"Cigar Butt" Investing
Just to expound on an email I rattled off this morning to a couple friends - although I think the stock market was cheap (before the 10% run up), I think there is the case for "worser". When is "worser" coming? I think the next few quarters earnings will give us a good idea of how things will pan out during this recession and I'm hopeful that stocks will trade at single-digit multiples. Just to remind you - we're coming off a period of above average earnings with above average multiples and it has been reported that the DOW event at 8,000 is trading at 10x next year's worst-case scenario earnings (according to first call 2009 estimates, which I know, is always slow).
In any case, what's a person to do? Recently, during the muni crunch, I moved my money into a Vanguard Muni Money Market fund. Liquid, relatively risk free (not as good as treasuries, but conceivably supported by the ability for municipalities to increase taxes) at 5% tax free. That equates to around a pre-tax 8% yield. Buffett's recent preferred deals have gone for a 10% yield warrants as a kicker. I'll use Buffett's 10% yield as a hurdle; deals above that are worth looking at.
That leads me to CEG (Constallation Energy Group). Buffett has agreed to puchase the stock at $26.50 cash, currently you're in the $24 range. Anything below, say $23.50, particularily before December 5th (there's a divvy for shareholders on record December 10th) yields 12% and looks worthy. The deal is supposed to close 2Q09 so a >12% return for that period is pretty good.
So where's the risk? The risk is that CEG shareholders vote down the deal. In the event that the deal is voted down, CEG is going to have to go to the market it's liquidity needs. That means CEG shareholders think they can pay Uncle Warren the breakup fee, go to the market to satisfy debt needs, and still end out ahead. It could be said that credit markets are a little looser than they were during the crunch, so taking into account the various class-action suits against the company, the scenario seems possible.
Another risk is that Uncle Warren renegotiates the deal - that can happen, although I think Buffett is okay paying 30 cents on the dollar and won't risk mucking the deal to get 25 cents on the dollar. As he's said before, he'd rather be approximately right than precisely wrong. Besides, this is a slam-dunk deal for him, as he's getting the company on the cheap.
All in all, at a >12% return for a 6-9 month investment seems pretty decent to me. In the event that it falls out, there may be the case for an even greater return. If you look at where the company was before the credit crunch, you're in the 60-80 dollar range. My guess is that the deal will close with Buffett and he will have gotten a company on the cheap (although you can buy the company cheaper).
Lastly, I should say that I've never purchased in a take-out scenario, so this is a first for me. But I think the reason the deal isn't closer to the closing price (besides the reasons above) is because a lot of the arb-guys are finding financing to be expensive, hard to come by, and frankly - take-out arbitrage has been very risky this past year (i.e. lots of deals have fallen through or gotten renegotiated). Essentially, those with cash get to be greedy while others are scared.
In any case, what's a person to do? Recently, during the muni crunch, I moved my money into a Vanguard Muni Money Market fund. Liquid, relatively risk free (not as good as treasuries, but conceivably supported by the ability for municipalities to increase taxes) at 5% tax free. That equates to around a pre-tax 8% yield. Buffett's recent preferred deals have gone for a 10% yield warrants as a kicker. I'll use Buffett's 10% yield as a hurdle; deals above that are worth looking at.
That leads me to CEG (Constallation Energy Group). Buffett has agreed to puchase the stock at $26.50 cash, currently you're in the $24 range. Anything below, say $23.50, particularily before December 5th (there's a divvy for shareholders on record December 10th) yields 12% and looks worthy. The deal is supposed to close 2Q09 so a >12% return for that period is pretty good.
So where's the risk? The risk is that CEG shareholders vote down the deal. In the event that the deal is voted down, CEG is going to have to go to the market it's liquidity needs. That means CEG shareholders think they can pay Uncle Warren the breakup fee, go to the market to satisfy debt needs, and still end out ahead. It could be said that credit markets are a little looser than they were during the crunch, so taking into account the various class-action suits against the company, the scenario seems possible.
Another risk is that Uncle Warren renegotiates the deal - that can happen, although I think Buffett is okay paying 30 cents on the dollar and won't risk mucking the deal to get 25 cents on the dollar. As he's said before, he'd rather be approximately right than precisely wrong. Besides, this is a slam-dunk deal for him, as he's getting the company on the cheap.
All in all, at a >12% return for a 6-9 month investment seems pretty decent to me. In the event that it falls out, there may be the case for an even greater return. If you look at where the company was before the credit crunch, you're in the 60-80 dollar range. My guess is that the deal will close with Buffett and he will have gotten a company on the cheap (although you can buy the company cheaper).
Lastly, I should say that I've never purchased in a take-out scenario, so this is a first for me. But I think the reason the deal isn't closer to the closing price (besides the reasons above) is because a lot of the arb-guys are finding financing to be expensive, hard to come by, and frankly - take-out arbitrage has been very risky this past year (i.e. lots of deals have fallen through or gotten renegotiated). Essentially, those with cash get to be greedy while others are scared.
This entry was posted by Mike, on
Wednesday, October 29, 2008.
You can leave your response.
leave a response