Special Situation Investing : A Guide to Low Risk Investments

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April 24, 2022

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What is Special Situation Investing?

Special situations are distinct from the common occurrences in which businesses find themselves. It could take the form of a buyback, stock split, spin-off, tender offer, stake sale, merger, acquisitions, litigation, shareholder activism, bankruptcy, capital structure changes, CEO resignation, strike, lockout, or any other event that affects the company’s future prospects. Such circumstances present an investment opportunity for those who can anticipate and evaluate the significance of the opportunity ahead of time.

A special situation in investing is a once-in-a-lifetime event involving a company or other asset that investors view as a buying opportunity. When corporations engage in particular financial activities that are perceived to bring value to their shareholders, the exceptional and special aspect comes into play. Raising funds, changing the corporate structure, mergers and acquisitions, reorganization, spin-offs, delisting, buybacks, and asset sales are all examples of financial transactions. 

Investing in unusual situations has three distinct characteristics: 

  1. Generally, opportunities arise as a result of company initiatives. 
  2. The risk that is estimated and expected should be kept to a minimum. 
  3. The majority of the information required is already available.

This information can be obtained through a business’s announcement to the exchange, news releases, corporate notices, investor presentations, and so on.

Special Situations

A special situation is a one-of-a-kind event that motivates investors to purchase a stock or other asset in the expectation of a price increase. 

By definition, the unusual situation has little to do with the stock’s underlying fundamentals or any other factor that investors use to make investing decisions. It’s an attempt to profit on the special situation’s potential for increased valuation. Here are a few special situations that could lead to gains for investors:

Spin-Offs & Demergers

Spin-offs and demergers entail the transfer of some of a company’s business division’s assets and liabilities to a news organisation. As a result, the parent company’s stockholders receive shares in the new organisation. And the combined value of shares, i.e. the parent company’s shares plus the spin-off unit’s shares, is higher than in the previous situation. 

 Many significant corporate organizations, including Reliance Industries, Bajaj Auto, Max India, IIFL, Aditya Birla, and the Adani Group, have done so

Mergers & Acquisitions

Acquisitions are widely used as a long-term strategy for business growth. Merger and acquisition (M&A) activity is generally the indicator of a mature business looking for new development in a mature industry. Acquisitions, on the other hand, have recently been employed as an incubator centre or to broaden a company’s products. Byju’s recent shopping spree is an excellent example of this. 

In a specific situation, these mergers and acquisitions can result in some substantial and speedy rewards for investors who notice these changes.

Take, for example, the merger of Ponds India and Hindustan Lever Limited a few decades ago. Three shares of HLL were offered for every four shares of Ponds India under the merger scheme. Thus, one Ponds share was valued at roughly Rs. 1,250, while four Ponds India shares were valued at nearly Rs. 5,000. 

HLL was trading at Rs. 1,960 per share at the time. This means that a savvy investor might acquire four Ponds shares for Rs. 5,000 and convert them into three HLL shares at Rs. 5,880. In just over three months, an investor would have made a profit of Rs. 880 on a Rs. 5,000 investment.

Ponds India’s merger with HLL was a one-off event that provided investors with an opportunity to make some quick and healthy profits. Price differences have occasionally arisen during mergers and acquisitions. In consequence, the mispricing creates a unique position for a limited time, allowing opportunistic investors to profit quickly and with minimal risk.

Change in Promoters

New promoters bring new energy. Neil Bahal, Founder & CEO of Negen Capital is 

a firm believer in the potential of this changing special situation for a better investment. 

Take the example of Max India, whose questionable corporate governance standards led the valuation of the share to fall consistently for a few years and trade at a discount compared to its competitors.

This was followed by the demerger and change in promoters, with turnaround specialists – US-based private equity firm KKR and Abhay Soi, Promoter, Chairman, and Managing Director of Radiant Life Care Private Limited splitting the hospital business from Max India to form Max Healthcare. Radiant and Max Healthcare merged on June 1, 2020, leading to India’s second-largest hospital corporation by revenue.

The EBITDA margin grew from 8 to 9% to more than 20%. The stock price rose to Rs 240 per share in April 2021 from Rs 48 per share in April 2020. 

Warren Buffet’s Investment Strategy

Special scenario investing has been used by some of the greatest value investors of all time to achieve greater stock market returns. Great investors like Warren Buffett have made a career out of taking advantage of these changes, while the majority of investors have run for cover at the first sign of trouble. 

During his stint as CEO of Buffett Partnership Ltd, he used special situation investing to produce a 31.6 percent compound annual growth rate (CAGR) and to outperform the Dow by more than 20% yearly.

An analysis was done by Ben Carlson, CFA clearly demonstrates the success of Buffet’s outperforming strategies. 

In 1965, Warren Buffet bought the share of Berkshire Hathaway at a price of $14.86/ share in the hope of turning around the business to make it a profitable venture and investment. Failing to do so, he then started using Berkshire Hathaway as his investment vehicle – acquiring other businesses to turn them around. 

The Berkshire Hathaway stock currently trades at $515,815/ per share. Warren Buffet is a testament to the efficacy of special situation investments, where turning a crisis into a search for unexpected opportunities is the way to proceed.

What to Look Out For?

In such cases, an investor should search for price dislocation or mispricing in the stock. Given the current circumstances, the market has discounted the firm’s stock and it now trades for less than its actual value. As the name implies, special situations do not occur very often, and if one can identify and select the right stock, it can result in very substantial returns when compared to traditional investments. Furthermore, unusual scenario investing returns are almost impervious to market risk. Brexit, a business demerger resulting in a subsidiary’s IPO, and even a quick rupee appreciation are all examples of unusual circumstances.

Understanding the Risks

Special situations may have significant yields, but they also have their own set of obstacles. First, the returns will not be linear because they will be determined by market-specific situations. Furthermore, not every case will result in a large payout. During bull runs, special scenarios would be limited. 

Finally, investment science literature shows how the stock market reacted to each of these unique situations, from buybacks to de-listings. However, before investing on their own or through special situation funds, investors should conduct their own due diligence.

Very important note: The objective of this blog is to share knowledge and info about multibagger ideas/opportunities. Neither is this trading website nor an analyst website nor a Buy/Sell call website. For stock market success, always do your homework, own analysis, and make your own decisions.

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The author of the blog Mr.Suyog Dhavan is a Full-time Investor / Value Trader and Value investing/Trading Mentor. His style of Investing is inspired by Mohnish Pabrai, Peter Lynch, and Porinju Veliath. He is the founder of Strategic Alpha Wealth, A Premier stock market mentorship firm with a mission to touch the lives of 1Lakh people through its mentorship program.

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