TIP677: You Can Be a Stock Market Genius w/ Roger Fan
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You listening to T I P on today's episode.

i'm joined by my friend Roger fan to discuss joe Green light book. You can be a stock market genius. Joe Green ba is one of the greatest hetch front managers of all time, as he famously averaged forty percent a year over twenty years.

At that rate, one million dollars grows into eight hundred and thirty six million. Dream boy is also the author of best selling classics like the little book that beat the market. IT was a key character in William Green book, richer, wiser, happier.

Now my guess today is Roger fan, whose the chief investment officer at R F capital management, any likes to invest in these types of businesses that are discussed in dream. Lets book you can be a market genius, which is special situations. Rogers returns at R F capital sync caption in twenty seventeen, or fourteen percent versus twelve percent for the S M P.

Five hundred. And over the past five years, he's had returns of nineteen point three percent per year, generating six percent tage points in over that time period. During this conversation, Roger and I give an overview of joe Green batts background as an investor, author, teacher, and why Green boy focused much of his attention on special situations to beat the market, what a spin office and why they are right. Punning round from mispricing one agreed by its favorite case studies for spinoffs, the three key characteristics to look for in a spin off transaction for investors, how joe Green blad views investing in bankrupt deals and rest guardati situations, which situations Roger prefers to invest in and whether he's adopted dreams lets, highly concentrated investing approach and much more. This was a great chat with a sharp investor, so I hope you enjoy today's discussion with Roger fan.

Celebrating ten years and more than one hundred and fifty million downloads, you are listening to the investors point cons network since twenty fourteen. We study the financial markets and read the books that influence self made billionaire most. We keep you informed and prepared for the unexpected. Now for your host play, think.

All right, welcome to the investor podcast on your host, clay fink. And today, i'm happy to welcome my friend Roger fan to the show. Roger? Thanks so much for joining me.

It's great to be here. Thank you for having on so on.

Today's episode will be covering joe Green black in his book you can be a stock market in which covers special situations in detail. So special situations isn't a topic. We've covered too much on the show in detail.

And as i've gotten to know Roger here, I found that he knows and understand special situations much Better than ideal admitted. So it's excited to just be a good opportunity to bring Roger under the show to discuss the spoken joe Green black and his approach to investing. So we've actually feature joe Green black honor show multiple times in the past, and he's also great person overall. So how about you paint some color around just how good of an investor Green blad was and why you admire him personally as a fun manager?

Yeah absolutely. You know I my Green black for a few reasons. First, informal. I mean, he's got a phenomenal track record.

I mean, the first decade, I got them, he did fifty percent returns, and the second decade, he did three percent. And so over two decades, that comes out to forty percent. And so even if you take the standard two and twenty five, that's a thirty percent net return.

And so some people might say, oh, thirty percent net, that's you know it's okay. Will keep in mind he didn't employ leverage. He wasn't leverage for the one or twenty the one.

And so he was basically a pure vana thirty percent that return, which is phenomenal. And if you take that relative to the S P. Five hunter, for example, I mean, he just destroy the market.

His guy, you say, wonderful track record and one of the best long investors that I know. And second, you know, he's just a phenomenal writer. You talk about the book.

You can be a stock market genius in my pain as this best book. This is wonderfully britain. Easier understand. Anybody can really just grass the concept from that book and really apply to their investing. He's also bring other books.

And though the one that comes is the little book that beat the market, that is also a great book, really easy understand, got a great sense of write. And that book really details his current strategy now, which is buying companies are cheap er and good. So taking the buffer approach, he did an extensive back testing of the strategy and it's been shown to be the S P of five hundred, quite handy as well.

And he is also a phenomenal teacher. If you look as old columbia lecture videos, they're really good. I mean, he just explains things so simply that you can just understand what he saying, even though the subject matter is actually quite complex like, you know, if you watch the video on options, for example, I mean, you really got to a stop and think sometimes.

But he really explains IT very well. He's a great communicator and he just breaks things down really simply. And another thing I really like about Green plant is he's actually really good at backing investment measures and so obviously is a match himself.

But he's also IT seems like, see when I privy to the overall returns of all the in the horses that he's backed but he backs s from famous managers Michael berrie is when that comes to mind of the big short Michael berry is pat a phenomenal record at sit and I think he's still doing pretty well now. But Michael berry is up there in terms of fame in when the best manager that he's ever backs. This is also a guy named norbert loop, a punch card capital.

Norbert leo is not as famous, but I think that hard by investors all know about leo, and he really takes the punch card approach that both the advocate tes to heart. I mean, norbert leo, if you just pull the chinese, if you just look at the filings, he has really the handful of positions. And so he really takes even joe Green less concentration to hurt.

And last, he is a good person, is a great human. He done a lot of work and philanthropic love work in education. And so I know his stuff with charter schools, not.

And so all these things added together, and he got the record. He's a great writer, teacher, professor, create backing managers. And also the philanthus think he's got the overall package. And so I really admire him as a fun manager. He's up there in terms of the mount rushmore of .

great investors. Man, i'm not sure if I could have put IT any Better myself. So thank you for that great introduction to Green black. I think he's probably most well known for the magic formula. But today, again, we're going to be discussing special situations and he's also just a well known value investors.

Well, so it's amazing how we can sort apply these different flavors to the game of investing for those in the audience who might not be familiar. Special situation includes an unusual or a unique event that can potentially affect the company's value. Could be a spin off, a merger, a bankrupcy, a restructuring. And sometimes this means the company is sort of going through a transformation period and sort of reinventing itself to some extent. And investing can just be so interesting because there's a lot of second order thinking that needs to be applied to be a good investor.

So when someone hears the term spin off for bankrupt here, special situation, I think most people's initial gut reaction is that's going to be too complicated or that is not a good investment in coincidently, that in itself can make IT interesting for somebody like Green, black or savi investor like yourself because the market might be overlooking the value that's there. So Roger, how about you share why does Green, black, fine special situation to be right? Ponting grounds may be expanded a little bit more on that and to what extent he actually utilized them in his investment approach?

Yeah, you're absolutely right. So it's that big factor, right? You just hear bankrupt or you hear about a distress company and you just they always too complicated.

It's not the situation I want be and to shy away from that. And so I think this the keyword is mispricing special situations is pony grounds because IT just naturally leads to mispricing. And that's the name of the game.

When you are fund manager for a private investor, you're looking for this pricing. And I don't know if you believe in E M T, the efficient markets hypotheses, but I think by and large, that's true, but is definitely inefficient at times. And there are pockets and issues such as a special situations.

We confine us pricing. And if we just go back to the magic formula or just companies in general, you know you have to fifty two week high and a fifty two week low. There is no way that a businesses valuation fluctuates tes as much as in a fifty percent or one hundred percent in one year.

IT just doesn't happen. And so the markets in general are efficient, but they are not always properly value and Priced. And so the special situation is a great place to look for this pricing.

And a lot of IT is you have what's called or selling or people who for non ic amic reasons. And that's because institutions, they have Mandates and they have very specific strategies. And so when security company that falls of the Mandate or the strategy, they just sell without asking questions because they can be in the portfolio.

And also, if you focus on the smaller situations, like the micro cat type situations that fall under the special situations umbrella of investments, you can really, really do well because i'm sure we'll get into some case studies. But if you just look at the bulk of Green glass k studies, all of them small situations. They're all five hundred million or billion dollars or less.

We're not talking about ten billion dollars, uh, or three billion dollar situations. I mean, maybe they are the size of parents, but not for they spent off or for the company has been acquired as central. And so to the extent that he uses them, he basically ran a special situations fund.

And so eighty percent of his portfolio would be in special situations. And he would say that of the eighty percent or more, I mean, he was just concentrate five, six or eight situations. And so I would say, obviously, we don't have their teens to verify.

And now I don't think he's made his litters public. But I think we can gather that the rest of that portfolio, the twenty percent or less, those are probably and risk situations and leaps and options and warrants and preferred and also just small cap value. He's got the magic formula now. And so I don't know if he had large positions are a small cap value, but I imagine he had small cap value names as well. But the focus portfolio was such situations, and he's known as a special situations investor as IT pertains to the first two decades of golden capital.

Yeah, that's simply amazing, giving how rare some of these great opportunities can be with special situation space. So let's dive into chapter three, the book. So in this chapter, Green black covers spending fs, partial spinoff and rights offerings.

And I think spinoffs are quite simple to understand from a high level. So spent off is simply when a corporation takes a part of its business and then just simply separate IT from the parent company, creates a new and independent company. And this can happen for a variety of reasons.

Perhaps a managment team was to separate and unrelated business. Sometimes there is a bad business that maybe dragging down the valuation of a good business or maybe something as simple as like a strategic anti trust or just a regulatory issue. So IT paves away for the business strategy going forward.

Green black claims that both spinoffs and the parent company significantly outperform the market post that transaction. So one study that he referencing the book looked at a twenty five year time period, and I found that stocks of spinoff fs outperformed their industry peers and the S M P five hundred by around ten percent per year in the first three years of their independence. And then when he looks at the shares of the parent company post spent off, they are performed by six percent annually during that same three year period.

So of course, this doesn't mean we should go out and buy a basket of spent us, but instead potentially tells us that it's a maybe a good pond to go fishing. And if that something in and of course, past performance is doesn't mean it's going to continue into the future. But dream black, at the time of the book was quite convinced that IT was a good pounding of fishing. And so what are your thoughts on this and how I might apply to investors today?

yes. So I think john Green blad is I think what he read about is still very relevant today, and I think results will continue. Office, give me ten percent. But if you pick your spots out of the many spin us I take place in a year, I think you can generate similar results related to the market.

And so the first thing is that spin off, they're gonna continue to occur regularly because the same dynamics that happen today that are in the markets today is the same as one thousand nine and eighty five or the early two thousands. Because what spin off does is that IT leads to Better market perception and appreciation of the separate businesses. And Better valuations are definitely to happen for the good company, but also for the bad business as well.

When you separate out when you have the parent co and the spin COO and you also tax considerations make spin, ffs, possibly a Better option than outside sale, for example. And so if these are just strategic options that management teams have at the disposal, and I think you touch on her as well, but it's a way to solve strategic issues, antitrust issues, regular or issues. And when you solve these kind of problems, they lead to acquisitions and other transactions because all times anti trust issues or the teacher problems prevent companies from doing deals.

And so if you do that spend off, you solve that problem, then the deal that they were actually think about gets done. And I also think the spin up returns will continue because I I always tell people, and you know my alyse, that half of the game is this investor psychology or it's knowing market psychology. Half of IT is economics.

Half of IT is doing models and working with the numbers and doing all the good reading and stuff. But the other half is mark and psychology. And so just in general, shareholders, when they receive the shares of spin offs, they've just going to dump p the shares because they were investing in the parent company.

They don't necessarily want anything else. And so when they get shares in their brokers account, that is for a small company that in a really bad business, this sell, the same thing goes with institutions. They were invested in the multi billion dollar company, not this little three hundred billion dollar market s situation.

And also, you know, when that situation comes into the portfolio, again, if he doesn't fit their Mandate and or size parameters, they just have to sell no matter what. And so again, you have this fourth selling this noneconomic. Selling IT makes no sense. But for private investors and for enterprise investors are looking for special situations, they can really step in and take advantage of those situations in the forest.

You don't want buy them, all right? But you have to analyze each and every one of them, and they pick the ones that you have the most condition in, the ones you can value, the ones that you can understand if you are concentrated faster, put IT on and size, and also on that. No, you know, this is spin off companies.

When they get spent off, they can also really focus on the business and just improving the business, turning around because when they are kind of stuck with a parent, the parent company has to allocate resources to all the divisions, and so is just hard to unlock value. And so at the end of the day, spring offs is just a way for the parent company to unlock shareholder value. So overall, I think finals are still a great place to look. It's more competitive of these days, but it's still a great place to look. You have the same market dynamics and market participants.

and so it's still gna work. Yeah, I love your points there. I mean, the market psychology aspect certainly makes a lot of sense, especially when you have these big institutions just automatic selling post transaction.

And then I just love that it's also an example of if you just simply do the work that other people aren't willing to do, you can be even awarded handsomely for that. I think many individual investors in the audience might be wondering you how they can even find a special situation or how they can even find to spend off in the first place. So are there any new resources that compiled these types of events just so investors can simply identify them in the first place?

There's not go to resource, but there is definite a lot out there. I mean, whatever you're looking at, the great thing about this D N H is that we have google. For example, joe Green, black did not have access to information like we do now.

And he ran and off them, right? He was an eighty and nineties and two thousands. And even then he didn't have the internet that we have today. It's just not the same.

And so if you're looking for spin offs, you can say, hey, go to google and type in spin off calendar and a bunch of results will come up and do actually give your calender with all the spin offs. Or you know, if you're interested in rescue atrides, you know you can just google that and you'll have a calendar of situations to look at. But you were talking about doing your own work, and I actually do people even that.

So my recommendation to investors is to actually do your own work right, to make your own Price, your own calendar. Because the differences, if you do your own work, you search for press releases, you know you have keyword alerts fed to you, you're actively searching for these situations in yourself. You can actually internalize everything and you're more connected to the corporate events and transact as opposed to depending on five, ten or resources to feed information, then there's a disconnect there.

And so this is a similar in the way that I train my alyse. For example, I always tell them you need a build on model. And what that means is IT starts with putting in your own numbers.

Don't import the numbers. So if you put in the numbers by line, sell gonna be color one with the numbers. If you do that, you go to the painstaking process of putting on all of the numbers.

I suppose importing IT and having your mouth without a number at you, you're gonna be able to see things in a different way. You numbers and information differently. It's like when you use pen and paper to take notes as opposed just typing IT out just the way that your brain and code information from the pen to paper, it's just a lot different.

And so it's almost like sing the matrix, right? You're able to see the patterns within the patterns. And so there are a lot of resources out there. But my recommendation is if you have the time, if you are a really good investor, good analytic formation, just put together your own calendar or a spreads y of all the situations I dreamed about, talks about spin offs, merger securities risk, batch post bankrupcy exits and not like a stuff.

So let's talk about one of the case studies from the book. So this one is on a host marriage. And by reading through this case study in the book, and it's one of those examples where a bad business is essentially being separated from a good business on, my god, this is wonderful Green black and going by this good business, it's got all the toxic waste and separated from IT.

And it's like, oh, no, he's interested in the toxic ways, not the good business. So I just love that the contrary and nature of looking for the bigger mispricing that place. So how about you talk through what even let this spin off to take place for post marry out?

absolutely. So at the time, very corporation, they announced in october. And so at this time, what happened was there was a huge realistic downturn.

So what end up happening was there was just a bunch of hotels that they just could not sell. So they brought in a gentlemen but named Stephen bombing buck to solve the problem. And Steven bombed book.

He was an expert in the industry, and he worked with the biggest companies in the space. And he worked holiday, disney, Hilton, AIGC. So mary, at the time, had two businesses.

The first was the hotel margin business, which is the good business without everybody wanted, where they generally consistent earnings from fees and basically they manage hotel progress for others, right? And so mary international was the parent company or the good portion of the spin off the other business involved or we was the toxic ways that you mentioned. This business was the development and ownership of hotel properties.

So this portion of the business would be called host marriage or this binkle with common sense. You can just think that with the development of hotels, only the properties involves a lot of debt. And the boombox solution was separate the two businesses so that shareholder about you could be unlock because with these two businesses mold up together, the market couldn't really appreciate the valuation of wonder both businesses. Let's take a quick brick and hear from today's sponsors.

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All right, back to the show. Let's see. IT was mario international. That's the toxic waste. And I love the point that cream plat made. He looks at this and am reading through these press releases in one night.

He's just like, who in the world is going to want this thing with all this realize that's really tough to sell? All this is dead and what not? And then he walks through three desirable characteristics in a spin off opportunity.

So we can just walk through this one. And as IT applies to the mario international and host mario transaction here. So the first one list is institutions don't want IT.

So we have a little of this before. Essentially, they don't want IT in the reason they don't want IT is for non economic reasons. So they're just selling IT just to get rid of IT, not because they think it's overvalued or anything. So they just want to sell their shares immediately and just move on with their strategy that might be in line with their monday, as you mentioned. So talk more about this characteristic and how IT applied in this case study here.

right? So we ve didn't talk about before. But just to recap, IT has to do with Mandates and size constraints. And also IT may not have been the business that the institution one of the big year and often times to shareholder and institutions just want to sock of the parent because that's what they invest in the first place.

So as IT applies to this case, study post marriage, which is the spinky, was actually only gonna ten to fifteen percent of the parent. And so at the time the parent was a two billion market cap. So if you do the math there, that means the spin KO was gonna just two hundred and three hundred million, which makes up a microcap.

And just a recap again, mary international was the management business. IT was dead free, and eighty five percent of the business evaluation was for my international als. And so institutions want that.

That's the business that they want is larger, is a fantastic. And so that's what they want. Host married was the toxic waste with the unsolved hotels and the two five billion eight d institutions.

They don't want that and they don't want the unceiled properties. And the only person I wanted that, the time that seems like was I that's what he wanted. And so that's where he looked.

That's a great point. I mean, most investors who are interested in the stock are gonna wanting access to the good business in the second patos tic waste could span out be of them are going to be interested in selling. So the second characteristic Green black list is that insiders won IT, which is of course, attractive because they're going to know the business Better than anybody else. So he actually found this to be the most important area because IT allies the incentives with the shareholders. So talk more about this one.

absolutely. So inside of participation actually is the most important aspect. And he'll say that is actually the first place that he looks when he dies and to the public documents. So it's not oh, you know look at the numbers are whatever else that people like to look at.

He actually goes straight to that section of the public document and he wants to know what this insider participation look like because the more stock center for new management, the Better in some this situation. Bollen box was a guy that was gonna run IT. And this guy, you know, he's got a reputation, as we all do, to maintain.

So you're not gonna a wanna be the C E O of a entity or company that's destined for failure, right? You don't want jump on a sinking ship. And so I think if you looked at public documents this back there, because nearly twenty percent of the spinal soc was going to be available for banana fort employees.

So the matching team, the employee, is the inside of ice to make this thing work. The second thing, which was the icing on the cake, was actually that the married family, they would still own twenty five percent of host after the spin off. So the marriage family was heavily invested in what was calling called the toxic waste.

So if you combine these two things together, the many families in IT, this turnaround specialist, or this guy who is really good at financial engineering, whatever his skill said, was that made him so successful? These two were on the same boat, shareholders. And so inside the participation supreme one.

alright. The third one is that a previously hidden investment opportunity is created or revealed. So this is where a lot of the work we mention earlier that investors need to dig lyor deeper, pass some of the show headlines and the initial filings.

So Green blad d explained that in the case of host mariage, there was tremendous leverage. So analysts expected that host stock was going to trade around five dollars per share. What do you you you simply round numbers here and the company would have somewhere around twenty five dollars per share in debt.

So this makes the approach, my value assets around thirty dollars per share. If we were to just have a fifteen percent move in the value of host assets, the stock could practically double because of that leverage that was at play there. If the vue assets were down fifteen percent, then if that would be absolutely determined the shareholders because of that leverage.

So essentially, if the market was even slightly off the market in the value of what the assets were worth, then this could lead to asem tric upside for investors. And IT turns out that tremendous leverage can be found in a lot of these spinoffs because IT allows the good business to shed off what's undesirable and trouble some to get rid of. So host mario had all three of these characteristics, so most institutions were likely to sell their shares without doing any further.

Second, insiders had a vested interest in the company, and in the mario family also had a vested interest as well. And then tremendous leverages would magnify the returns of the assets, turned out to be more attractive than what was initially anticipated. So in light of this, how did this all pan out for Green, black and for OS marry out?

IT worked out extremely well. He tripled his money within four months. So you do the animals return on that. What was a huge return force portfolio in his firm, golf in because he actually put almost forty percent of the fund assets in the host.

So you imagine and you know a private investors, one billion doll portfolio or you are managing thirty billion dollars, I mean forty percent of the portfolio in this situation. But the way he rationalized IT is that his downside was protected. Basically, he was just paying four dollars for the debt free assets, and he value those assets conservatively at about six dollars.

So six dollars for, see you getting about, you know, like a thirty percent margin, safety and everything else was essentially free option. So the subsidiary that was doing terribly, if that worked out free option, if the unsoiled hotels, they could be sold or monetizing some way, the free 好。 So basically what he saw was he was a situation where he couldn't really lose money.

And so he sized up to forty percent because that was a situation where basically what he looks for when he puts together a forty percent position is that he is looking for situations we can't lose money. I think most investors get wrong and they flip at the other way. They're looking for situations where they can make a lot of money.

The problem is, if you got a four percent position and the situation doesn't work out because you improperly evaluated the downside and other risks, you're actually gonna a have a very bad year. And so long story short, the investment worked out very well. But I will note that he made a sound a lot simper than he actually was.

And so the execution of the trade was actually quite complicated. And so the way he structured the investment in a host actually involved preferred chairs and call options. And I think he was involved the country in this because, you know, if you put in four, four percent fund something, it's not gonna be all options, right? And so the other thing I take away from this is that that's what you analyze.

All the security are available to you after you analyze the situation of work situation, once are available, if they're available, you know all the warns call options at sea and just take a big picture with you and you just think yourself what is the best way to play the situation. And sometimes it's just a common stock, and so it's a easy investment, but sometimes maybe you do a cent type struction IT around preferred and call options in the common. So this case study is just one of my favorite is fascinating because middle, if I see a lot of debt on the baLance like that, I also have in the version to that. But it's a great reminder to myself to way through the documents and take a look, don't look the leverage and the debt to swag you from investing because then you're gonna miss out on the triple and four months.

That's simply amazing, say the least. So and it's also just impressive to see, you know, if you're implementing options and these are one year, two year options or however long data they are, you really need to do your how, mark, you know your downside quite high if you end up being wrong. So let's transition to one of the other chapters here where Green, black covers risk arbitrage.

So from a high level, this is also fairly simple to understand. I would say so in its simplest form, this is when a company is set to get bought out at a predetermined Price and the stock might trade that a slight discount to the bio Price. So investors have the opportunity to essentially bet that the deals gona close, they're able to capture that spread.

And of course, these types of deals are no short thing. There is a chance that regulators stop IT their financing issues are certain things are uncovered in the due diligence process. Green black often references the florida cyprus dens or A B trade he'd bet on early on in his career is betting that the deal he's going to go through, he's going to make a quick buck.

But cyprus gardens ended up falling into a single and ended up losing a lot of money. On that bat and probably a very humbling experience for some of my camera only in his career. Warn buffs, also someone that's ventured in the risk arbitrage opportunities as well.

So when he feels that the downside is just eliminated, that's when he gets certainly interested. So back in early twenty twenty two buffs participated in microsoft and activision risk our play and the bert che. They took gravely a one billion dollars stake in activision in early twenty twenty two that was seventy nine dollars per share.

And then the deal ended up closing in the fall of twenty twenty three and bircher and at a twenty percent gain in around eighteen months, which when the downsides eliminated that something that's pretty tractive to buffett. This certainly can feel like a low hanging fruit, but there's always that uncertainty of what's going to happen before the deal closes. So to what extent do you see these types of opportunities and what makes these attractive to give you or to give dream black the certainty that may think it's going to close?

yes. So just as an opportunity that there will always be investment opportunities in this area. And you know, if you just follow the papers who also for journal, the financial times, whatever you may be, there is always M N A activity going on.

And that's because risk arbitrage know M A really what keeps the greece going. Now he keeps the entire cycle going. And what I been by cycle is it's just on a big picture level.

You know, you have a cheap company. That cheap company gets acquired an M A deal, and then the company and our industry gets overheated. Everything's great.

And then you have a bankrupcy. So after the bank psy gets done, there's a cheap company again. That cheap company gets back in an ma deal.

And then he repeats itself again. right? cycles. great. Now is in the comedy business, he gets the peak. You got a bunch of dead going on.

Bankrupcy, as is bankrupcy, becomes a cheap talk again. And so is this a virtuous cycle that keeps going? And Emily is at the center of IT all.

And so it's like the lion king, the circle of life. That is how the markets and companies Operate. However, I will say that it's gotten very difficult over the years because of increased competition there.

A lot of funds doing risk are spreads have come down as well. It's not the hay day of the seven and eighties where you can just make a killing and reata. It's different now.

And there are risks, as you mentioned, and the risks as you touch upon include anti trust risk, financing risk. And you've also got the whole position sizing on the process management side of things. And just in recent years, for example, the government has gotten very involved in some very high profile situations involving anti trust issues.

And so if that deal was through and you size the too big, you're gonna SE a lot of money and you ve IT to the situation, I an that problem there fell into a single. So how could you possibly anticipate something falling through a single le when you're doing your risk calculation on the spread and reading finding? Think about a sin kle is just a way out and love fill, but have to account for that.

And so for that reason, that's why joe Green, but actually recommends merger securities over risk. And merger security are, well, first is just a safest way to make money than risk. And so what merger security are is forms of payment that get in on deals.

And so typically, deals are done, right? The require is are making a deal for the target and the payment is typically cash and or stock is typically not preferred or warrant or bonds, right? Typically just cash and or stocks.

So IT goes back to the whole dynamics of this spin off and all the other types of special situations when people get security that they we're anticipating or they don't want or that doesn't fall within their Mandate, they just going to sell IT. So imagine you on the stock in the acquired company of sudden the deal closer and you've got, say, preferred, maybe you're unsophisticated advisor. You even know what preferred are, right? It's just automatic.

And so just going back to the overall opportunity, it's definitely there. But you have to look and especially with mergers charity because the wall fy journal, the financial times in new or times, whatever is your publication of choice and not going to feature mergers securities because is so boring, nobody is gonna talk about those things. And so you have to follow the deals and the on top of the information because eventually, but the clothes I hey, you know, we're adding this in or we're throwing this into the deal structure.

So it's interesting that you mentioned that Green black was more interested in the merger orbital than the risk arbiters. I mention he actually in in his first job at a college, he in risk arbitration, he figured out that he didn't really like the risk reward. So you might make, say five percent or ten percent and three months, but if you happen to be wrong, you might lose twenty, thirty, forty percent at times.

That can be just not an attractive risk reward for you, really completely eliminating the downside. But if you are entering this arena, you want to be pretty sure that he goes through. And another thought that kind of comes to mind is that someone like Green blood, his time and his energy and his attention, it's very scarce.

So to be able to go through all the filings on a merger arbitrator, risk arbitrator, you need to be sure you're spending your time in the right place. And if something offers a five percent jump in three months now, is that really worth the time? Is that the question I would sort to be asking if I was in issues?

So you actually highlighted to me, uh, another recent risk arbitrator's play that you participated, and I believe is called locks on. And this was a long, long listed luxury company. IT was taken private by a french billion aire.

So the socks was trading at around thirty two hong kong g dollars a few months before I was taken private. Thirty four hong kong dollars, representing around a six percent spread. How did you talk more about this since it's a more recent example in something that you participated?

So I first read about this in the financial times. And more specifically, IT was the lex column. And I know people don't really read newspapers, this is, but I still find reading newspapers to be a great way of generating ideas.

IT could be the financial times. IT could be the wall sty journal. But in this case, IT was the lex column. And for those without know on the lex column is in the back the paper that has all stock pitches.

And Michael Price once quipped that he could run a fund just based on the lex column alone, so that give an idea of the quality of companies that are written about in the ex colo. And so just the first thing that jumped out was I was actually familiar with lots of town, and so there, no, I here. And there are in all the balls there, in all the outlets, and there are just everywhere, right? The company Operates in ninety countries worldwide, and they have more than three thousand retail outlets and over thirteen hundred stores.

I believe. And also, if you have a friend, a colleague, a girlfriend or wife, you've probably bottomed from there as a gift. And so I think one of the most popular products is like a hand cream.

And they've got IT this formula down to the tea and supposed to just work really well. But they get locations. They have creams, oils, all kinds of building cosmetic products.

So the article went on to say how they we're going to take the company private and they wanted to conduct the tender offer to buy back all the other hand chairs. And so the offer was for thirty four dollars per share. Hongkong, and so this just use thirty two as the example because you time that this occurred.

And so you're saying, okay, a two dollars spread, it's not a lot, right? It's like a six point two five percent return or something poetry like that. But if you annualized IT out place on when you buy to the closing, you're looking at a double digit of return, especially if he closes in three months or six months or so, six percent becomes a double digit t return.

And so depending on your analysis, if it's relatively safe and you don't think the deal is going to fall through, IT gives your portfolio something to do rather than hit t in cash, which as you know, cash does nothing and it's a bit alternative of the treasury ies because treasuries, depending on in the situation you bought for IT, could be like if you invest in this situation, right? So reno gear, he was the chairman of loss at on and he's also bill in actually, but he owned about seventy percent of the shares and so he was the majority owner. And so it's safe to say, and just with common sense, if you are the majority owner and you're pushing for this is likely that the deal is going through, right, unless you just have second thoughts and you just back out the deal.

So that part of equation was pretty sault. And in terms of financing wishes there, the C. F, I, they raise two billion euro to buy out the minority shareholder via the deal.

And so one point six billion came from black stone golden sex, and the other four hundred million came from B, C, A, C, I, B. In my mind, the financing aspect is also pretty cure. I mean, if it's coming from black zoning, golden sex, they've got the financing done.

And so why did he like that? The deal done and the motivation for getting deals done is actually very important, both in this situation and also for any risk deal. And so they just made a bad decision with an acquisition and they overpaid and financing, they took on too much that, but that doesn't mean they're bad business.

They use me the bad ratio c move. And so that could be one reason. And they actually decided that the homesite index was down like forty five percent over the past five years and also down forty six percent from its peak in two thousand and twenty.

And IT makes sense given all let's going on in the chinese and hongkong market. Anyway, for all intensive purposes, IT looked like a sand dog. Everything was in place. And so the downside is, of course, the deal are going through, but of course, tender offers tend to go through more often than not. It's not short thing, but it's definitely not a risk ARP situation where you have potentially an anti trust issue or regular or issue.

So in my mind, the worst his scenario was I will be stuck with an average to above average business, but a business with a recognizable brand that was trading for about fifty times E V E beda. And about seven times E V ebit. And so while I would like to paint lower multiples in the m in a world just multiples in general and compassing all times of businesses across all industries, those multiples are fine, right? And the business was also genuine free cash flow and the revenue care for the last three years was eighteen percent.

So yeah, that's pretty decent. And they return to as a capital was over fifteen percent. So you know, you have the good and cheap aspect of joe Green blood magic formula here.

And so basically, my thinking was the worst businesses to be stuck with if the ten of red and go through. So how to work out pretty well. IT took only five months from the initial buy to the cloth.

The could actually complete the the delisting on the top of your team. And so assuming you buy in may for three, two box and you could have gotten for a lesson dollars, but IT has assumed thirty two dollars, your analyzed return would have been about fifteen point seven percent. So fifteen point seven percent to point in ideal just to end for you just to sit and wait for five months.

And presumably this portion of your portfolio wasn't cash anyway. So oh, now I worked out really well. Let's take a quick brick.

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That's a good question. So I think a lot of times this spreads exists because there is the element of the deal not closing. And so in an efficient market, the shares should have traded the thirty four on the day of announcement, but from the deal announcement to the closed, a lot of things can happen.

And so for whatever reason, market participants as a whole thought that the tender offer might not have been completed. And you there was a threal. I believe the rush hold was something like ninety percent or something like that.

And so there was a threshold that they had to reach for. They tend offer and the whole deal be completed. And so it's kind of draw Green buses in general.

He doesn't know why businesses are in the value. He doesn't know why you see situations like host these situations in general, why they exist. All he knows is that they exist. And if you do the work, you do the valuation work and there is a gap and transit value and you put on the trade and size, you can do very well. Yeah, I think there's certainly something .

to be set around, just things simply being uncertain. I mean, you think something might happen, but you never know for sure. So that certainly seems like logical reason to me, especially with how many of these could happen in theory within a year.

So let's transition here to the chapter on bankrupts and reorganization. So unlike spending, fs bankrupcy are actually in area where investors should generally steer clear. Just do the base rates of success for shareholders in the amount of complexity that's involved in these. I think most investors would, of course, just steer clear anyways. I don't think they need to me here me to tell them.

And I think that would certainly be a White decision in most cases, many times with bankruptcies, the equity holders can since or at the bottom, the total pole that can be totally wiped out since the bondholders and other parties are above the equity holders prior to the bankrupcy and who gets paid. So why is this even a chapter in Green black book? And you know what makes further rare case in that investors might be interested in something like this?

You're absolutely right. So private investors and small funds in general should be clear of companies in bankrupcy or those that are about to file for bankrupcy. Because first of all, when the companies in the stages vulturine investors and stress at funds, they're going to have an advantage over you due to the sheer size as well are legal expertise.

So you're already add disadventure from the get go, right? You see this situation, but there are professionals out there that is domain. And so you already had a huge and so what Green black recommend and what eye recommend is to analyze post banker cy exit instead, post banker cy exits are easy to understand because all the toxic waste has been dealt with, right? And you've got a disclosure statement.

And once they X A bank acy, you just slept analyze and the common stock. Again, like most special situations, you're just really looking at the common stock to start with. And so it's a much easier analysis and you don't need to go to law school and you don't need to be a vulturine investor to do well with post bankrupcy exits.

And so with that being said, is still a very tRicky area. And so the best way is to be extremely selective because companies followed bankruptcy for a reason, right? There's a reason why they got there in the first place.

So one way to approach post bank of the access is to just invest in the good businesses and see you might be wondering like how is a good business impossible there, a post bankers' exit? Well, there are a few things I could have happened actually. The first is they may have been over leverage due to a takeover that they did or via N O B O.

And so they just made a bad decision with an acquisition and they overpay and they think the finding, right, they took too much. The second is that they had a short term, you know, Operating or performance issue. So maybe they missed a quarter or two or maybe they had a bad year or they actually had a Operation issue within the business and they couldn't pay the debt because you have that, you have the service that, that to make the payments and maybe they can make the payments.

And so they had a file banker, cy, to handle that issue. Another interesting reason why a good business could end up in bank arctic is there are ability bwc its for example. So maybe the product liability loss, you was really bad and they felt that, oh, you know, we were probably lose this or the outcome is such that the verdict, the amount is not something that we can pay.

The so banker says one way to protect yourself from pop liability lawsuits. And of course, you don't have to sit with good business as if you think you're really smart. You can absolutely at the devalue situations, you can look at the verd business, but you're really just making the game more complicated than that should be.

And it's just it's a difficult judged call and make you're looking at bad houses at levered businesses. Got that too hard pile I put post excess that fAllen in those category in the two hard pile. But talking about host may guy, look sometimes .

yeah i'm reminded I recently interviewed an investor named ed Derek polikey. And during the great financial crisis, he bought into general growth properties, which was being walked through their bankrupcy process. Backman policy mated a one percent position in his portfolio and did that ended up being a twenty bagger forum? So big, big winner there. I would think with many of these bankrupcy, the post bankrupcy company, I think over the longer term, especially when we get to the next case study we're going to walk through, IT tends to not just be a great company that own in a lot of cases, but that first year to IT still might be just severely under valued.

When you look at the assets and what not, I was curious to get your take as a long term value investor, how do you think about miss pricing actually coming end up for a vision when you might be holding something that isn't all that great of a business? Is that a case where generally year just avoiding bad companies altogether that might be melting ice cubes in our dead or what not? Is this the case where the mispricing can do to be so large that it's hard not to get involved with IT?

So I think this is a problem that most of, not all, value investors struggle with. If you got the melting ice q ve got a business in the secular decline. But valuation makes sense and it's at a low multiple.

And so I would take the Green blood approach and types of businesses. You have to take more of trading than a now it's going to be a five, ten year forever type investment, right? It's like more of a two to three year investment.

But you're thinking, hey, maybe if things goes out, am out so you can get into these types of investments and say, I will hold IT for a decade or could be a buying hold forever like more of what keep in mind when business has buying hold forever, that's for the highest quality businesses out there, right? If you're talking about these types of businesses, not so much. And so that's why it's actually best to identify cellists because cellists will get the attention of market participants and cellists can come in different forms, right?

Could be a new product service IT could be a matter change in A C E O, C, F O, replace them. Somebody really good comes in. Maybe they doing restructuring the doing asset cells, maybe they're buying and acquiring companies, maybe they've got new contracts, just anything that's on the horizon in the over the next one to three years.

And then once you ve got the press releases out, you probably have improved Operating performance that will get the attention of investors right? And IT also helps to have a strong baLance. E, so ideally, you have a lot cash and you have minimal to know debt.

why? Because if you have a strong baLanced, you also become a prime take over candidate, right? If you are a bio firm, you would rather take over companies that have a very clean baLances. And so these are ways that you can get around the melting ice.

Q issue, right? There just needs to be something that's gonna happen over the next two to three years where value can act actually be realized because there are lot of companies, for example, like we're not talking about the value here, but net nets, there's a reason why net nets stay. Net nets. It's because there just typically bad businesses in average to below average that don't do anything spectacular, and that's why they stay in net, net territory. And for people who don't know what net that are there, basically companies trading at liquidation value there about.

So the last case study I went to touch on today was K R, which was quite an interesting special situation. So they filed for bankruptcy in two thousand two. And then they went through some corporate structuring, perform to spend off and seems like they just one through this whole playbook.

The so prior to the interview, you had told me that E D lamps he put on a master class in restructuring K R and maxi zing shareholder are value with the assets they had. And I believe you studied a research this quite intensely back when you're in school. So I want to give you the chance just to talk through this one and share some of your learnings from IT.

Yes, so you mentioned school. So this deal actually has a special place in my heart. So I took advances bankrupcy in law school. And this just one of my favorite classes during my time there. And that makes sense, you know, investor special situations that all make sense. So I actually use this case study, but at the time, not just, you know, oh, I want to get to a in the class, but he was mostly just to learn more about the stressed that investing given my interest. But I also really like any lamps story, his track record and just his concentrated and investment style.

And so ended up using km or and as the case study and low and below, I actually got the top grade, the class, but I was actually kind of a shocker, because get this, my professor was actually on the king other case when he was a partner as scared and arms. And so for me, I was like, I was getting the stamp of approval from an expert who actually live the situation in real time. So some background for people who don't ever know what k.

Mart is, which is actually entirely possible because the last game, mark standing, is actually in miami, like the very last one. And it's not even a full size store. And there are four other ones in U.

S. Charitable ies, I believe, one in gm and three in the virgin islands. So the reason why people may not have heard about car is the Younger folks.

K, R, at this peak had around two thousand five hundred stores. So k, are, they were massive. They were the retailer.

So just going back, big picture special, crispy and john rey, they formed a partnership, ty nine seven, to open five times stores. So this can stores. But this partnership dissolved in nineteen sixth, seventh. And the S.

S. Crash c. Company was formed, right? And so the first came out, opened in one hundred and sixty two.

And because nine five percent of sales came from k Marks in one thousand hundred and seventy seven, they change the name two k mark. CoOperation. But going back to cycles came up with him very well. So between one thousand and eighty four and one thousand and two diversified, they got into into wolden book company, homestead of america, sport authority office, max and bonds. So basically stuff that's not the core competence.

And so when that happening, as you can imagine, they had to start selling these non core assets, and they had to close over two hundred stores between one hundred and ninety four and nineteen and ninety five. But even after they did all that, they still required five billion and refinancing. And so in two days, dollars, that's ten billion.

I mean, that's a sizeable trumpy change. So you know, as you said, came back declare bankrupcy in two thousand and two. And I love that was because they face stiff competition from walmart, target and amazon.

S at the time was on the rise. And e commerce, not where they are today, but there are still a player. And so incomes, A D lad.

So A D lad was touted as the next to warn buffs. And I swear, this is like a warm buffer. Never be as warm buffer. But here's this guy got a stine resume, yale graduate. So cloudy he goes on to work at the risk of a desk at golbin sex.

So he worked for Robert rubin and the whose who are the finance world went through the risk of desk, and they all went on the start famous hetch funds, right? And so when he was really have a Young like, I think in this early twenty, or in late I am thirty, right? He was back by Richard rainwater, who is also a very probably one of the best investors of all time as well at rain water.

But he backed at amp. With eight million. And so he started E, S, L investments in one thousand nine hundred and eighty eight.

And so know this hedge fun. O R might get this. If you look at our investors, you know, he is for a fin, Michael dell, George soros, zf brothers, the tish family.

I mean, you just all star roster, right? And this A U. M, got to as high as fifteen billion or something like that.

Two thousand and six. And his returns up until around two thousand and four were really good. Joe Green blood types numbers twenty nine percent annualized.

So going back to the care situation, so waiting up to A Q four or two thousand and one right this point of court court sales and earnings having some trouble, november of two thousand and one standard imports downgrades the debt to B, B. In december. Also, downtown grades are on to hear dut to junk status B A two.

And then in january, potential downgrades them from hole to sell and you know like win an analyst, downgrades you from hold the cell, you know something in trouble because everything's buy or a hole in the banking world. And so if you get downgrade to a sel, there's something seriously wrong, right? And so in january, they are unable to come up for money for charity bonds, you know things start to go sideways, are unable to pay flaming, for example, which was a major food grocery whole l sale at the time.

And they file for check, loving, bankrupt, right? So let's get into what a lamprey d does. So what he's doing is what we call vulture investing and solvent ture investing is actually a form of activist investing, is where you influence manager. When you gain control, you strategically purchase and hold percentages of various classes of outstanding debt.

And just as inside, it's probably best to buy probably more than the third of the claims in the class because the classes deemed to have accepted the plan, if at least the majority of the claim holders and you know at least two thirds of the plans. So you just want to buy as much as possible. And the overall goal, like all induction, is to exit by selling the securities at a higher Price.

But really, how you really make money is by converting the dead that you to a equity. So what does A D amper do? A D lampre buys a bunch of claims, or, right? So let's go down the list.

You know, he bought the number eight, two million of pepeta lander claims about one point eight billion, and preposition note claims sixty one million. And trade venture, at least rejection, claims and trust prefer obligations. So all in all be total investment, which was accumulated over time, two point three billion.

And third avenue was also involved. Third avenue mari women there are also very well regarded in the distress dead and just value investing space. And so marty, also about nine, nine million and prepare tion, no claims, and seventy nine million and trade venture, this rejection claims.

And he was basically in support of what a lamprey was doing. So got this big chunk of securities right? What does he do? During bank of proceedings? He gets appointed as chairman, director, K, R, A gamer, when he also point six of the nine K R board members.

And he also set on the F, I, C, which is the financial institutions committee. And so this is what he gets really interesting IT all comes on the mispricing. And I have no idea how these bankers came up with these values because they were bring dict ous, right? But the estimated value of came, they were saying he was worth two point two, the three billion, by using copenny, sis and D C S.

And so basically they were saying that k mark was worth maybe eight, five a share to 80 share。 Their but the valuations completely wrong. I mean, if you just use common sense, if you just actually look at the filings, they use discount rates of twenty and twenty five percent.

Twenty and twenty five percent is quite excessive. It's a bit high for my tastes, right? Especially if you trying to pinpoint the exact valuation of your business and they value the ppn just and not get to why that such an regions Price.

And then the liquidation analysts was for something like four point six million, and they were saying that the S. M. Recovery range was just thirteen to nineteen percent.

So maybe not that makes sense to the casual listener, but basically this was a classic. This Price situation, the business and the assets were left for dead. And so here's why that valuation is completely wrong.

And he was not just wrong, but he was just way off the reservation. So if you just use two thousand and four as an example, when they made transactions and they sold their existing stores, if you use those comes in those transactions to value came much for foo. That portfolio is actually worth something like eighteen billion, eighteen billion with A B versus what I just send.

So I guess the lesson is, take large positions in various classes, the debt, and use that influence and size to influence, you know, the outcome of the bankers acy process. So how does this work out? k.

Marin, words from bankrupcy in may of two thousand and three, but get this IT seems like you can make a lot money, you know, and claims. But the post banker of the equity here, the stock went from fifteen dollars to one hundred and nine, fifteen to one hundred and nine. That's a 7x in a matter of eighteen months。 So if you annualize that out, that's a two hundred and twenty nine percent return.

So what I got from this was even if you want A N D and don't have billions of assets under management and army of lawyers at your disposal, you can still in. You could have profit very handstands just by buying k market stock straight bankrupcy. And you would have your two hundred and thirty percent return.

I love that story, and I love how personally was to you back in law school, in those bankrupcy classes, I wanted to jump or to chat more about a bit about your investing approach. So Green light book IT covers many different types of special situations. We've talked about many of them here today based on your experience in managing money professionally. Which of these types of situations are most interesting to you? And why does this type of situation seem to be most appealing?

So they're actually all interesting, but that depends on the opportunity and IT depends on which looks most traffic at the time. So the answer is I really like spin off because there's always a consistent calendar of those happening, and I really like risk arb and tender offers. But the problem I have with those, and I think you are to IT as well, is that you can take large positions in the portfolio.

I mean, you would be an idiot if you seize your risk, our trade at ten or twenty person of your portfolio, because idea, you can very much block in your face. But I always keep going back if I have cash position and going back to emerges. Charities doesn't always available.

Cash and stock are usually a typical forms of payment, but if there are merged out there, I like the situation, I would be happy to put on the size. What position in those as well? Post bankrupt equities are definite.

Interesting, as I just talked about. K, R, you know, you can potentially have very explosive returns. Know the thing with post bankrupt exit is that bank of season general right are driven by where we are in the economic cycle.

And so they may not always be available to. However, you can find a situation I came up, everyone's in a while, right? Or a toys for us, for example.

Toys are us actually no longer around, right? But that that was also spin off and there was a hundred x, so you just have a bunch of post banker's exit that just diphenyl tally. Well, obviously, for every K, R and toys at us, you will have a complete bus, but that we have the picture spot and concentrate as jogi by advocates.

And one thing we didn't talk about as much but restructures and diversity ors, those are actually pretty interesting as well because they're always happening. Companies are always looking to restructure. They're always looking to sell off assets. And so when you get situation where there are hidden assets or things are sold off and you own mess the value of the good business, those situations cannot provide excelling returns.

amazing. I'm reminded when a joe Green black was on our show with Williams Green on the Richard wise er happier podcast, one of the points that he made that I really liked was that he doesn't know most things. He only knows a few things really well and focuses his attention on that so willed him about some specific subject and he just happy to say, I honestly don't know, but i'm happy to share my thing ion in light of that.

So in the way William responded to that is to simply stick to playing games that your equipped win. So also during that conversation, Green blah also stated that he doesn't think that having most of your portfolio and sixty eight companies is too concentrated as long as you know and understand those businesses really well. So it's funny when you look at the stock mark, you tell someone you own six, eight or ten companies.

They say you're quite concentrated, but if you are in, say, the town you live in and you told someone you owned a businesses in different industry, you on the car wash, you into restaurant, you know all these businesses you know well and you think they're good companies and they seem to be pretty stable over time. I don't think most people consider that too crazy, which is quite interesting because in some ways it's owning businesses, right? You know, that's how we think about IT as value investors. So i'd be curious to hear your thoughts on to what extent you like to apply Greenblatt's philosophy of concentration.

Yeah, I believe every word he says about concentration. So matter of capital, we typically have five to ten four holdings and we size up on our positions. And so our starter position is typically a five percent in the opposition and then ten percent is baseline. And you know with more conviction and our favorable Price action will take you up to fifteen or twenty percent. And generally, we don't really like having positions be more than twenty or twenty five percent at costs, but i'm going to do IT if the downside is absolutely protected, haven't done forty percent position like the Green and did but to perhaps someday if I see a situation. So what we do really matches up with what he says about in the five, eight investments making up eighty percent of the portfolio.

Our top five or ten, definitely the first eight percent of portfolio, and the rest is cash, special situations and may be short and the smaller positions that we have outside of those five or ten in a cold holdings, those are situations where we can take a five percent plus position, right? So because of the elevator risk and so be like a leap or location, IT could be a short IT could be a risk. Our position just situations where you can go past five percent, especially when IT comes as shorts and also options.

awesome. Well, thanks so much, Roger. I mean, you certainly did your homework and revisiting many these case studies and revisiting just dream blood book.

I mean, what a fun conversation. And I can't wait for the listeners to get a hold of this one. So before let you go, how can the audience learn more about you if they would like and get yes.

So my website, R F capital management outcome is the best way to get in contact. You can fill the form admission box, and we can connect that way. We also post our recent investor letters, interviews, media, pearson ces like this one, so that everything will be linked to that website.

So it's the best way I most one X I have posted often, but I am on x my handle is R G R F A N most linton, you can just search Roger fan and there. And I think in the coming months, i'll also be publishing on sub stack, so will be posting research notes and also block post pertain to know investment approaches and philosophes at sea. And so i'll definitely link those work posts through the website. Eggs and linton.

wonderful. Well, I get that linked in the shown nuts as well. So Roger, thanks so much. Again, I really appreciate the opportunity. This is really fun.

Same is fantastic chatting with you about two Green blast special situations and just the value investing in general. So thanks again. There was a pleasure.

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