The Business of Value Investing.pdf

216 The Business of Value Investing

many value investors devote ample time and effort to investigating

spin - offs simply for that reason: Initial shareholders who desire

to hold only the original company will sell off any spun - out entity to

monetize part of their investment. As a result, many spin - offs expe-

rience selling pressure that sends prices to bargain levels.

However, around September 2008, the B shares were trading at

$ 6 while the A shares were hovering around $ 9, or a 50 percent pre-

mium to the B shares. This was an absurd spread that could have been

explained only by the irrational market behavior that took hold of

the fi nancial markets after the near collapse of one major investment

bank, Bear Sterns, and the failure of another, Lehman Brothers.

The arbitrage investment trade was simple: Go short an equal

dollar amount of A shares against a long dollar amount of B shares.

Within days, the spread had closed to within 20 percent. The goal

was to exit the position when the spread came close to the histori-

cal 5 to 10 percent. But as luck would have it, several weeks later, at

the next annual meeting, the company announced that it would put

to a vote a resolution to make the A shares convertible to B shares

on a one - to - one basis. The spread closed to within 1 percent immedi-

ately. Although the 50 percent gap in the share price between the two

classes of stock wasn ’ t dependent on news of convertibility between

the two shares, the announcement was icing on the cake. At a 50 per-

cent spread, the short/long trade was like taking candy from a baby.

Fertile Hunting Ground

As of early 2009, the global economy is facing challenges the likes

of which have not been seen since the 1930s. There is no quick

fi x to our economic problems, brought about after many years of

unchecked optimism and easy credit. Faith in equities is at an all - time

low as equity markets collapsed in 2008 and continued to do so dur-

ing the start of 2009. It is during these moments of maximum pessi-

mism that the seeds of fantastic investment performance are sown.

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