Value Investing does not always involve purchasing stocks that
trade at a discount to their perceived future cash flows. In
fact, some value propositions are not predicated on the
assumption that the market will eventually recognize the
underlying value and subsequently bid up the price of an
under-valued equity. Buffett referred to these special situations
as Workouts.
Students of value investing may be aware of the Buffett
Partnership coup which unlocked the underlying value of Sanborn
Map is the late 1950s. Sanborn Map traded around $45 per share
but had an investment portfolio which amounted to about $65 per
share.
The problem Buffett encountered was dealing with the Sanborn
board which consisted of various members of the insurance
industry who used the company's products but had little interest
in separating the investment portfolio from the business. The
management and board viewed the excessive liquidity as a rainy
day fund without regard to best interests of shareholders.
Further, the board owned very few shares of the company and held
little in the way of motivation to unlock the underlying value.
Buffett had spent many months buying up the shares for himself
and his family as well as successfully encouraging others in his
investing sphere to do likewise. His fellow investors included
the likes of Walter Schloss, Fred Stanback and Henry Brandt, all
of whom continued to buy up the stock. The idea was to purchase
sufficient shares to effectively take control of the company and
force a tax-friendly separation of the investment portfolio from
the operating business. Once the two entities were separated
through a tax efficient method which involved swapping the
investment for stock, shareholders would be free to sell their
shares and recognize a substantial gain.
Finally in early 1960 Buffett's extended efforts became
successful and Sanborn Map exchanged a portion of the investment
portfolio for company shares. As part of the deal, the Buffett
partnership tendered all their shares.
What Is a Workout?
A workout is a special situation where an investor does not rely
upon the market to record a gain on his investment. The workout
may be a direct result of shareholder activism which is intent
upon unlocking the value, as in the case of Sanborn Map, or it
may be a simple arbitrage play where a favorable spread exists
between the buyout price of a company versus its current offer
price. Other examples would be spinoffs, special dividends or
various hedging techniques. For instance, Benjamin Graham was
known to utilize a simple hedge of going long the preferred and
shorting the equivalent common stock to grind out profits during
certain market periods.
Workouts can take many forms but they do not come without risk.
An investor had better be quite sure that a merger is certain to
take place if he is willing to purchase common shares at a price
that is just slightly lower than the take-over price. If the
merger fails for any reason, the price of the stock is almost
certain to drop to well below the price that the arbitrage
investor paid for his shares.
Further, sometimes a buyout offer is not taken seriously by the
market and the arbitrage premium is little more than a mirage.
Case in point, in the spring of 2005, George Schultze made an
unsolicited bid for Imperial Sugar (formerly IPSU) merely because
he was perturbed at the low price of the stock. While the offer
temporarily spiked the price of the stock, Wall Street quickly
recognized that the offer was not serious. Unsavvy arbitrage
investors who took the $17 buyout offer at face value were burned
when the stock soon dropped below the price at which it was
trading prior to the "attempted takeover."
TATT as a Workout Strategy
Last month financially troubled KMN Industries who is the
controlling shareholder of TAT Technologies (
TATT
), was served with a petition which granted a lending institution
the right to enforce a lien against KMN. The purpose of the lien
was to usurp the shares of TATT which KMN held as collateral for
an outstanding loan. On Oct. 23, the lending institution filed a
petition requesting the appointment of a temporary holder for the
enforcement of that lien.
No formal announcement has been made; however, it appears that
over 50% of TATT stock is now controlled by a lending
institution. When a bank seizes majority control of a company,
the most likely result is that the company will be sold in the
near future. In other words, the current TATT situation is not so
different from Buffett's position with Sanborn Map in the late
1950s, although the goal of the lending institution will likely
involve selling all the assets of TATT rather than merely
dispersing its excess cash and investment. Similar to the lending
institution, Buffett had no real interest in owning the map
business; instead he wanted to liquidate the investment portfolio
which was not reflected in the value of the stock.
As of last quarter, TATT had around $7 per share of net current
assets and a tangible book value of about $9 a share. Included in
those current assets were approximately $2.70 per share in cash
and short-term bank deposits. It is highly probable that the
lending institution could sell the assets of the business at a
price of somewhere between its net current asset value and its
tangible book value.
Concluding Remarks
Successful investing in workouts or special situations is a
matter of risk versus reward and it remains imperative that the
investor demand a sufficient margin of safety without regard to
the nature of the catalyst. In the case of Sanborn Map, Buffett's
activism and his seat on the board provided the key catalyst
necessary to unlock the value of the company. Still, had
Buffett's activism failed to separate the investment portfolio
from the business, it is unlikely that his investment would show
much of a loss. The price to book value was low enough and the
company's profits were sound enough that the stock would have
likely languished near the price that Buffett was paying for his
shares.
Value investors frequently hold on to stocks that sometimes
appear to be terminally undervalued. Net-nets frequently languish
for long periods absent of a catalyst. Such has been my
experience with TATT. I have held the stock patiently for over
four year and I have averaged down along the way. It been my
expectation that its earnings would eventually increase as
various cycles in the aircraft industry reemerged.
It now appears that a sale of the company rather than increased
profitability will provide the needed catalyst to drive the price
per share higher. Even if the sale of the company does not
materialize as I anticipate, the stock still holds a substantial
margin of safety in the form of a 33% discount to its net current
assets.
Disclosure: Long TATT
Read More:
About GuruFocus: GuruFocus.com tracks the stocks picks and
portfolio holdings of the world's best investors. This value
investing site offers stock screeners and valuation tools. And
publishes daily articles tracking the latest moves of the world's
best investors. GuruFocus also provides promising stock ideas in
3 monthly newsletters sent to
Premium Members
.