of $1.189 billion.  I then projected future FCF out ten years and then discounted the present value of those free cash flows using a 10% cost of capital.  I also estimated the terminal value after 10 years using a sustainable growth rate of 5% (approximately equal to the long term nominal GDP growth rate). This gave an enterprise value of about $25.58 billion. The new company will have approximately $3 billion in net debt so my intrinsic value estimate is $22.58 billion or $45 per share (based on 500 million shares outstanding). TEL closed last Friday (July 6, 2007) at $39.82.  That’s only an 11% margin of safety.

Next we have Covidien.  Covidien is primarily a medical device manufacturer.  Medical device manufacturers often have patents on the devices that they develop that protect them from intense competition.  This likely provides Covidien with an economic moat. One drag on this competitive position are the weak commodity business lines in medical supplies and retail sales.  The company estimates that sales from these businesses could experience negitive growth in 2007.

Based on the companies guidance of 4 to 6% revenue growth, I’m going to assume that free cash flows are going to grow at about 6%.  FCF was $903 million in 2006.  Using a similar method of valuation as the one I did for Tyco Electronics, I came up with an enterprise value of $20.59 billion.  The Covidien will have $4.45 billion in debt after the spinoff and about $800 million in cash.  Therefore, my estimated intrinsic value for Covidien is $16.94 billion.  Using the diluted number of shares outstanding of 499 million, I estimate the intrinsic value of one share of COV to be about $34 per share.  COV last traded at $42.31 on July 6, 2007. There is no margin of safety on this one unless I got something really wrong in my valuation.

Finally, we need to look at the parent company, Tyco International, after the spinoffs.  I must admit that out of the three companies, I was biased towards Tyco International.  I think the parent company will be left with the widest moat business of the three companies.  The security and fire alarm systems have strong brands and likely have high switching costs. I believe the ADT and SimplexGrinnel are pretty strong brands. I see ADT sign up all over my neighborhood and back in college when I worked as a security guard for a summer I became familiar with looking a Simplex panels at all hours of the night. I’m guessing companies and individuals stick with the reliable brands that they know when installing security and fire alarm systems. I could probably go on an on about the competitive position of Tyco International, but I really should just move on to the valuation of this company.

Tyco International produced $1.05 billion in free cash flow in 2006 according to the investor presentation.  I’m estimating that FCF will grow at about 8% over the next ten years.  Then I assumed a 5% terminal growth rate after that.  I also used a discount rate of 10% and I started discounting back estimated cash flows in 2008, since we are already half way through 2007. I estimated the enterprise value of Tyco to be $26.67 billion. Debt after the spinoff will be $4 billion and cash with be approximately $3 billion, giving a negative net cash of about $1 billion. Therefore, I estimated the intrinsic value of Tyco International to be $25.67 billion.  There are approximately 507 million shares now after the recent 1:4 stock split. This gives you an intrinsic value per share of TYC of $50.60.  I was hoping that I’d get TYC at a discount but alas it is trading at $53.17.

I am curious as to what others have estimated the intrinsic value of each of these shares to be. Please share your estimates in the comments section below.

I was really excited for the Tyco spinoffs, but I maintained my discipline and decided to pass on this opportunity. Time will tell whether I was too conservative with my estimates. Regardless, I would rather pass up opportunities that turn out well than invest in money potentially overvalued stocks that could cause me to lose capital.  Of the three companies, my least favorite company, Tyco Electronics, currently provides the best value. However, I don’t think it provides a sufficient margin of safety.

Disclosure: I do not currently hold shares in any of the stocks mentioned in this article.

There were tender offers that appeared as plain as day.  It was clearer than crystal that tender offers could provide investors with opportunities. So I set forth with investments in Tribune Co. (TRB) and Navigant Consulting (NCI).

It was May 1, 2007. Sam Zell was offering cash for shares of Tribune Company, so I bought 99 shares for $32.76 per share.  The tender offer was set for $34.00 per share up to 126 million shares.  As you might have guessed by the number of shares I bought, odd lots (lots held by owners of less than 100 shares) would not be prorated if the offer was oversubscribed.  The result of this little transaction was beautiful.

On June 8, 2007, I found that $3,341.00 in cash had arrived in the Special Situations Real Money Port.  That was a net return of $90.81, which is a return of 2.8% after expenses.  That might look like a rather meager return, but it actually is a 26% average annualized rate of return since the transaction only took 39 days.  That’s right in line with the Special Situations Real Money Port internal rate of return.

The second tender offer began on May 10, 2007 when I purchased 85 shares of Navigant Consulting for $20.65.  I only bought 85 shares because thankfully I ran out of cash in the Special Situations Real Money Port.  Normally, I would have bought 99 shares for a tender offer with an odd lot preference in order to maximize my return. 

The Navigant Consulting tender offer was a modified “Dutch auction” with a price range from $22.50 to $19.50 per share. I usually try to avoid buying into tender offers when shares are trading significantly above the lower end of the tender price range.  However, I figured that I would be safe if I made my tender conditional on the offer being above $20.75.  I’ve observed that stocks tend to go up after tender offers are completed so I figured I would be safe if my tender was not accepted due to the condition I added.

Well, Mr. Market had other plans.  The market took are rather big tumble right before the June 7th expiration date for the tender offer.  The tender offer ended up significantly oversubscribed.  Everyone wanted to be cashed out of NCI it appeared.  The final tender offer ended up being for $20.50 so my shares were not accepted.  At the end, Navigant Consulting accepted for purchase 10,623,624 shares of its common stock at a purchase price of $20.50 per share.  Since the tender price was below my conditional offer, my shares were not cashed out.

Then something strange happened.  The price of Navigant Consulting shares plunged to $20.36 on June 8th and it is now trading around $20.  As of June 19th, I’m down 3.7% or $64.75 on this trade. 

This unexpected result for the Navigant Consulting tender offer caused quite a stir at Fat Pitch Financials Contributor’s Corner.  Shareholders could have gotten a better sale price just about anytime during the month of May.  This transaction was for 19% of outstanding shares, which is a larger than average tender offer.  Some members speculated that the resulting low offer was caused by the announced earnings that came in below trend just before the tender offer announcement.  Others thought that all the liquidity in the market is just looking for relatively safe opportunities like tender offers.  Are hedge funds and private equity now invading and overwhelming tender offers?  Maybe it was just folks ducking for cover as the market looked like it was starting a tumble. Join Contributor’s Corner if you want to jump into this conversation.

Two tenders, two very different outcomes.  One was for a large-cap company and for fixed price.  The other tender offer involved a mid-cap company and the offer involved a price range to be determined by a modified Dutch auction.  One was profitable and the other was not.  At the end, it was a wash.

It will be interesting to see how the next few tender offers work out.  It might be time for me to move back to focusing on going private transactions, but maybe this really does not mean anything given the results of the Tribune tender offer.  What do you think?

Let me recap the trades in the Special Situations Real Money Port this month. I took the cash I received for my MAXCO Inc. (MAXC) shares, and I used it to purchase 99 shares of Tribune Co. (TRB) at $32.76 per share. Tribune announced a tender offer that provided odd lot holders with a preference in the case of any need to prorate the tender offer. My shares were tendered for $34.00 on May 24th and I’m waiting to receive the cash for this nice odd-lot tender offer.

On May 2, 2007, I sold all my shares of Premiere Global Services (PGI) for $12.65 per share.  I had bought those shares previously on April 24th for $11.97 per share. This was a nice quick 5% gain. This tender offer was suppose to close on May 24th, but luckily I had a limit order in for the tender price of $12.65 and my limit was triggered early on May 2nd, thus saving me a $25 tendering fee.

I also bought 85 shares of Navigant Consulting Inc. (NCI) on May 10th for $20.65 per share. I would have bought 99 shares of this stock, but I ran out of cash in the account. This tender offer will be closing on June 7th. The dutch auction for this tender has a minimum price of $19.50 and a maximum offer price of $22.50. Hopefully, the offer will come in at the high end of the range.

The most significant change this month has been the rapid appreciation of my KBR Inc. (KBR) shares. My original investment in Haliburton (HAL) before the split-off of KRB was $3,174.95. My KBR ended the month of May valued at $4,322.21. That’s well over a thousand dollar gain so far. I’m considering locking in these gains with a stop order soon.

The bottom line is that the Special Situations Real Money Port ended the month of May with a balance of $12,239.27, of which only $28.66 is in cash.  If you would like to see the breakdown in all my current holdings and the complete history of the Special Situations Real Money Port, you can subscribe to Fat Pitch Financials Contributor’s Corner. The subscription will also gain you access to all my research in current going private transactions, odd-lot tender offers, and other special situation opportunities.

This weekend I read an article in Barron’s titled, ”Buckle Up!” by Jack Willoughby.  In that article, Mr. Willoughby reports that nearly 65% of money managers say it’s hard to find attractive stocks.  I found comfort in the following comment by Himanshu Shah, founder of Shah Capital Management, confirming my own thoughts:

“This market is not cheap by any measure. The pendulum has swung since 2002, and prices have been bid up by the presence of private-equity buyers and the anticipation of bids. The search for value now amounts to special situations.”

If you too have resorted to searching for value in special situations, not that that is a bad thing, join me and the other members of Contributor’s Corner in our pursuit of these opportunities.

Let me now discuss my analysis and rationale for buying Broadridge. First, I believe that Broadridge Financial Solutions will have a sustainable competitive advantage due to the high customer switching costs associated with their integrated security processing and investor communication services. Changing a back office service, such as the ones provided by Broadridge, involve considerable planning and could result in business disruption. Most companies will tend to avoid second guessing their non-core backoffice solutions unless a problem arises. 

It appears the highest risk of a customer switching to a different service provider occurs during mergers according to Broadridge statements.  There has been quite a bit of consolidation among brokerages over the past few years.  However, it has also been my impression that for every merger there seems to always be new firm that pops up afterwards.  We recently saw BrownCo and TD Waterhouse merge into E*Trade and TD Ameritrade respectively, but TradeKing, Zecco, and SogoInvest (I’m sure I missed others.) have emerged in their place. In addition, Wells Fargo and Bank of America have ramped up their brokerage services by offering free trading to their banking customers.  Given this dynamic market for brokers, expanded international interest in stocks, as well as the constant creation of new funds, Broadridge will have good opportunities for new growth in the future.

The next thing I looked at was Broadridge’s value.  For an initial quick and dirty analysis, I used the Graham’s formula to quickly value BR shares. The equation for this formula is:

P = ProjEPS * (8.5 + (2*G)) * (4.4/AAA yield)

I used $180 million for 2007 projected net income based on a recent Broadridge investor presentation (pdf). I divided that 180 by 139 million shares outstanding to get $1.29 in earnings per share projected for 2007 (ProjEPS).  Broadridge has provided guidance that their forward outlook is for 10-15% EPS growth.  I come up with a more conservative 9% long-term growth rate (G) based on the increase in pro forma earnings per share from 2006 to the low end of the projected 2007 earnings per share.  Finally, I adjusted the 4.4 in the equation for the required rate of return to 4.6 to more closely reflect the 10-year Treasury Note rate.  The long term AAA yield for corporate bonds is about 5.9%.  Using these inputs, I got the following:

(180/139.5)*(8.5+(2*9))*4.6/5.9 = $26.76

Given that shares of BR were trading for about $19.25, I thought there could be a margin of safety in this spinoff opportunity, so I did a bit more research. I ran a few discounted free cash flow models that I wasn’t too confident in but they mostly showed me intrinsic value estimates from between $25 and $55.  Therefore, I feel there is a margin of safety here.

There has been a bit of confusion regarding Broadridge’s EV/EBIT ratio on Value Investing News, so I decided to clear up that issue first.  I calculated the enterprise value (EV) by taking the current stock quote of $19.25 and multiplying it by 139 million shares.  Then I added in $690 million in debt and subtracted out 84.8 million in cash based on the December 31, 2006 pro forma balance sheet.  That comes to a $3.28 billion enterprise value.  Since 2007 is well underway, I decided to use the average projected 2007 earnings before interest and taxes (EBIT) of $343 million.  That gave me a EV/EBIT of 9.6 or an EY of 10.4%. I also calculated a return on capital for 2007 of about 22%, which is much higher than the company’s cost of capital. These fundamentals are very attractive.

My next question was whether institutional investors would dump Broadridge shares. Given that index funds have so much influence in institutional ownership of stocks and ADP is on the S&P 500, there was the potential that the new institutional owners of Broadridge would dump their shares.  However, Broadridge has been added to the S&P MidCap 400. I don’t believe the MidCap 400 is as widely held as the S&P 500, so there still might be some selling due to rebalancing. I was hoping that it would not be added to an index so quickly because I wanted the maximum potential spinoff discount resulting from institutional selling.  Regardless, shares of Broadridge did face some selling pressure and high volume for its first three days of trading.

It looks like the new management of Broadridge will be highly motivated to boost the value of this stock since they have started receiving generous stock option grants.  The CEO, Richard Daly, has already received a large number of stock options.  According to this Form 4, Mr. Daly on April 2, 2007 had over 494,140 stock options with average exercise price of $17.89.  Mr. Daly will be working real hard to boost the value of this company over the next few years in order to fully reap his rewards.

Some of you might be concerned about the $690 million in debt.  A high debt burden is fairly typical with spinoffs.  However, this leverage often acts to turbo charge future returns to shareholders.  It does add a bit more risk, but spinoffs usually enter a high growth phase that offsets the costs of this capital.  In Broadridge’s case, I’m a bit disappointed that the debt did not boost cash holding more. Most of the debt is going to pay off the parent company, ADP.

Finally, I believe the freeing up of Broadridge from ADP’s payroll and human resource focus will allow its management to better focus on fulfilling the needs of its financial clients.  It will be interesting to see how Broadridge develops over the coming year.  Hopefully, its new focus, independence, and motivation will lead this stock to a profitable future.

Full Disclosure: I own shares in ADP and Broadridge Financial Solutions.

What are split-offs?

Split-offs are a type of reorganization where the stock of a subsidiary is offered in exchange for shares in the parent company. A split-off differs from a spinoff in that the shareholders in a split-off must exchange their shares of stock in the parent company in order to receive shares of the subsidiary, whereas the shareholders in a spin-off do not need to trade in their shares in order to receive shares in the subsidiary. The key difference here is that you have to take action to opt into a split-off and you have to give up your shares in the parent company to receive shares in the subsidiary.

A split-off is also referred to as a tender offer exchange.  This is often how you will find split-offs described in regulatory filings at the SEC. I actually discovered my first split-off opportunity when searching for odd-lot tender offers. Mixed in with other tender offers, I first ran across a tender offer exchange that was being offered by McDonald’s (MCD), which I describe in more detail below.

Why are split-offs profitable?

There are four main reasons why split-offs are profitable for individual investors.

1. Exchange Premium: Split-offs often provide a premium for the share exchange. The split-offs I have participated in have offered a 7.5 to 11 percent bonus in the exchange of the parent stock for the split-off.  For example, I received $1.11 dollars worth of Domtar (UFS) for every $1 in shares of Weyerhaeuser (WY) I tendered in the exchange. The exchange premium gives you an automatic boost in your potential return.
2. Odd-Lot Preference: Split-offs are likely going to limit the number of shares that will be offered. If too many shareholders in the parent company opt to exchange their shares for the split-off stock, the amount of shares that are exchanged will be prorated to avoid an oversubscription to the offer.  However, many split-off opportunities provide an odd-lot preference that allows all stock tendered by shareholders holding less than 99 shares (i.e., an odd lot) to be exchanged first before any prorating occurs. Whenever I see an odd lot preference, I know that this is a clue that individual investors might have an advantage to earn profits.
3. Focus: A split-off often results in an increased focus of the parent company’s business, and also the split-off company is usually very focused in one line of business. A simplified business is often valued at a higher rate than a complex conglomerate. Some investors actually value businesses by summing values of the various parts of their operations. A split-off also often unlocks the value of stock in the subsidiary on the parent company’s balance sheet. In addition, the increased focus of the management of both the parent company and the split-off company tends to lead to better performance.  The expectation by most investors is that both the parent company and the subsidiary will perform better as separate and more focused companies.
4. Require Action: Split-offs are not something you can take advantage of by being a passive investor.  In order to capture the exchange premium, you need to purchase shares in the parent company and then call your broker with instructions to tender your shares. Many shareholders will never read the filings concerning a tender offer exchange and still less will bother to call their brokers to take advantage of such opportunities. Hedge funds and institutional investors won’t make such a mistake, but the profit potential for them is limited because of prorating. As an active individual investor, you are in a small minority and can take advantage of this potential market inefficiency.

I’m sure there are other reasons why split-offs tend to be profitable investments. Please share your thoughts below in the comments section on other reasons why split-offs tend to be good opportunities.

What are some examples of profitable split-offs?

McDonald’s Split-Off of Chipotle
My first experience with a split-off was with the McDonald’s (MCD) split off of Chipotle Mexican Grill (CMG.B). I first heard about the McDonald’s split-off of Chipotle in September of 2006. McDonald’s offered to exchange up to an aggregate of 16,539,967 shares of Chipotle class B common stock for outstanding shares of McDonald’s common stock. The exchange offer was designed to permit holders of McDonald’s common stock to exchange their shares for shares of Chipotle class B common stock at a 10% discount to the calculated per-share value of Chipotle class B common stock. Stated another way, for each $1.00 of McDonald’s common stock accepted in the exchange offer, the tendering holder would receive approximately $1.11 of Chipotle class B common stock, based on calculated per-share values, subject to a limit ratio and to proration. However, odd-lot holders were exempt from proration.

I purchased 99 shares of McDonald’s on October 2, 2006. The tender offer was going to expire at 4:30 PM on October 5th, so I contacted my broker to make sure there was still enough time to process the tender offer exchange.  All went well and on October 24th, I received 87 shares of Chipotle Mexican Grill class B shares (CMG.B) and $49.91 in cash. Since the class B were selling for a discount to the class A shares even B shares had superior voting right and it also looked like Chipotle’s incredible growth might continue, I decided to hang onto my CMG.B shares for a while.

I finally sold my CMG.B shares on February 27, 2007 for $56.90 after my $57.00 stop order was triggered.  I decided to place a stop order because I was getting nervous about the market. Never the less, I made $1,013.45 in net profit in 148 days.  That 26.1% gain produced an average annualized return of 64.4%. Given the impressive performance of this split-off, I decided to keep split-offs on my radar and also track them for members of Fat Pitch Financials Contributor’s Corner.

Weyerhaeuser Split-Off of Domtar
As my investment in Chipotle was coming to an end, I spotted a fat pitch opportunity in the announcement at the beginning of February that Weyerhaeuser (WY) was planning a split-off of their Domtar (UFS) subsidiary.  Under the terms of the offer, participating Weyerhaeuser shareholders would receive approximately $1.11 worth of Domtar Corporation common stock for each $1 of Weyerhaeuser shares tendered in the exchange offer, subject to a limit of 11.1442 shares of Domtar Corporation common stock per Weyerhaeuser share. There was also a provision that odd-lot holders would not be prorated.

I backed up the truck on this deal and purchased 99 shares of Weyerhaeuser in my Roth IRA and I also told my wife to purchase 99 shares of Weyerhaeuser in her account. Ideally, I would have both these shares in the Special Situations Real Money Port, but that account lacked sufficient funds.  I purchased the 99 shares in my account for $76.65. 

A few days later, I sent an email to my broker instructing them to tender my shares for Domtar.  I reminded them that I qualified for the odd lot preference. It cost me $25 to do the tender.  On March 15, 2007, I received 1,103 shares of Domtar in my account (my wife also received the same amount). I planned on selling them right away, but I was in a conference all day and I did not notice that the shares had arrived until after the market closed. However, the next day I quickly placed a limit order to sell my shares close to the previous day’s closing price. I was able to sell my shares on March 16th near the close of trading for $9.38 per share. I received $10,339.19 in cash for a net profit of $2,718.89 (a similar amount of profit was also earned in my wife’s account).  That was a gain of 35.8% in just 42 days!  That comes out to an average annualized return of over 311%. This deal went down in the record books as one of the best special situations I’ve ever invested in.

Where can you find the next split-off opportunities?

The Special Situations Real Money Port is already invested in the next split-off opportunity. Member of Fat Pitch Financials Contributor’s Corner know about this deal and you can too if you sign up.

I’m sure you can also discover this split-off opportunity in this very well known company on your own.  You will need to search through the thousands of recent SEC filings and dig through dozens of recent tender offers filed with the SEC. It will take you time to sift through all the filings and then you will have to read though the details on many of the individual deals. I do this daily, so I’ve built up some methods to save myself some time. Thankfully, some of the members of Contributor’s Corner also help keep me up to date with all the various special situation opportunities we track.

Regardless of whether you research split-off opportunities on your own or with Contributor’s Corner, you will likely also find many profitable opportunities in these somewhat rare and unique special situations opportunities.

Full Disclosure: I do not currently own shares in McDonald’s, Chipotle Mexican Grill, Weyerhaeuser, or Domtar.

So how well did I do?
I initially purchased 1,200 Western Sizzlin rights at $0.52 a piece for $630.95 on November 27, 2006.  I exercised my rights on December 8, 2007 for a $25 fee and an additional $4,200 for 600 Western Sizzlin shares at the $7.00 price the rights entitled me to.  Today, I sold my 600 shares for a net $5,993.05.  My net return from this trade was $1,137.10.  That is a 23.4% gain on my investment.  Since this deal took 100 days to complete, my average annualized return was 85.5%.

Rights Offering Details
The Western Sizzlin rights offering was basically an experiment on my part.  I wanted to learn more about rights offerings, so I thought I would dip my toe in this one and try it out.  Joel Greenblatt had great praise for rights offerings in his book, You Can Be a Stock Market Genius.  I’ve never really spotted one in action before, so I decided that this would be a fairly low cost learning experience. I was also interested the Western Sizzlin rights offering because I know Bill Mann of the Motley Fool also has been a long term holder of the Western Sizzlin common stock.  He usually has a pretty good knack of finding value.

The details of this rights offering are provided in the Western Sizzlin rights offering prospectus.  In a nut shell, the Western Sizzlin rights offering provided every shareholder at the close of business on November 9, 2006 with 2 transferable subscription rights for every share they owned of the common stock.  Every 2 rights would allow you to “subscribe” to the Western Sizzlin stock offering at $7.00 per share. On November 8, 2006, Western Sizzlin’s stock was selling for $9.00 per share.

Since the rights were transferable, the could be bought and sold.  The rights traded on the OTC Bulletin Board under the symbol WSZLR.  The rights would then expire on December 8, 2006 unless the period was extended by 15 days.

Since I bought my rights for $0.52 per share, I essentially bought 600 shares of Western Sizzlin for a total price of $8.04.  Let me break that down.  To subscribe to one share of Western Sizzlin I needed 2 rights, which I bought for $0.52 a piece.  It also cost $7.00 a share for Western Sizzlin at the discounted subscription price.  Therefore, the total was $1.04  ($0.52 x 2) plus $7.00, which is equal to $8.04.

I assumed at the time that new holders of the rights would likely dump them.  This did not really happen right away.  I got impatient so I ended up kind of overpaying at $0.52 per right.  The market for the shares of Western Sizzlin drifted down in price rather dramatically at the beginning of the rights offering to where it was actually cheaper to buy the stock outright without buying the rights and subscribing to the offer.  My theory was that this might have happened because the rights might have been easier to buy into because they were more liquid at the time. My estimate at the time was that WSZL was worth somewhere between $9 and $11.  I was betting that $8.04 was an artificially cheap price and that I would soon sell it for some price closer to $9.00 per share.

The price of the rights drifted down to $0.45 shortly after I made my purchase.   A week or so later I believe the rights traded down to around $0.15.  Now, that would have been a great price to purchase rights.  As we often observe, patients usually pays off.

To excersize my rights, I had to send my broker instructions.  I believe I sent my request in at the beginning of December.  You want to make sure you give your broker enough time before the expiration date to complete the transaction.  Most brokers need at least three full day before the expiration date to complete a request.  My broker recommends a week to be on the safe side.

Part of the instructions to your broker should also involve addressing any oversubscription privilege associated with the rights.  The oversubscription privilege entitles you to subscribe for and purchase additional shares of common stock not purchased by other rights holders through their basic subscription privileges. The Western Sizzlin rights provided an oversubscription privilege.  However, the prospectus said the following:

“You will be entitled to exercise your oversubscription privilege only if you are a stockholder on the record date and exercise your basic subscription privilege in full.”

The record date was November 9th, so I figured I missed out on the oversubscription privilege.  I was also out of cash in the Special Situations Real Money Port at the time, so this was no big concern.  However, I noticed that the price of the rights trading looked as if buyers anticipated having the ability to oversubscribe.  One of the members of Contributor’s Corner, morning son, actually did request to purchase any shares that were oversubscribed even though he bought his rights after November 9th and he still received 84 shares during the oversubscription period along with the 400 shares he aquired by excersizing 800 rights. This really did not make sense to both of us unless maybe his broker transferred the rights internally. Does anyone else have any insight to shed on the oversubscription privilege process that might shed light on this apparent inconsistency?

Another strange thing occurred with my rights.  It took me much longer to receive my shares than it took another member of Contributor’s Corner to receive.  I only got my shares of Western Sizzlin on January 30, 2007.  That is well over a month after the rights offering was completed.  I think my broker caused some kind of delay and that delay caused me to miss out on some initially better prices for Western Sizzlin.  Luckily, Sardar Biglari is really pushing hard to generate value for Western Sizzlin and the price has spiked up recently.  Actually, today WSZL even reached $11.30.

Lessons

I learned quite a few lessons from this experience. I think it would have been better to be holding WSZL before the rights issue, because then I would have been given one right for free for every two shares that I held.

One thing to note, Greenblatt only recommends rights offerings for spin-offs in his book. I didn’t remember that when I first jumped in on this deal. I guess my memory of the book had faded a bit. I think I’m going to stick to spin-off rights offerings unless I develop a better understanding of recapitalization rights offerings like the Western Sizzlin one or I get the rights for a significant bargain when the market is not being efficient at pricing the rights relative to the common stock.

I discovered that I like the management of Western Sizzlin.  They are very straight-forward and Sardar Biglari appears to be a top notch value investor that might turn Western Sizzlin into a mini restaurant Berkshire Hathaway.  If the price of Western Sizzlin drops in the future, I might even add this stock as a permanent holding.  I did not keep Western Sizzlin because all the event driven activity on this stock is pretty much over now and the Special Situations Real Money Port is not the place for my long term holdings.  Maybe someday, Western Sizzlin might end up appearing in the Fat Pitch Financials Port instead, where my long term picks reside.

Full Disclosure: I no longer own shares of Western Sizzlin.

We last discussed the performance of my special situation portfolio at the beginning of the year when I told you how I did in 2006. Now that we are two months into 2007, it’s time to give you another update.  Only two transactions have occurred since the beginning of the year.  On January 30th, I received 600 shares of Western Sizzlin (WSZL) as a result of excersizing 1,200 rights to purchase Western Sizzlin that I bought back on November 27, 2006 for $0.52 per right.  The Western Sizzlin rights allowed me the purchase one share of Western Sizzlin for every two rights and $7.00 per share.  I exercised my rights on December 8, 2006 to acquire 600 shares of Western Sizzlin.  There was the option to request additional shares for $7.00 in case not all the rights were excersized, but I was out of cash and the terms indicated that you had to have been the original recipient of the rights.  However, another member of Contributor’s Corner indicated that they were able to receive additional shares of WSZL via over-subscription even though they bought rights on the open market.  I’m up about $634 dollars as of February 28th.  I have an order in to sell these shares when they reach my limit price.

In addition to the Western Sizzlin activity, I also contributed another $2,000 to this account on February 9, 2007.  Each year I contribute the limit to my son’s Coverdell Education Savings Account.  I have yet to invest this $2,000 but I’m sure I’ll find the right opportunity within the next few weeks.

In summary, I’m currently holding the following in this account as of February 28, 2007:

• Cash: $2,106.09
• 300 shares of Sally Beauty Holdings (SBH): $2,715.00
• 600 shares of Western Sizzlin (WSZL): $5,490.00

My performance for the first two months of 2007 has been 76.1%.  This is primarily due to the returns on Western Sizzlin. Since inception on October 19, 2004, the rate of return for the Special Situations Real Money Portfolio has been 19.1% IRR.  I have really recovered from some of the setback this portfolio faced in 2006.  When I last reported the performance for the Special Situations Real Money Port, my rate of return since inception was 14.5%. I’ve improved my overall performance fairly dramatically this year so far. However, my goal is to try to increase my rate of return to at least 20% since inception by the end of 2007.  Given my current performance, I believe that maintaining a 20% rate of return is a very attainable goal.

If you would like to keep up with every move of the Special Situations Real Money Portfolio, consider signing up for Fat Pitch Financials Contributor’s Corner. In addition to timely updates on transactions in the Special Situations Real Money Port, you will also gain access to a list of current going private transactions, odd-lot tender offers, and other special situation opportunities that you probably won’t read about anywhere else. There is also a very active forum where other members (many of whom are performing even better than I am) discuss their current special situation and risk arbitrage investments. I encourage the sharing of ideas by rewarding members who provide information 3 free days for each contribution they make. I get a lot of great ideas from fellow member this way, and I’m sure you will too if you join.