Liquidation

As a special situation liquidation can come in many different forms and stages – sometimes it’s a company that is selling all of its assets and intends to distribute the proceeds ex liquidation costs to shareholders, sometimes the company only intends to sell the assets and a lot of uncertainty regarding the sale still remains. The other times, it can be a company that simply has its assets in run-off and needs to wait a certain amount of time before winding-up. Thus, usually, a liquidation involves a lot of moving parts (value of remaining assets and operations, cash burn, management’s incentive, etc.). The tricky aspect here is estimating the eventual distributions and the likelihood that all other parts of the play will work out as expected. This involves valuation mechanics and quite often some guesswork as well. Usually, liquidations include a few partial distributions and a final one (sometimes the last one takes significantly longer due to certain outstanding conditions).

When stumbling upon a liquidation case, it is important to figure out at which stage it is currently in. The more assets, operating businesses there are left to sell, the more uncertainty regarding the potential upside and timeline. Checking the background of the company and the asset sale can help to understand whether the remaining assets will be sold easily (assets have demand in the market) or maybe it is something that management has been trying to get rid of for a long time already, but wasn’t able to yet. Timing plays an important role when deciding on the attractiveness of the situation, as liquidations usually take longer than expected and it’s likely you don’t want to get stuck in a (potentially) illiquid stock for 3-4 years with limited updates from the management.

It is necessary to calculate the potential liquidation value of the company including the to-be-sold assets, potential cash burn, and liquidation expenses. This will help to get a better picture of the existing margin of safety – how much can the whole process get prolonged and how high can the expenses go until the upside is gone. Sometimes distribution estimates are provided by the company, in which case it is necessary to double-check if the management is not painting in the brightest colors.

Make sure to research the largest shareholders and, especially, what stake belongs to the management. A higher stake could indicate that they will be incentivized not to destroy value in the liquidation process. However, it is important to keep in mind that most liquidations include a conflict of interest as the longer time the whole process takes, the more compensation the management can pump out from the company until it winds up.

Finally, check if there are any special conditions related to the asset sale or distributions.