Good morning my dear readers,

A very happy Friday morning to you.

Today is a day of revision on Special Situations.

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"Both spin-offs and merger securities are distributed to investors who were originally investing in something entirely different. Both spin-offs and merger securities are generally unwanted by those investors who receive them. Both spin-offs and merger securities are usually sold without regard to the investment merits." Joel Greenblatt.

The above words have shaped my outlook to markets and especially changed my outlook to value investing.

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Apples for Apples example

If there are two hypothetical companies (Company A & Company B) under a conglomerate or a 'holding company' structure.

Lets say these are holding companies, which usually trade at a significant discount to fair value due to their complicated structuring.

Now, if company A has a plan to reverse merge or spin off some assets while company B has no such plans, it is very likely that Holding company A is likely to end up creating value versus company B.

(Considering all factors like discount to fair value, sectors etc are same, hypothetically).

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Hence, if I were to spot value investment opportunities in the stock market where Company A and Company B have similar structures and characteristics, I would most often select to invest in the 'Value Investment' which was undergoing a special situation versus the company which was 'just cheap' but had no immediate plans for value unlocking via demerger, delisting, reverse merger, new promoter etc, i.e, special situation.

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And as always, whenever there is a spin off which you like for investment, always investigate if there is 'promoter buying' also in the demerged entity.

(That is like reading the promoters cards at a hand of poker, you would know what the promoter thinks about the company's future prospects).

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Very often, such demergers will also have a serious lack of available information and thats why investors ignore such special situation opportunities.

Hence, for a diligent investor, these events are a great time to do real on-ground scuttlebutt.

Head to the factory, AGM, EGM, talk to their customers, vendors etc. This can often give you useful hints.

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Personally, I do not see this spin off 'anomaly' going away in the future too. Most often, the large shareholders advice management to 'weed' out the non-core, smaller assets to 'create value'.

And guess what, post demerger, once these very large shareholders get fractional or small amount of shares of these non-core, smaller asset which they themselves asked the management to discard from the parent company, then these big shareholders are usually sellers post the listing of the spin off entity.

And often, these smaller non core assets are pocket change for them...its usually 3-5% of their overall investment, hence they dont care very much about how and at what valuation they end up selling these new spin off entites.

(It doesnt move the needle for them, but for the diligent special situation investor, it matters very much).

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Ok, now the paragraph below is slightly new language and maybe complicated for new or part time investors, but try nevertheless.

“Work-outs – these are the securities with a timetable. They arise from corporate activity – sell-outs, mergers, reorganizations, spin-offs etc. .. the category produces more steady absolute profits from year to year than ‘generals’ do. In years of market decline it should usually pile up a big edge for us; during bull markets it will probably be a drag on performance. On a long term basis, I expect the workouts to achieve the same sort of margin over the Dow attained by generals.” Warren Buffett 1966 letter to shareholders.

Basically Warren Buffett is saying that Special Situations (he used to call them 'Work outs') tend to perform better than 'generals', which are normal companies without any corporate actions, in the long run.

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Another quote I found which mentioned Special Situations, this time from Mohnish Pabrai, he is talking about Warren Buffett's partner, Charlier Munger.

“Charlie [Munger] mentioned if an investor did just just three things the end results would be vastly better than the rest. 1) Carefully look at what the other great investors have done, 2) Look at the cannibals, ie businesses buying back huge amounts of their stocks, and 3) carefully study spin-offs. 

Charlie said that an investment operation that focussed on these three attributes would do exceedingly well.” Mohnish Pabrai

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Conclusion:

This is being spoken about since multiple decades by some of the best investors in the world, but what I see is that not many people care about this.

And thats actually good for the most part for the diligent investor.

And ofcourse, mind you, there have been failures in special situations also. There is no magic bullet at all. All special situations do is give us a good entry valuation at times. But after that, if an investor's thesis itself is wrong, then still, losses can occur.

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Just a correction from our 7th July newsletter.

We had mentioned that the PMS was +22.29% vs +12.85% for Benchmark for last 12 months. While the Negen performance number is correct, the benchmark was +22.20% and not +12.85%.

(It was an error which was due to a technical glitch and I just got to know. Wanted to correct it as good corporate governance is always best).

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That is all for today my dear friends.

We embark upon the second half of the year, I love the festivities that will soon begin all across our lovely country.

Lets enjoy, celebrate and be grateful for this pleasant trip.

My Best,

Neil Bahal

Founder

Negen Capital

On a side note: I am so happy that Football season has started again. I am hopeful that Liverpool put on a good show this year.

But to be honest, I feel it will be between Arsenal and Man City again this year.