Street Capitalist: Event Driven Value Investments

A couple of days ago, Reuters ran a story with current arbitrage situations and their spreads. With the credit situation still poor, a number of spreads have widened considerably, adding to deal risk and ensuring sizeable spreads.

Because my mother isn’t here tonight, I’ll even confess to you that I have been an arbitrageur
-Warren Buffett

Here’s a few merger arb deals I’m seeing right now:

Target: Clear Channel Communications
Buyer: Bain Capital, Thomas H. Lee Partners
Arbitrage Spread: 13.6%
My take: CCU’s buyout was approved by shareholders on October 1st, if the buyout is successful shareholders will receive $39.20 per share, representing a 13.6% premium over today’s price. With the deal expected to close December 1st, this represents an annualized return of 331%

Some investors may be spooked at the fact that Providence Equity is thinking about walking away from a deal to purchase 56 television stations owned by CCU. This should not be an issue though, as the company said in a recent filing that the sale of the TV assets is not a condition of closing the buyout, which was approved by shareholders in September and is awaiting regulatory approval.

Clear Channel’s 3Q numbers were positive and this certainly looks like an attractive situation for investors at the moment.

Target: PHH Corporation
Buyer: The Blackstone Group
Arbitrage Spread: 45.9%
My take: The spread is huge on this, because of the immense deal risk. The Blackstone group is currently having issues with securing financing to buy PHH, an outsource provider of mortgage and fleet management services. All mergers involved with sub-prime mortgages are extremely dicey.

The company’s 3Q numbers came out and they were extremely poor. I’d sidestep this all together, there’s no sense in you trying to be a hero and making a huge return in the face of the huge risk that the deal may fall through.

Target: SLM Corporation
Buyer: J.C. Flowers – Led Group
Arbitrage spread: 53.65%
My Take: The spread is huge here for two reasons. One, J.C. Flowers wants to lower the price his group is bidding for the company since he feels that current congressional legislation will have an adverse effect on SLM’s business. SLM is arguing that J.C. Flowers knew of these risks when it made their bid for the company.

Secondly, because of this dispute, SLM is taking Flowers to court. SLM seems to have a pretty strong case, but I don’t think the situation is worth your investment at the moment, since the case will not be brought to court till sometime in June. It may be worth studying for the time being though.

Target: Tribune Company
Buyer: Samuel Zell
Arbitrage Spread: 13.3%
My Take: Here, you’ve got a 13.3% spread with an annualized return of 107.54%. Sam Zell seems very committed to seeing this deal through, but there’s an issue with the FCC regarding media control in the same markets. Zell may have to sell some of TRB’s properties in order to make the deal go through. This doesn’t seem to be a problem because as Zell says:

“I’ve had offers on every single asset in the portfolio. Chuck Schumer”-the New York senator-”calls me, because he’s hustling for some people who want to buy Newsday. Baltimore people are calling, Allentown’s calling, Florida’s calling, and, in L.A., David Geffen and Eli Broad. So all I can tell you is that for a dead industry with no future there are an awful lot of schmucks who want to take it away from me!”

Out of these four situations, I feel like TRB and CCU offer the best ideas. CCU is held by some notable investors: Eddie Lampert and Daniel Loeb. TRB is held by: Charles Brandes and Brian Rogers.

One of the first posts I wrote on this blog was a study from a previous break up, Cendant. The companies which split ended up being quite profitable for any early investors. There are many times when certain properties are neglected during these situations created grossly undervalued securities. Here’s one for us to look out for in the future-

Today IAC/Interactive Corp (NASDAQ:IACI) announced that it would break up the company. Barry Diller is an extremely sharp media dealmaker. I remember first learning about him when I read through Bruce Wasserstein’s Big Deal. This is going to be a good idea because the management structure will be more simplified and companies will have the freedom they need to create value. A number of the properties within IACI really didn’t mesh besides an involvement with the internet (CollegeHumor and Interval, for example), so splitting them apart makes sense.
Let’s try to examine the preliminary details of this deal. This analysis will be qualitative, closer to the actual break up date I’ll have a more in depth financial analysis. For now, this will at least get IAC on your radar screen.

The company will be broken into 5 pieces.
1.IAC
Key Companies: Ask.com, Citysearch.com, Evite.com, Math.com, CollegeHumor.com
CEO: Barry Diller
IAC will definitely be interesting for a few reasons. One, Barry Diller has chosen to be this group’s CEO. Since the company’s head is choosing to go with IAC, it’s safe to assume he sees it as having a prosperous future. It has one of the smallest operating incomes out of the group, and the companies are all involved in the internet. Ask.com is interesting because as a search engine it isn’t as popular as Google or Yahoo, but it has been gaining ground. They seem aggressive about this and have taken to advertising on television.

2.Home Shopping Network
Key Companies: HSN, Frontgate, Garnet Hill
CEO: Mindy Grossman
HSN has the biggest revenues out of the whole group, coming in at $2.09 billion. Brand-wise, HSN is pretty popular, the channel is still on cable television. However, HSN is a retailer which is a pretty tough business. Especially at the moment.

3.Ticketmaster
Key Companies: Ticketmaster domestic and international
CEO: Sean Moriarty
This company has the highest operating income out of the group. I have to say that Ticketmaster is the one company I’m probably most interested in. They seem to hold a vice grip on large concerts and are able to tack on large “convenience fees”. These fees apply to all tickets, even if you choose to purchase online. Brand-wise, I’d say Ticketmaster is just as big, if not better than HSN, but I think it’s moat is larger. Ticketmaster has fewer competitors in the larger concert market which is still popular. If you follow the music industry, you’d see that many artists, like Madonna, are working on making new deals that involve live performances since they make more money off of live shows than record sales (which are declining anyway).

4.Lending Tree
Key Companies: Lendingtree.com, Realestate.com
CEO: C.D. Davies
Lending Tree would be my least favorite out of all the businesses. LendingTree.com connects individuals with mortgage lenders, a horrible market at the moment. RealEstate.com allows you to find new homes to purchase. Another bad place to be right now. Most don’t forecast the housing problems to last forever though, so pessimism could create an undervalued company here. Still, I find the other companies more compelling. Most people I know are still doing their house shopping off-line for the most part. LendingTree was also the only company to have an operating loss ( $14.5 million) also making it more undesirable.

5.Interval International
Key Companies: Interval, CondoDirect
CEO: Craig Nash
This company is mainly involved in timeshares and vacation rental properties. The tourism industry hasn’t been too bad so far. Some major hotel acquisitions went down this year, but this line of business is a bit different. Still, a play on tourism/vacations. Revenues and operating income are positive, it’s possible that investors may pay more attention to the other companies making this neglected and undervalued.

Out of all the properties, I like Ticketmaster the most. IAC has great potential but I believe it’s really speculative. It’s helpful that Barry Diller will be leading the company– usually this is an indicator of which company is likely to perform the best post-break up, but many of the smaller companies within the new IAC are websites which received seed funding (think: vimeo, brightcove). This makes IAC have a good deal of uncertainty because some of these will turn out to be duds; the video sites in the portfolio are at a major disadvantage over players like YouTube.

Overall though, I think value investors should watch this situation unfold, we may find some nicely undervalued securities come out of this.

I’ve established a new position in Wheeling-Pittsburgh Corporation (WPSC)

I’ll add more on this position later today.

Today a rumor circulated that Bear Stearns is attempting to sell as much as a 20% stake in the company to private investors. Such a move would be beneficial as Bear navigates through some tough waters while facing mounting criticism by its investors.

So who are the possible investors?

One number being circulated is Warren Buffett. I’m not buying it. The reason being, Buffett already had a walk down Wall Street when he worked on fixing Salomon Brothers and I just don’t know if he’d want to do that again. Granted, the problems at Bear Stearns pale in comparison those of Salomon’s. An investment on Buffett’s part would signify a vote of confidence for James Cayne. Buffett has mentioned that Berkshire has its wallets open and is eagerly looking for some businesses to acquire.

Bank of America and Wachovia are also names being circulated. These banks could definitely benefit from some synergies they would gain from Bear’s fixed income groups, and many people have thought that Bear might be a possible takeover target at the moment. A small 20% stake could be the start of something larger.

Lastly there’s talk of Citic Group or China Construction Bank. This kind of talk has circulated for a while as Bear sought to sell a stake in itself in order to gain access to China and market its investment banking services. Since the Chinese investment talk lead no where in the past, I don’t see why it should now now, especially when the firm’s business is in trouble.

So who is it?

One group that I haven’t seen mentioned are Gulf-state sovereign wealth funds. The reason I bring this up is because Dubai has talked about its wish to create an international investment bank, a stake in Bear Stearns could be the ticket to that. Petrodollars are pouring into these countries and they’ve already waged wars over foreign stock exchanges. They seem intent on raising their profile through acquisitions in the financial services industry, and Bear could be their ticket.

Overall though, these could just be rumors. James Cayne’s friend, billionaire Joseph Lewis already purchased a sizable stake not too long ago. Cayne himself holds a large stake in the company, solidifying his power within the company and allowing him to make whatever changes he needs to make in order to fix Bear Stears. The stock is up 7.71%, trading at $123.05, down from a 52-week-high of $172.61. Any kind of acqusition would certainly make Bear Stearns worth studying as a long term investment.

The term special situations is a vague one, but is used often in investing. Many value investors will allocate a certain percentage of their portfolio to special situations, these are usually investments based on corporate balance sheet events.

Below are some great insights from a Financial Times article on Luke Newman, manager of F&C’s Special Situations Fund:
MANAGED FUNDS SERVICE: Strength in special situations

Newman believes the best opportunities are found in companies that are in the process of recovery or a turnaround.

Companies under new management or companies in an environment that has recently become open to consolidation provide strong value.

Young industries also are regularly undervalued and Newman says that he’s “trying to find companies that could remain at growth levels ahead of their competitors… Online gaming continues to look like very very good value to me because there are so many regulatory hurdles to be crossed in the US. The longer the status quo remains, the better the value.”

Unfashionable markets are also appealing and Newman says,“I like to invest in companies that have a contrarian feel to them” in order to find industries where a number of companies may have been neglected by analysts and thus trade at a discount to NAV.

Newman also invests with macro-economic trends in mind, he is “looking to increase the fund’s exposure to oil equipment companies as he thinks they will see rising profits as oil groups such as BP and Shell send business their way.” and is “bullish on consumer stocks in the UK as a play on all the speculation that interest rates will have a big impact on consumer spending levels within the country.”