Special situations in investing are potentially lucrative, aming to seize short term opportunities for outsized gains, but not always easy to identify. This week we take a look at three types of these situations.
When you hear value investing you probably think Warren Buffet and Berkshire Hathaway; growth investing might conjure the more recent example of Cathie Wood and her ARK Innovation (ARKK.NYSE) fund and on the more exotic end, quant investing may bring to mind Jim Simons and the Renaissance Technologies’ Medallion fund.
There is, however, another breed of lesser discussed investor; the special situations investor. These investors look to profit, in the short term, from opportunities that present themselves. There are myriad opportunities but we will examine three common ones.
This is a classic special situation; one company makes an offer for another and the target’s share price rises but trades below the offer price. The opportunity is in buying the target, riding the price up till the deal closes and harvesting the difference. Typically, as conditions to close (successful due diligence by the acquirer; approval from shareholders of the acquiree; regulatory approval if required etc) are ticked off the market price will converge to the deal price.
The acquisition of TAMIM holding Uniti Group Limited (UWL.ASX) was a text book merger arbitrage opportunity. A telecommunications and digital infrastructure entity holding infrastructure assets that have been in demand with several similar entities acquired in 2021.
The below chart shows the share price (SP) movement from $4.12, when UWL first mentioned discussions with parties in relation to a takeover, to $4.99 after a binding scheme implementation deed was signed, a 21% gain in just under three months.
Not all mergers are created equal. On the other end of the scale is Elon Musk’s bid for Twitter (TWTR.NYSE). When he emerged as the largest shareholder the price was $49 and a merger agreement was subsequently signed for $54.20. Musk has since sought to terminate the deal and the SP is currently in the mid $30s. A world of pain (so far) for those who tried to arbitrage to $54.20 but is it NOW a great merger arbitrage opportunity? Plenty to play out still and a lot for any investor to ponder in that trade.
Large scale global events can have material effects on markets and particular companies. Let’s take the current war in Ukraine as an example.
On 10 November 2021, the United States reported an unusual movement of Russian troops near the border of Ukraine. By 28 November, Ukraine had reported a build-up of 92,000 Russian troops.
On 7 December, US President Joe Biden warned President of Russia, Vladimir Putin of "strong economic and other measures" if Russia attacked Ukraine. This signalled the willingness of the United States to assist, potentially militarily through supplying weaponry. This was bullish for American defence contractors with Lockheed Martin (LMT.NYSE): and Raytheon Technologies (RTX.NYSE) two of the leading firms in the space.
The chart below shows the SP performance of the two entities with the eventuation of the invasion on 24 February 2022, providing a good exit with returns dependent on how early (brave) you entered the trade. This trade was also counter to prevailing market conditions, providing an even greater relative return.
Sometimes a particular product or service can be impacted by supply and/or demand dynamics which create an opportunity. Earlier in 2022 an infant formula shortage gripped the United States. This provided an opportunity for other nations/companies to assist in filling the void. The two best known infant formula (IF) companies on the ASX are The a2 Milk Company (A2M.ASX) and Bubs Australia (BUB.ASX).
The shortage was due to the compounding of a number of issues:
The recall would have had some special situation investors taking notice as that took things from difficult to crisis point.
Out of stock rates for IF are normally 10% but by the end of April had risen to ~30%; mid-May to 43% and 70% by the end of May. On 30 May 2022 BUB announced it had been granted immediate permission to import infant formula into the USA and had an agreement with the Biden administration to provide at least 1.25m tins. The share price rose 40% that day, providing an exit.
Note however, that A2M was in a down trend all year (also dealing with issues like a covid-exposed reliance on the Chinese market and Diagou trade and class action lawsuits) and by the end of June was 30% down from the start of the year. Special situations are certainly not risk free.
In 2021, a similar trade (based on demand of a service) was buying Australian Clinical Labs (ACL.ASX) as COVID intensified in Australia and demand for (government subsidised) PCR testing skyrocketed.
As we have seen, special situations come in many forms. The intention is to profit in the short term which can deliver outsized returns, sometimes counter to the market trend. That said, there are risks involved both idiosyncratic (i.e. the company you invest in may have issues specific to itself that derail the investment) and systematic (i.e. prevailing market conditions increase the likelihood of failure e.g. A2M).
Finally, it’s important to keep in mind your thesis and realise your gains when the special situation plays out or, if it doesn’t, cut your losses.
Disclaimer: UWL is currently held in TAMIM portfolios.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.