2011年6月17日 星期五

So the management wants to buy you out? What do you do?

Let’s say that you are a small value investor. Somehow you bought this cheap stock and hold this cheap stock.

Now one day out of blue, there is this news that the management wants to buy out the stock investors and take the company private. What do you do?

Well, this is what I will do:
1. Find out the terms of the deal. What is the management offering to take your part of company away from you? What is the market price that you can get for your share of the company today?
2. Figure out how long it typically will take for the deal to work out.
3. Assess the possibility of the deal to work out.
4. Assess the stock’s intrinsic value in connection to the market price. What do you think the stock will be worth 2 to 3 years later if the buy our deal fails?

The first 2 steps give you the gain and the annualized return assuming the deal passes. Typically the gain itself could only be a few percents. However, depending on the time it takes for the deal to work out, the annualized return can be 25%-40%. These kinds of returns are high compared to the 10% long term stock market return.

Interestingly, probably due to the small “raw” gains from this kind of situation, not that many individual investors try to look into this.  A second possible reason is that once a company is taken private, its information is no longer tracked by many financial information services. This makes studying this kind of situations hard for typical small investors to understand how this works.

Anyway, let’s say that you go through the first 2 steps and now are very excited for you may potentially gain 8% in 2 months as you realize that is a 38% annualized return.  But, wait a minute, the deal could still fall part!

That is why you need to go over the last 2 steps. If the management owns more than 50% of the stock, the deal typically will go through with or without modification in terms. Sometimes the initial offer from the management is so low that the minority shareholders go to court to sue if the local regulation allows. In these cases, typically a small increase 5-10% of buyout price will be offered by the management to appease the minority investors.

The last step is the most important one. I suppose that if you call yourself a value investor, you must have some senses about what the stock is worth, right? How is the market price following the announcement of the buyout offer compared to your estimate of the intrinsic value of the stock?

If the price already reached your estimate of intrinsic value, you may want to sell out directly. Alternatively, you may want to wait for an improvement in deal terms or gain the extra small but high annualized gain from the deal.

If the price is still much lower than your estimate of intrinsic value, you must recognize that this is a “head-I-win, tail-I-don’t-lose” situation. Time to buy big time. In other words, if the deal works, you make small gain with high annualized return in a few months.  If the deal does not work, you make 15-20% a year after 2-3 years, which is not the end of the world.

What I am offering you here is a thought process.  I hope that you find it helpful.  However, your success will depend on how well you can execute the 4 steps that I mentioned above.
Now if you want, you can do this on your own as an exercise using the case of the 國巨 management buyout!

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