Special Situation Investments

SSI tracking portfolio is up 0.9% in May 2023. A detailed performance breakdown is provided below.

Summary of SSI activity during the month:

Portfolio Ideas – 9 were closed.
Quick Pitches – 11 new Quick Pitches were covered in our SSI weekly newsletter.

Below you will find a more detailed breakdown of tracking portfolio returns by individual names as well as elaborations on names exited during the month.

TRACKING PORTFOLIO +0.9% IN MAY AND +2.6% YTD

Disclaimer: These are not actual trading results. Tracking Portfolio is only an information tool to indicate the aggregate performance of special situation investments published on this website. See full disclaimer here.

The chart below depicts the returns of SSI Tracking Portfolio since the start of 2017.

PERFORMANCE SPLIT MAY 2023

The graph below details the individual MoM performance of all SSI Portfolio ideas that were active during the month of May 2023.

PORTFOLIO IDEAS CLOSED IN MAY 2023

Transcontinental Realty Investors (TCI) +66% In 2 Years
Transcontinental Realty Investors was an externally managed real estate company with a portfolio of Class A multifamily apartments in the Southeast. TCI seemed significantly undervalued as the stock saw almost no recovery from the COVID lows, despite the pandemic having virtually no impact on the business and other TCI peers already trading at pre-COVID levels. The company traded at a 50% discount to BV and 12x FFO vs peers trading at 20x FFO multiple. The even more interesting aspect was that US financial reports seemed to significantly undervalue TCI’s real estate and book value, whereas mark-to-market reports in TASE (Israeli stock exchange) suggested the true book value of TCI was at least 60% higher than what was reported to US investors. Thus, the real discount to book value here was extremely wide. The key catalyst for re-rating was the planned monetization of the JV assets later in the year. As this investment case became more popular and the company proceeded with the JV assets sale, the stock moved up substantially. However, a wide 50% gap to marked-to-marked BV still remained. Initially, I thought that once the sale proceeds hit TCI’s accounts and marked-to-marked BV becomes clearly visible, the stock will re-rate even higher. Unfortunately, that did not happen and the market still continues to put a large discount (currently over 60% to BV) on TCI due to governance issues as well as management’s reluctance to return cash to shareholders. The stock remains cheap, however, the whole case has now shifted into a RE company valuation thesis and bet on TCI management’s ability to prudently invest the cash. Hence, I decided to close the idea marking a 66% gain in 2 years. A decent result overall, however, in hindsight, the idea could’ve been closed much earlier, e.g. in the Autumn of last year after the JV sale has been completed. Nonetheless, a bet on a more substantial re-rate seemed worth a shot at the time.

Talaris Therapeutics (TALS) +20% in 1 Month
Talaris Therapeutics was yet another failed biopharma that traded at a large discount to its net cash, had only a few employees left, and was running a strategic review of alternatives. Certain arguments suggested that the company was likely to liquidate soon. Conservative calculations of liquidation value landed at $3.05-$3.30/share implying a 25%-40% potential upside. Credibility of the parties involved significantly lowered the risk of a value-destructive reverse merger. TALS was controlled by several prominent PE/VC firms (led by Blackstone) that owned 57% of TALS combined. Management, many of which were affiliates of these PE/VC firms, owned a further 17% stake. All parties seemed to have clear incentives to maximize shareholder value as suggested by certain the preceding developments. Over the next month, the share price has gradually approached the low end of the estimated liquidation value. With limited remaining upside and some remaining uncertainty regarding the company’s path forward, the position was closed with a 20% gain in 1 month. Since I’ve closed the idea, TALS’ share price has already retraced substantially from those peak levels, so I might consider a potential re-entry soon.

Companhia Brasileira de Distribuicao (CBD) +17% in 1 Month
This was an interesting spin-off situation in LATAM with an unusually large discount to the sum of the parts valuation. Companhia Brasileira de Distribuicao was a Latin American retail consortium that operated several supermarket banners in Brazil and also owned large stakes in two publicly listed companies: French e-commerce platform Cnova (34% stake) and Columbian grocery retailer Almacenes Exito (96.5% stake). The company decided to spin-off most of its Exito stake (83.2%) to shareholders. As part of the transaction, CBD shareholders were to receive 4 Exito shares (also in US ADRs) for each CBD share. At prevailing Exito prices, the spin-off distribution was worth 20% more than CBD’s market cap. Even assuming a 15%-20% decline in Exito’s share price post-spin-off, investors were still to get remaining CBD’s Brazilian retail operations as well as other balance sheet investments for free. Gradually, CBD share price approached the conservative SOTP valuation and the idea was closed with +17% gain in 1 month. The transaction is set to close in Q2 2023.

TCR2 Therapeutics (TCRR) +8% in 2 Months.
TCR2 Therapeutics was getting acquired by a larger peer Adaptimmune Therapeutics for 1.5117 ADAP per each TCRR share. Despite tiny market caps, liquidity here was quite decent. The spread stood at 14% explained by this being a micro-cap clinical stage biopharma merger and also some uncertainty around shareholder approvals. Nonetheless, both approvals seemed likely to pass as the acquisition was very important for the buyer and allowed it to raise a substantial amount of cash amid the financing troubles in the biopharma space. The target’s shareholder approvals also seemed likely due to high insider ownership, looming shareholder dilution in a standalone scenario, and large price premium offered in the bid. After a few months of high volatility, the spread finally narrowed down to minimal 2-3% levels just before shareholder meeting. I decided to lock-in the gains and the closed the idea with +8% (after deducting borrow fees) in 2 months. Shareholder approval was subsequently received and TCRR was delisted yesterday.

Enzo Biochem (ENZ) +10% in 2 months
Enzo Biochem agreed to sell its Clinical Laboratory Services segment to LabCorp (LH) for $146m. The sale was transformational for the financial profile of the business as before the transaction, ENZ had operated as a going concern, with the CLS segment accounting for the vast majority of the cash burn. Despite that the company was trading at a 20% discount to the pro-forma net cash. There was a chance that management would try to sell the remaining segment too, which seemed potentially worth another half of the company’s market cap. It seemed that the company would re-rate after the Clinical Laboratory segment sale gets closed and proceeds drop-in. Eventually, communication with the management indicated that the taxes due for the LabCorp sale will be significantly higher than was initially anticipated, significantly lowering the expected pro-forma net cash. Due to this shift in the risk/reward balance for this setup and further lack of clarity regarding managements’ plans for the remaining business segment, it seemed prudent to just take the 10% gain and move on.

GasLog Partners (GLOP) -2% in 3 Months
The owner and operator of LNG tankers, GasLog Partners, was being taken private by its GP for $7.7/unit. The special committee of independent directors was reviewing the proposal. Overall, the situation seemed similar to multiple other successful MLP buyouts previously covered on SSI. The offer was clearly lowballed coming at just a 10% premium to the pre-announcement prices and a 50%-60% discount to the ~$15-$20/share levels at which GLOP traded during 2018-2019 before the dividend was suspended. The offer also looked way too low relative to the existing FCF generation, historical trading levels, and peer valuations. Another interesting part was that the GP owned only 30% of GLOP, so minority shareholder approval was required. All in all, it seemed very much possible that the special committee will renegotiate a higher bid, potentially in the $10-$12/share range. However, the expectation was significantly undercut and the bid was raised by only 12% to $8.65/share. The buyer was stealing GLOP at these prices and some small shareholder pushback emerged. Initially, I wanted to keep the idea active as a safe bet on another offer improvement. However, a recent court ruling on a related case unambiguously showed that in MLP buyouts all the cards are in GPs’ hands, removing any incentives for GPs to offer fair prices and also reducing the chances of shareholder rejection. Thus, I’ve closed the idea at a tiny loss.

Large-cap M&A Basket -2% in 1 Year
In May of last year, spreads of most U.S.-listed large-cap mergers widened substantially due to the market volatility. It seemed like an interesting opportunity to add a basket of several filtered out large-cap arbs. I’ve outright noted that the edge on the market in large cap arbs was limited but the basket approach seemed intriguing for two reasons: (1) some spreads have widened amid an overall market sell-off without any news directly relating to the mergers, (2) the expectation that on average these cases would work out. One year later, the opportunistic foray into large-cap merger arbitrage ended up exactly as it could have been expected – the basket of 6 bets has lost 1.8% altogether. Unsurprisingly, it has once again proven that betting on large-cap mergers is a difficult affair and such arbs are most often efficiently priced by the market.

Taiga Building Products (TBL.TO) -2% in 1 Year
Taiga Building Products was Canada’s largest independent building materials wholesaler with significant exposure to lumber products. Due to housebuilding sector tailwinds during 2020 and 2021, the company started generating lots of cash, cleaned up its balance sheet, eliminated expensive debt, and was in a good position to return funds to shareholders. A C$30m special dividend had already been paid out in Q1’21 and an even larger dividend was expected in Q1’22. However, this did not pan out as the company simply continued to invest all of the excess liquidity into working capital (inventory + receivables), instead of paying out dividends. The company remains cheap, trading at just 6x-7x normalized FCF with no leverage and the whole market cap covered by net working capital. But now TBL remains just an undervalued Canadian microcap in a cyclical sector with controlling shareholder/management and limited financial disclosures. With the special situation angle gone out of the window, the idea was closed with a 2% loss in 1 year.

Hollysys Automation Technologies (HOLI) -14% in 9 Months
The two-year-long saga of Hollysys Automation Technologies privatization seemed to be coming to an end. Reuters reported that the founder/CEO Changli Wang received a blessing from Beijing regulators and had partnered with a certain state-owned firm to take HOLI private at $29/share – over 50% premium to the market prices at the time. The report said the consortium had nearly secured financing from a major state-owned Chinese lender and aimed to get a number of large PE firms on board, including Warburg Pincus. Several aspects, including recent large share purchase from the CEO and rumored presence of state-owned backer suggested that HOLI might indeed get acquired soon. Privatization and relisting in China also seemed to make sense from the financial standpoint as HOLI would’ve likely received a much higher valuation in the local markets. Unfortunately, since those initial rumors came out, all privatization chatter went completely silent and no new updates regarding the buyout have came out yet. The privatization thesis has clearly failed, which is kind of strange given the high number of parties that were previously reported to be interested in acquiring the company. Although HOLI remains cheap and has 65% of mcap in cash, as a Chinese ADR with very limited visibility into the business it can remain cheap indefinitely. The idea was closed with 14% loss in 9 months.

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