Do You Invest in Special Situations?

After the prior posts about investing in great businesses, with honest and competent management teams and a reasonable valuation, many people ask us about some of the special situation investments they hear us talking about or read in our quarterly letters.
 
In other words, don’t you guys invest in other types of situations also?
 
Well the answer is yes but we wouldn’t recommend trying it at home unless it’s the only thing you are going to do.
 
That being said what are these special situations? Generally, these are stocks that are being sold off for a reason other than the business is doing worse than expected.
 
Stocks sell off all the time, but most of the time there is a good reason. Earnings were worse than expected. The CEO resigned. The company is entering a legal battle and may have to pay a large settlement.
 
But sometimes stocks sell off for purely technical reasons.
 
A technical reason is where the owners receive stock in something that they didn’t originally intend to own. The most common of these are called spin-offs and post-bankruptcy reorgs.
 
A spin-off is where a bigger company creates a new company that is comprised of a smaller portion of its business. Therefore, the owners of the bigger company now have two stocks, the big company they originally wanted to own and the smaller company they don’t care about.
 
Guess what they do with the stock of the smaller company…they sell it! Without regard to its economics or intrinsic value. Therefore we track every spin-off and step in and buy when the price gets crazy.
 
The second most common situation is when a company comes out of bankruptcy with a much better balance sheet and the owners of the stock are now the debt holders who exchanged their old debt for stock (the prior stockholders were wiped out).
 
Guess what they do with that stock…they sell it! They are usually debt funds and often aren’t even allowed to hold stocks. This gives us another chance to step in and buy at crazy prices purely due to technical reasons.
 
Historically, there weren’t that many people who followed these things. Today there are many more, which makes it more difficult. But there are still opportunities out there to those of us paying attention.
 
So yes, we do invest in special situations, but we don’t recommend you try it at home!

All the best,

Your Fortis Capital Management Team