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Two relatively new demutualizations

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September 17, 2010 – Comments (0) | RELATED TICKERS: ORIT

I've been a little quieter than normal lately because I have been a tad under the weather, but I did have two interesting demutualization situations pop up on my radar over the past couple of weeks. One that I purchased a small stake in and as a result cannot talk about right now.

First, here's a little background on why this type of situation often offers investors interesting opportunities to profit...taken from a post that I made on the subject a couple of months ago:

"Special Situation Investment...Demutualization

Ever since reading Joel Greenblatt’s You Can Be a Stock Market Genius several years ago I have been a huge fan of investing in spin-offs. From time to time if I’m trying to procrastinate, I’ll surf around the web looking for information on planned spin-offs. I found one today that has piqued my interest, but it’s a little different than the straight splits of public companies that I normal find.

The spin-off that I found is actually a planned IPO by a non-listed company. I’m normally not a huge fan of IPOs…with one big exception, conversions of mutual insurance companies to public corporations. 

Such conversions often offer investors the opportunity for huge gains. I first became aware of this phenomenon while reading about the famous investor David Einhorn in the book Fooling Some of the People All of the Time. I need to dig my copy of the book out to find out exactly what he said, but in short Einhorn made a passing reference about how he loves investing in these situations.

When I read that money can be made on such conversions, I set about to figure out why. Here’s what I learned. Mutuals are insurance companies that are owned by policyholders rather than public shareholders. Insurance companies often start out as mutuals and decide that they want to go public in order to fuel future growth. The conversion process actually has a name…demutualization.

A few weeks ago I stumbled upon an article on this subject that contains a fantastic description of how the process works:

Mutual Conversions – A Secret Hiding Place of Stock Market Profits: 

In order to understand why mutual conversions offer such an attractive area for uncovering inefficiently priced opportunities (and hence tend to be a secret hiding place of stock market profits), it is useful to quickly walk through the mechanics of a mutual conversion in order to more fully understand why this is so. 

When a mutual insurance company converts, it goes from being owned by its policyholders to being owned by a holding company which, in turn, is owned by the general public. The conversion process usually starts with a subscription offering, through which the policyholders, employees, officers, and directors of the institution in question are given the right to buy shares, typically for $10 each, in the new holding company. If there are any shares remaining after the subscription offering (and often there are not) the remaining shares are usually then offered first to people in the local communities that the insurance company serves, and then to the general public. 

The key aspect for investors to understand here is that not only do shareholders of the newly public company have a full claim on the IPO proceeds (as is typical), they also receive a claim on all the pre-conversion market value at no cost. Unlike any other type of initial public offering, in a mutual/thrift conversion there are no prior shareholders; all of the shares in the institution that will be outstanding after the offering are issued and sold on the conversion, so the entire existing value, as well as the cash raised in the recent IPO, will belong to the post- conversion shareholders. If you’re unfamiliar with mutual/thrift conversion, you may want to go ahead and re-read this paragraph one more time.

Again, the conversion proceeds are added to the pre-existing capital of the institution, which is indirectly handed to the new shareholders without cost to them. When describing the favorable arithmetic of thrift conversions and the reasons why investing in thrift conversions can offer such compelling investment opportunities for bargain hunting investors, Seth Klarman stated that “In a real sense, investors in a thrift conversion are buying their own money and getting the preexisting capital in the thrift for free.” Peter Lynch put it a little differently, once remarking that from the perspective of the IPO investor, this was equivalent to buying a house, moving in, and finding the seller had left the sale proceeds in the house for the buyer to keep. Indeed!"

Anyhow, since I can talk about the one that I purchased per the blackout rules I thought that I'd mention the second demutualization that has piqued my interest...Oritani Financial Corp. (ORIT). 

This company is a demutualization that David Einhorn picked up a stake in. This relatively small bank pays a solid dividend and it has been absolutely crushed by Mr. Market. 

Oritani's recent conversion from a mutual to a public corporation triggered a whole bunch of stock options and compensation that had to be taken into account in its recent results, making them appear worse then they really were.

I added ORIT to my CAPS portfolio the other day, but I have not had the time to dedicate to thoroughly researching it enough to purchase a stake in real life yet. Is anyone out there familiar with Oritani? I'd love to hear your thoughts on it.

Deej

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