A Few Ways To Generate Alpha

Welcome all new subscribers to Alpha Letter. Every week I write about interesting opportunities in the public market. I focus on stocks off the beaten path. Broken businesses. Assets trading under liquidation value.

I don’t like investing in large, popular companies and find a fascination with assets no one else is looking at. Today’s piece will be about a few ways to generate alpha in any type of market. But before we get in today’s piece, first a word from our sponsor…

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A Few Ways To Generate Alpha

Yesterday I blasted out a quick blurb on a long-time Alpha Letter stock. The CEO passed away and the Class B super voting shares he owned collapsed into Class A common stock. My argument for an investment is the company is now in play to be taken over by an activist as the company has no defense given the collapse of the Class B shares. The stock is illiquid and has a market cap under $200 million so few follow it. Anyone who knew the story and followed the death of the CEO was able to buy before the market found out. Since the death, the stock went from $24 to $29 per share. A cool 20% gain.

The quick movement in this stock got me thinking about different ways investors can generate alpha in the stock market. I’m a long-term believer in a deep value strategy that is research intensive. Focus on stocks and industries that are bombed out and left for dead. Assets trading significantly under their replacement value. Stocks so cheap that one single positive event will result in a re-rating of the equity. If you followed Alpha Letter for sometime you have seen countless examples of these ideas.

But today I wanted to highlight a few unique ways I have made money over the years as an investor hunting for treasure off the beaten path. These are special situations. Situations that come once every few years. But when they do come, swing your bat hard. Because most of the time you can generate strong returns.

Odd Lot Tender Offers

An odd-lot tender offer is when a company offers to repurchase its own stock from individuals who own less than 100 shares. An odd-lot tender offer is a public invitation made by a company for any shareholders who own 99 shares or less to either sell all of their shares back to the company for cash. Odd-lot tenders are a voluntary corporate action to eliminate small quantity holdings for ease of record keeping and to return capital back to shareholders.

These situations allow investors who don’t manage a significant sum of capital to generate an almost risk free return. For an example a company may offer an odd lot tender at $75 when the stock is at $70. The stock will fly to $73 and investors with 99 or less shares can collect a nice $2 spread on 99 shares. You can do this in multiple accounts to amplify your return. Anyone managing significant sums of money will not even bother. This strategy is for the beginning investor who is just starting to build their snowball. See more information here to get up to date information on tender offers.

Mutual Conversions

Many old school banks and financial institutions are organized as mutual companies. A mutual company is one that is owned and governed by its members instead of public or private shareholders. For financial institutions, the members are the depositors in the bank itself. Sometimes mutual financial institutions convert their stock from depositor ownership to public ownership. When a mutual bank does this it’s time to pay attention. There is a lot of money to be made.

To covert from a mutual savings company to a public company the bank will issue and IPO. Given the regulations depositors in the bank get subscription rights and are allowed to purchase shares in the institution before it goes public. There are investors who specialize in mutual conversions and attempt to become depositors at as many mutual banks as they can. I know some guys who even get a job in these small towns where these banks are located so they can get a deposit. When they convert, they buy as many shares as possible and make a killing at the IPO.

The reason why mutual conversions do so well is because these banks essentially go from a quasi-socialist type institution to a capitalistic organization focused on growth and expansion. In addition, when banks convert, they are extremely well capitalized, with a ton of cash on the balance sheet and typically trade at a strong discount to tangible book value.

If you don’t have the means to fly across the country to make deposits across hundreds of mutual banks don’t fret. You can always monitor when these banks go public and buy before other investors catch on. Mutual banks are some of the most boring, undiscovered way to generate alpha. Most investors won’t touch community banks and these things are so illiquid that big institutions can’t invest in them. Bank Investor tracks banks that recently converted and if you bought everyone the day the went public you would have done extremely well.

Death of a CEO

When a CEO owns and controls Class B super voting shares it gives the complete control over a company. The CEO can make executive level capital allocation decisions, hire cronies to fill his board, hoard capital and do god knows what CEOs do when they have control. However, when a CEO passes away, that is a significant corporate event that can be used to generate alpha.

It will take some work. You got to find all of the public companies with Class B shares. Then you got to go through the bylaws and figure out what happens to the Class B shares in the event that the CEO passes away. If the Class B shares collapse into Class A shares, track that company and get updates on when 8-Ks are filed.

If a CEO passes away and his/her Class B shares convert to Class A shares, you can make good money. When voting shares are eliminated activist investors can swoop in and get control of the assets. Class B super voting shares carry a higher cost of capital so when they convert into Class A the cost of capital should lower, resulting in a higher share price.

This is a one in a decade opportunity. But when this opportunity comes along swing hard at this ball.

Restructurings

I like to keep track of companies that have recently emerged from bankruptcy. Typically when a company declares bankruptcy the creditors own the equity when they go public again. Creditors are non-fundamental investors and usually don’t want to hold equity in a stock. This results in a large amount of selling pressure and a divergence between a company’s true value and its stock price. In addition, companies that emerge from bankruptcy trade on the OTC markets a lot of the time, which limits large institutional investors from owning the equity.

I like to run screens on companies that emerged from bankruptcy and also keep tabs on companies that I think will declare bankruptcy. There is a lot of money to be made in post-reorg companies and if you can do the fundamental research to determine what assets are truly worth, you can make a lot of money.

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