Special Situations or “Workouts”

As you might have noticed, I often talk about special situation investing here at Fat Pitch Financials. However, I just realized that I don’t believe I’ve ever defined what I mean by this term.

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?

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