Thursday, December 8, 2011

A very special situation

The value investors’ club is an online community of 250 members who share their ideas on value investments. Membership is by application with roughly a 6% acceptance rate – the application must include a detailed investment idea. I applied earlier this year and was rejected.

For non-members, the website is accessible with a 45 day delay – 45 days after an idea is posted to the website, anyone (who registers a free account) can access the idea. The idea below is from the website. The opportunity closed within the 45 days so we weren’t able to take advantage of the idea. But because it was such a cool and unique situation, I’m going to briefly describe it.

Norilsk Nickel is a Russian company whose shares trade on the Russian stock exchange.

When shares are only traded on one exchange, sometimes they are traded over the counter (OTC) on another exchange. In Norilsk’s case, they are traded as “American Depositary Shares” (ADS) on the “pink sheets” (a private company that provides an over the counter market in the U.S). Each Norilsk ADS represents 1/10th of a Norilsk share.

On September 8, 2011, the company announced a share buyback, where shareholders could tender their shares to the company, and the company would pay the shareholders out. The company was to buy back 7.71% of the outstanding shares, at $30.60 per ADS (or $306 per common share). That was to cost $4.5 billion in total.

After the announcement, the ADS were trading around $20. Why would they trade at $20 when they could be sold back to the company at $30.60 a few weeks later? Because the company was only buying back 7.71%, and if more than 14.7 million shares were tendered, shares in the offer would be purchased on a pro-rata basis. This means that if you bought hundreds of thousands of dollars worth of shares, you’d only be able to sell a tiny fraction back to the company.

But here’s the very special situation: the shares were not pro-rated for tenders of 1 000 ADSs or less (or 100 common shares or less). So if you tendered 1 000 ADS, the company was compelled to buy at $30.60. So you could buy 1 000 ADS for $20 000, and receive $30 600 about 4 weeks later when you tendered them to the company. Normally situations like this exist for mere minutes, as everyone buys up the shares and the price increases to the $30.60 (or slightly below to account for the risk that the transaction doesn’t go ahead). They didn’t in this case, because the only people “guaranteed” the $30.60 for each share were people who only wanted to sell 1 000 or less. Most professional arbitrageurs wouldn’t bother with this opportunity, because the maximum gain is likely to be around $10 600. If you’re managing millions of dollars of assets this isn’t particularly attractive – the time it takes to take a good look at the transaction isn’t worth your while when you can only put a tiny proportion of your funds into the opportunity.

The company specified likely scenarios where they wouldn’t buy the shares back, but these were limited and seemed unlikely. This was a perfect opportunity for Value Investors Club members – a diverse group where each could take advantage of a smaller opportunity, rather than one fund being able to deploy a large amount of capital itself.

So what happened? The deal closed, and everyone who bought 1000 shares at $20 each made about $10 600 in four weeks. Unfortunately, as we (currently) have only delayed membership, the bookbook fund was unable to increase its net worth by 20% in four weeks. But it shows the type of opportunities that are part of what we’re looking for. I’ll deal with other types of opportunities (more general underpricing) in a later post.

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