Special Situation Investing

Wednesday, December 20, 2006

Morgan Stanley (MS) to Spinoff Discovery

Just a quite note that Morgan Stanley has announced it will be spinning off it's Discover credit card unit. From the article:

The move comes as rival Visa International plans to go public in 2007, following in the footsteps of Mastercard Inc.'s banner listing earlier this yea

Morgan Stanley Chief Financial Officer David Sidwell said the outlook for Discover is bright. The announcement of the spinoff comes at a time where credit card companies are white hot -- Bank of America Corp. earlier this year acquired MBNA Corp. for $35 billion, and shares of Mastercard have doubled since their May 2006 debut.

Discover's fourth-quarter profit more than tripled to $199 million. By comparison, Morgan Stanley's retail brokerage profit rose to $171 million from $84 million last year.


The spinoff is expected to cost Discover up to $50 million in higher funding and overhead costs. The spinoff is expected to add up to $95 million per year in costs for Discover, and the company sees some $40 million of overhead savings annually.

Apparently, the spinoff may result in a downgrade to the new unit's credit rating:

Moody's said it will review what effect the "removal of implied parental support from Morgan Stanley" would have on Discover's credit.

Fitch Ratings said it may downgrade Discover's debt because the credit card issuer's credit is tied to support from its parent.

Standard & Poor's said it isn't considering downgrading Discover's debt because it thinks Discover's business prospects are unchanged.

Too early to give much of an opinion on this one. Let's see how it prices.

Information Collection

There is a vast quantity of financial information out there on the internet. The process of scanning through this information to find stocks that interest you can be quite daunting. Personally, I don't really have a single method to obtain special situation info. I mean I go to blogs, scan yahoo/google finance, read Business Week/Fortune/Barrons, do searches with google, it takes a LOT of time. So anytime somebody can suggest a method to optimize the search process I am all ears.

Alex Bossert sent me an email with a few good links. Actually the first and last link are more than just links, the parameters in the URL initiate searches on the SEC website. You still have the process of clicking on all the links and scanning through the documents to figure out the scoop but this is still faster than many other methods. Well anyways, here is Alex's email:

I have a few reasources that you might find interesting to help find special situations.
These are the sites i use:

This site profils special situations often:
Going private transactions can sometimes be very rewarding:
Going Private Transactions

If anybody else has any suggestions on methods to search for special situations I would love to hear them.

Thursday, December 14, 2006

South Street Financial Corp (SSFC) - Buyout Arbitrage

Thanks to Michael Guzzo for pointing out a good arbitrage opportunity on his blog. The arb is on a tiny bank South Street Financial Corp (SSFC). The company has recently announced it's plan to delist in order to cut costs. That doesn't really interest me too much. What I did find interesting was that (as pounted out by Mike) in their announcement they have indicated that shareholder of less than 750 shares will be converted to preferred shares on a 1 to1 basis. The preferred shares can then be converted for $10 per share each. Currently the stocks are trading in the low $9 range, offering a decent arb return should your account be small enough to benefit within the 750 share limit. In my opinion, it is this 750 share limit which is keeping the share price down as the usual special situation players, hedge funds, probably couldn't be bothered with this one. In fact, most instiutional holders would be motivated to sell due to the delisting and subsequent absence of reporting.

Where it gets a bit dicey is the date of the transaction and whether or not it will go through. Apparently there will be a special shareholder meeting in March, during which the delisting move will be voted on. At this point, I really don't have a very good feel for how long it will actually take to delist. On top of that, it is unclear whether or not the vote will go through.

In spite of these concerns, I am going to add SSFC to my own portfolio but won't be tracking it on the blog since it is such a small gain. In my opinion, the vote will probably go through as presumably management has talked to some of their larger shareholders about the deal. If the vote fails, well SSFC was pretty much trading in this range before the announcement so I see little downside. I am hoping that the transaction can be concluded in 3-6 months after the vote but that is pure speculation on my part. The company pays out a dividend of $.10 per share per quarter, so I will be getting over 4% while I wait. Considering that I bought my shares today at $9.08, I should get a 10.1% capital gain plus the dividends. I consider this an attractive and relatively safe arbitrage.


Do your own research on this and all securites mentioned on this blog. I am in no way recommending or endorsing this or any securities discussed on this blog. All information on this blog is purely my opinion.


I have been thinking quite a bit about the timing for the repurchase of the preferred shares. What I have concluded is that this would probably need to coincide with the application for delisting but could actually take place (this is speculative on my part) before all the actual paperwork goes through. The key component seems to be that the company has fewer than 300 shareholders to get delisted. It would seem then, that in order to reduce the number of shareholders the conversion to preferred shares would take place first.

In other words, it is my opinion that I will be able to exit out of this position a little earlier than I originally anticipated. If the vote goes through, then perhaps 1-3 months would be more accurate. At any rate, this is looking like a better and better play the more I dig into it.

A couple of references:

General information on going private. The article mentions the 300 shareholder limit and a 3-week wait for delisting. Deregistration takes a bit longer, the SEC has 90 days to approve this. In the case of SSFC preferred shares, I do not believe it is an issue as the preferred shares should be issued prior to de-registration.

A press release from Bennet Environmental which is filing to delist from the Amex. The press release was issued on Nov 22, requesting delisting take place on December 14.

Take Two Interactive (TTWO) - Sold Out Position

I sold my entire position in TTWO today, for $20.14 per share. I originally got into TTWO in August at $10.62 per share. Excluding transaction costs, this resulted in a gain of 89%.

My reason for selling was simply that I thought the stock got ahead of itself. Very little has fundamentally changed since August. There is still an ongoing investigation, the company may still be de-listed and they have yet to product a new blockbuster (although Bully is doing quite well). The market, in it's mania, just got very excited about video game companies recently. For the stock to go up 89% when so little has changed just doesn't make any sense to me. Hence I sold out.

Now this is not to say that Take Two is a bad company, it just isn't a bargain anymore. I would love to see it dip down again and would take a new position. In the meanwhile I'll look for other opportunities.

Tuesday, December 12, 2006

Medtronic (MDT) to Spinoff Defibrillator Unit

Medical device manufacturer Medtronic has announced that it will be spinning off it's external defibrillator business. Apparently the main motivation is to shed slower growing operations. The spinoff has potential as the new company will be quite small compared to Medtronic. The new company is expected to have a market cap of $700 M to $1 B compared to Medtronic's $62 B market cap. It is possible that some institutional selling will ensue as the new company may not make it into the major indexes. The spinoff is expected to be completed in the first 6 months of Medtronics 2008 fiscal year, which starts in May.

From the article:

Medtronic Chief Executive Art Collins said the company's board chose to spin off Physio now so the parent company can focus on devices for chronic diseases, in markets with larger profit margins and more growth potential than defibrillators. The Minneapolis-based company, with a market value of $61 billion, makes a wealth of devices ranging from cardiac pacemakers, to neurostimulators, to insulin pumps.

Physio-Control believes it will have more control over its own destiny as an independent company, and will be able to attract more investment for its Lifepak line of products, said Webster. The division will also presumably have more stable management than in recent years, when it became a revolving door for up-and-coming Medtronic managers.


Physio-Control will now compete directly with several companies in the defibrillator market, including giant Philips Medical Systems, Zoll Medical and Bothell-based Cardiac Science.

Saturday, December 09, 2006

Debt and the Ratings Agencies

Found a good article on the power that Ratings Agencies such as Moody's and S&P are currently wielding over general investors. The article points out that just a few years ago, during the bust, their was a lot of investor hatred towards these companies. However, now that the economy is steaming along all seems to have been forgiven in spite of the fact that nothing has fundamentally changed. I know, I know, fairly typical wall-street stuff but just a reminder to always be vigilant.

A few good points from the article:

At the same time, the agencies have been generating higher revenue by rating complex debt instruments called structured finance. Moody's revenue from structured finance increased 30 percent last year, while those from corporate finance rose only 7 percent, Peters wrote. Similarly, structured finance ratings contributed 40 percent of 2005 revenue growth at S&P.

That renews the question, "Are they willing to 'bite the hand that feeds' going forward? We think probably not," Peters wrote.


"Frankly, it is unhealthy for a $20 trillion tradable credit system to be subject to the whims and vagaries of the ratings agencies, no matter how well intentioned they may be," Peters wrote. "Last spring's correlation hiccup and market disruption on the heels of ratings downgrades in the auto sector is just a sneak peek of the credit world to come, in our view."

Anyone who has read this blog for awhile will know that I am not the hugest fan of debt and this just further strengthens my opinion. Debt levels keep ballooning, banks are reducing their reserves a a percentage of liabilities, equity overloaded with debt is barely marked down, it just goes on and on. I think ultimately their will be a price to be paid for this. As the value-investor saying goes, I don't have a crystal ball, but I do know a couple of things. Inflation and interest rates are at low points not seen since the fifties. Ultimately if interest rates were ever to rise, which sure as hell has happened before, a lot of these overloaded junk stocks & associated bonds that keep getting floated are in a lot of trouble.

This is not all a doom and gloom post. You will notice I said previously that companies which are overloaded with debt don't seem to be marked down sufficiently. Well by that same logic companies which are in good financial health are not being marked up enough relative to their debt-burdened peers. I think that if there is any general category of value in the market right now, this is where it is at. High quality companies with good finances are being treated like garbage by the market. Many hedge fund managers even go after them to raise more debt! I mean there is actually a derogatory term for low-debt companies, 'under-capitalized'. Well I'm not buying into Wall Street's obsession with debt. Too much of it is piggy, short-term thinking where the firms are only considering their own goals with no regard to what the future may hold. No matter what these types say, a strong balance sheet is still a good determinate of value.

Thursday, December 07, 2006

Apollo (APOL) - Purchasing Shares

Just a note that after all the commentary and a little more review on the situation, I have got to the point where I have committed some capital to Apollo. For the record, I got in today at $38.62. I feel that this is a decent (but not outright dirt cheap) entry point for a fundamentally high quality company. That being said, do your own research on this and all stocks mentioned on this blog.

Saturday, December 02, 2006

Duke Energy (DUK) - Spinoff a Potential Catalyst

Business Week draws out the argument for why Duke's impending spinoff of it's natural gas business may be a boon for the stock. According to Daniel Ford who advised on the spinoff:

The "narrowed management focus, more efficient use of capital, and removal of what appears to be a conglomerate discount on Duke's price will fuel expansion [for both companies],"

He goes on to peg a valuation to Duke:

Ford says that, on a sum-of-the-parts basis, Duke is worth 21 a share, and the gas spin-off 14.

Consider that the stock has traded in the $26-$32 range and it's rated post-spinoff at $35. The stock finished trading on Friday at $31.69, so it will seem the potential upside is less significant than the downside. I personally am going to sit this one out. In spite of my negative opinion given what I have been seeing with the last few spinoffs (WU, SBH, HBI), I would not be surprised if this is a money-maker.

With many spin-offs, the sum-of-the-parts have actually traded several percentage points higher the very day that the spin-off occurs in spite of the fact that the transaction was announced months in advance. How this works absolutely dumbfounds me but there has been easy money to be made on these deals. However, I am just not that kind of investor. Until I see a company being spun-off that is actually reasonably priced and has promising business characteristics I will wait. I already have natural gas investments through Apache and given my inability to pick commodity prices that is enough exposure for me.