Tower Group (TWGP) disclosed after market close on September 17, 2013 that "it plans to release its second quarter 2013 financial results during the week of October 7, 2013". This press release contains little new information to the market because the company indicated on September 10 that it "expects to announce on Tuesday, September 17, 2013, the date for its second quarter earnings release and conference call, and the date on which it expects to file its Form 10-Q". The press release on September 17 precisely fulfilled this objective by releasing the earnings announcement date. Yet, its stock price dropped from $13.86 to $9.98, a whopping -28%. On September 20, the stock dropped another 8.14% without any new information. And on September 23, the stock dropped another 5.36%, when an SEC filing reveals that CEO sold 1.2 million shares. As an accounting professor and a former Wall Street analyst, I start to suspect this is an overreaction. Such a big price drop is often related to accounting fraud, but I have no reason to believe this is the case on TWGP.
The SEC filing on September 20 convinced me that the price reaction to TWGP's press release was a classic overreaction, facilitated by a huge liquidity imbalance (read SEC filing). Specifically, Michael Lee, Chairman and CEO of the company, was forced to sell 1,233,460 shares of TWGP on September 18 by "a financial institution in accordance with the acceleration of repayment obligations pursuant to a loan agreement under which these shares were pledged as collateral" (SEC filing). The financial institution turned out to be Citigroup Global Markets. Essentially, CEO was hit with margin call and the shares were liquidated by Citigroup to repay a loan. Details of the SEC filing suggest three transactions associated with the share sale.
1) 9,900 shares executed at prices between $11.91 and $12.39.
2) 55,901 shares executed at prices between $10.91 and $11.90.
3) 1,167,659 shares executed at prices between $9.91 and $10.90.
These price patterns exactly match the price pattern from 9:30am to 11:45am, as the stock price did not move beyond $10.50 and below $9.98 after 11:45am. Essentially, Citigroup liquidated Michael Lee's 1,233,460 shares right after the market open. Given the average daily volume of about 500,000 shares for TWGP, a forced liquidation of 1,233,460 shares was just too much for the market to handle. As a result, we observed a price free fall. After the liquidation completed around 11:45am, stock prices started to stabilize. Some people may ask why smart investors did not step in. Well, given the price fall, investors did not know what was going on and thus were unwilling to step in due to information uncertainty.
In sum, I think this is a classic example of price overreaction, which was initiated by a forced liquidation of a large amount of shares. Liquidity imbalance from this forced liquidation caused a price free fall, which in turn caused investor panic. It is an unfortunate event for Michael Lee, as I'm sure that he did not expect the financial institution to liquidate his shares. When dust settles, stock prices will converge towards firm fundamentals. At the price to book ratio of 0.4, TWGP is very cheap. Even after additional reserve charge that the management proposed for Q2, which has guidance of a maximum of $110 million, the tangible book value is $12.85. Insurance companies rarely trade below tangible book value. I'm confident that stock price will move up in the near future. A 30% return is not impossible in a matter of weeks. For this reason, I initiated a long position.