Distressed Equity Investment

During COVID-19 I was studying a company that had $3 billion in sales and was trading under a a $50 million market cap. The stock price had fallen from over $40 to less than $0.75.

I got real close to buying it a whole lot of it. The risk was simple. They could declare bankruptcy and I would lose my entire investment. On the flipside, they could make it through a downturn and I could 10x my money.

To limit risk in a world that was completely shutdown I put a minuscule portion of my portfolio into the stock. If my thesis played out I could make a ton of money. If the thesis fell apart I would walk away with a scratch. There was asymmetric upside compared to the downside and I wanted to be apart of it.

Fast forward a couple of years and the stock ended up going to $20, sold a segment for $810 million, did a $12 dollar per share special dividend and is currently trading around $7 per share today.

I added to my position as management executed on their turnaround strategy and have gotten all of my initial investment back from the company in the form of a special dividend. I still hold the stock and believe it still one of the cheapest valuations in my portfolio over a multi-year cycle.

There are a few key lessons I learned from investing in this distressed equity situation.

1. Research and study companies or industries that are hated and unloved. The market tends to misprice valuations and astute investors who can stomach buying distressed assets when everyone else is selling can make out like a bandit.

2. Keep your positioning in a distressed investment small and add to the position when management executes and your thesis begins to play out.

3. Learn to admit when you are wrong and salvage as much capital as possible if your thesis turns against you (see here for a stock I was completely wrong on).

Ever since my big win in a distressed investment I have continued to stay patient and look for more opportunities where the rewards outweigh the risk.

When you are looking for these opportunities you need to stay patient and turnover a lot of rocks.

Most of these distressed equity investments are trading like this for a good reason. So when you find an idea where you could have 10x plus upside if a turnaround happens you need to do all of the work.

For the past few weeks I have been studying a new company that is in a distressed situation. The valuation has fallen from over $2.5 billion to $100 million. The stock peaked at $142 per share in 2018 and is trading at $6.27 today.

The stock price has never been this low before. The market is implying bankruptcy is on the horizon. Everyone who wants to get out is getting out.

On Friday, I started to buy the stock.

There are a few reasons why I like the setup.

1. Insiders have started to purchase at these basement level lows. Since February 2022, insiders have purchased $740,000 worth of stock, including the CEO who purchased $200,000 worth in early March.

2. The company is looking to sell excess assets including real estate to shore up the balance sheet. From my analysis, I think they could sell all of their real estate and do a sale leaseback to take out their entire debt.

3. Management suggested at a conference that talks with key suppliers is going well and things could bounce back really fast.

4. Costs have been removed from the model and contracts are getting amended to include index based pricing which de-risks the business model. A leaner company and passthrough contracts will allow the company to emerge from the downturn as a winner.

5. Private equity is snooping around the industry with two takeover buys that I am aware of with potentially more to come.

I am keeping my position small for now but will average down if the thesis stays in tact. If management starts to execute on the turnaround strategy I will likely average up. The stock is just too damn cheap at this price and I want to own it at the current valuation.

I hope you enjoy my research on this company. Feel free to reach out if you have any questions.