CORPORATE ANNOUNCEMENTS SUCH as buyback, spin-off, mergers, acquisitions, etc., often lead individuals to invest so as to make quick money in the market. Then again, mis-pricing of shares can occur due to firms facing situations such as regulatory or policy changes, management restructuring, disruption in the business model due to technology, innovation or any temporary challenges in the operating environment. The concept of investing in such scenarios is known as special situation investment. Let us discuss the same in detail.
What are special situations?
Special situations are not the ordinary situations that companies find themselves in from time to time. It could be come in different forms and events such as buyback, stock split, spin-off, tender offer, stake sale, merger, acquisitions, litigation, shareholder activism, bankruptcy, capital structure alterations, CEO resignation, strike, lockout or any other event that have an impact on the company’s future prospects. Such situations posit an investment opportunity for those investors who can foresee and interpret the implications of that opportunity well ahead.
What to look out for?
As an investor in such special situations, one should look for the share’s price dislocation or mis-pricing. Considering the current situation, the market discounts the firm’s share price and trades at lower than its intrinsic price. Special situation, as the name goes, does not happen often and if one is able to identify and pick the stock, that could lead to very large returns compared to conventional investments. Further, investment results of special situations are almost immune from market risk. For instance, Brexit, a corporate de-merger leading to a listing of a subsidiary, and even a sudden rupee appreciation are all special situations.
How to approach?
One could encash special situation opportunities in direct investing. As an individual investor, one is able to identify such a situation and buy the shares at a right price otherwise one could choose to go through the fund route. There are many asset management companies / mutual funds that offer retail investors the chance to invest in special situations through listed firms only.
Understand the associated risks
According to various national and international equity research reports, special situations arise in India at regular intervals. In the last seven years around 54 such special situations / risk arbitrage opportunities were reported. Such opportunities, with an average holding period of three to four months, provided 20% annualised return. While many learned investors may make the highest returns out of special situations, lay investors have to do proper due diligence considering the period of investment and downside possibilities.
Though the returns on special situations could be high, they come with their own set of challenges. First, the returns will not be linear because the returns depend on available special situations in the market. Further, every situation may not provide big payoffs. Special situations would be limited during bull runs.
To conclude, investment science literature documents how the stock market behaved for each such special situation ranging from buyback to de-listing. However, investors should do their own due diligence before investing on their own or through special situation funds.
The writer is a professor of finance & accounting, IIM Tiruchirappalli