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My 691% Return * & a New Spin-Off

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June 29, 2011 – Comments (9) | RELATED TICKERS: SUG.DL2 , WMB , SHLD

 

Wow that was fast.  I go away on a short vacation with my family and boom a stock that I only bought a couple of weeks ago soars.  Those of you who read my musings from time to time will recall that I wrote about establishing a position in a company that recently agreed to be bought out by Energy Transfer Equity (ETE) earlier this month, Southern Union Company (SUG).  My investment thesis for buying a stake in SUG, was that Mr. Market was underestimating the value of the purchase offer which was made in the form of a strange merger security rather than a straight cash or stock deal (see post: An investment idea that I haven't heard anywhere else yet...A new "Merger Security").  I viewed this as a trade that had very, very little downside and a decent, but not huge upside.

I always knew in the back of my mind that the possibility of another, higher bid being made for SUG existed, but that was never the reason I made this trade.  I suppose that a competing offer was essentially another free embedded call option in this low risk trade.  Well what do you know,  another company, one that I coincidentally currently own a small position in Williams Companies (WMB), decided to make a more aggressive offer for SUG a week or so after I established my position. 

This offer, instead of the strange $33/share merger security that ETE was offering, offered $39/share in cash for SUG.  Not surprisingly, SUG's stock immediately shot up nearly 19% above the price that I purchased my position at.  I decided to sell my stake in the company a few days later and pocket that 19%, for a solid 691% annualized return on my money (I put the * in the title of this article because this isn't an absolute return, but an annualized one).  I may have sold a little too early because I have missed out on the $0.50/share that Mr. Market is now betting that another, higher offer will be made for SUG, but I am happy with my profit.  My logic in selling is that I don't think that ETE has enough access to capital or the willingness to beat WMB's offer and that I don't see anyone else coming out of the woodwork with a better one.  Furthermore, it is very possible that this deal will result in a lawsuit between the three companies that will drag on for an extended period of time or even worse that somehow SUG's management, which is being handsomely in the form of multi-million dollar consulting contracts that are associated with the ETE offer, will somehow be able to force the first deal through.

Anyhow, this was a very interesting situation to be involved in.  It will likely continue to be interesting for some time as I follow it from the sidelines.  Let's hope that I didn't leave any money on the table by selling too soon.

In other special situation news, late last week Sears (SHLD) announced that it will spin-off a small hardware store chain that it owns called Orchard Supply Hardware Stores.  I've never heard of Orchard Supply before.  Apparently it's a California chain. 

Sears to spin off Orchard Supply Hardware

Is anyone out there familiar with it?  Orchard Supply is so tiny compared to SHLD that this deal seems like it might go under the radar.  If Orchard shares come under selling pressure after they are issued to Sears shareholders who theoretically night not want them, there might be an interesting opportunity to pick them up on the cheap.  Having said that, more often than not this phenomenon...which used to happen quite frequently with spin-offs...doesn't seem to happen any more.  It's difficult to say why that is the case, but it's likely a combination of the popularity of Joel Greenblatt's book You Can Be a Stock Market Genius, which extols the virtues of spin-offs, combined with the massive number of hedge funds out there looking for places to park their money.  In any event, this is definitely something to keep an eye on and again, if anyone out there is familiar with Orchard Supply, I'd love to hear more about the stores.

Deej

9 Comments – Post Your Own

#1) On June 29, 2011 at 5:42 PM, EnigmaDude (93.26) wrote:

I don't know the hardware store but I'm not surprised that Sears is trying to raise some cash.  In another post I wrote a few days ago http://caps.fool.com/Blogs/10-brands-that-will-disappear/607624, the author of the article that I referenced predicted the demise of 10 brands in 2012, one of which is Sears.  I think they are in serious trouble and are looking for any possible way to survive.

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#2) On June 29, 2011 at 5:49 PM, EnigmaDude (93.26) wrote:

oh, and congrats on the great call on SUG!

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#3) On June 29, 2011 at 6:04 PM, XMFConnor (98.01) wrote:

Deej,

I was wondering where you had been with this call! Haha not too bad an annualized gain- congrats.

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#4) On June 29, 2011 at 6:56 PM, ChrisGraley (29.64) wrote:

You got me to jump in right before the Williams bid.

Thanks. 

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#5) On June 29, 2011 at 7:14 PM, portefeuille (99.60) wrote:

well done.

0.824% per trading day also give you around 691% "annualised return" ...

 

http://www.google.com/#q=(7.91)^(1/252)

 

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A common assumption is that P = 1/252 (there are 252 trading days in any given year)

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(from here)

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#6) On June 29, 2011 at 7:26 PM, TheDumbMoney (38.50) wrote:

I have been to the OSH (as it's called) in South Pasadena, CA many times.  I had no idea it was owned by Sears.  Like Trader Joe's (another CA chain), it seems to go to pains to not look like it's owned by Big Corporate America.  I like it, but the reality is there is virtually nothing there that one can't get at Home Depot, plus one can get a ton of other things at Home Depot that one can't get at OSH.  I have no idea what its growth prospects are.  It feels like "Home Depot Light," with slightly more of a garden/lawn care focus.  OSH is where lightweight homeowners go when they are looking for stuff for basic projects.  But all the Mexicans looking for work hang out outside the Home Depot, because that's where everyone doing serious lawn or home renovation goes, that's where many contractors go.  I used to go to OSH, now I go much more often to Home Depot.

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#7) On June 29, 2011 at 9:00 PM, TMFDeej (99.43) wrote:

Thanks everyone.  I wasn't trying to ignore you, Connor.  I just wanted to sell and couldn't talk about the company per TMF trading rules.  I am now free to discuss :).  Too bad I couldn't reap any CAPS points from SUG.  A conversion to cool B ETE shares didn't lend itself to CAPS.  I'll gladly take real money over CAPS points anyhow :).

Also, thanks for the feedback on OSH everyone.  As I sort of thought, there doesn't really seem to be anything super special there.  If that is indeed the case, it means that the stock would likely have to come under significant selling pressure after the spin to make it an attractive investment.  We'll have to take a close look at the prospectus and an eye on it after it begins trading.

BTW Connor, I know that you follow SEMG closely.  What do you think about the company's decision to spin off its best assets (SemCrude) into an MLP instead of converting the entire company.  I would have much preferred the latter.  A spin-off of the assets isn't the worst thing in the world because it will be only a partial spin, which theoretically will demonstrate that the market is currently undervaluing the division and the ownership stake that SEMG retains.  Plus it will be more tax efficient for SEMG, but it's annoying that we won't be getting that juicy 9% yield from SEMG itself.  !@$%%^$&*.  

I guess that this is what the company meant when it talked about a "drop-down MLP" structure.  I would much prefer that it spin-off the MLP assets directly to shareholders than through an IPO.  You know that the underwriters will somehow screw up the issuance of shares and screw SEMG out of proceeds that it deserves.  Plus, what is it going to do with the proceeds, other than pay down debt?  Do we trust the company's new management to invest the money wisely.  I'm not sure that I do.  I'd much rather have the MLP shares myself than trust SEMG management with the potentially underpriced proceeds from the IPO.

I'll have to see if the shares look attractive and if I have the ability to actually get in on the IPO offering.  Schwab isn't great with that.

At least the company was able to refinance its debt at much more attractive terms like we thought it would be able to.  That should help its earnings going forward. 

Deej

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#8) On June 30, 2011 at 10:41 AM, XMFConnor (98.01) wrote:

Deej,

Ahh yes.. TMF trading rules... glad I do not have to follow those anymore (although they are probably for the best in terms of compliance).

In terms of SEMG, I still think it is incredibly attractive. The thesis is starting to play out.. even if it is not exactly how some expected...

The refinancing I think is still being a bit underappreciated.. it should cut 50% of interest expense. I think that's a bigger deal than the market is giving credit for (but hey, with no analyst coverage.. what do you expect?!).

I was a bit caught off guard by the way they decided to spin SemCrude.. however I am not sure we know exactly what their future plans are. In the press release... 

"SemGroup believes that the MLP structure will provide it with the

opportunity to enhance the value of certain of its assets by

contributing them to a tax-efficient entity that will be positioned to

build additional value through the acquisition of additional midstream

assets, either from SemGroup or third parties"

I generally agree with your sentiment about the partial spin/ IPO not as attractive as directly to shareholders. This is obviously a new story so there isn't as much clarity on it as there will be, but I wonder if this is just the first step..?

Overall, I think this should still be a nice catalyst for the stock, albeit not exactly the one we hoped for. People seem to be tough on mgt, but that seems to stem more from previous mgt. missteps than their short stint with the company. They have refinanced the debt and found a tax-efficient way to demonstrate their undervalued assets. I'd give them a chance-- at this price I think the downside is still very limited and that once this thing gains some analyst coverage, we should start to see a more rational price.

 

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#9) On June 30, 2011 at 11:22 AM, TMFDeej (99.43) wrote:

Thanks for sharing your thoughts Connor.  I agree that SEMG is still making some very solid moves in terms of the interest expense reduction and highlighting its undervalued assets. 

I don't think that I am going to sell my position at this point, but I would have much rather seen them convert the entire company to an MLP or spin SenCrude to shareholders.

Deej

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