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Chris DeMuth Jr. is the founder of Rangeley Capital LLC. Rangeley is an investment firm that focuses on event driven, value-oriented investment opportunities. Rangeley Capital and his value investing forum, Sifting the World (StW), search the world for misplaced bets. Rangeley exploits them for... More
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  • Brother-In-Law Investment Ideas 24 comments
    Aug 22, 2013 2:54 PM | about stocks: AB, WPSL

    It has been a good August for fly fishing in Maine. This morning, my brother-in-law caught 17 fish in only a few short hours. I try to avoid wrecking the mood with shop talk, but every once in a while, I manage to slip in an idea or two. What is my "brother-in-law" investment idea standard? First, too small or illiquid for Rangeley Capital. Secondly, unlikely to lose enough money that it would be worth mentioning. So, ideally no downside or extremely limited downside. Thirdly, enough upside to be worth mentioning if it works. I want it to be something that doesn't matter or that makes some money. A great outcome is great, and okay outcome is okay, but I don't want it worse than okay. Ever.

    What types of ideas are mentioned? Reverse stock splits/going privates that can make a few thousand bucks with little risk are always nice. I like eminent domain suits and have a small one in Canada that should be good for a large gain on a small amount of capital. There is a tiny bank deal that is a beauty of a merger arb spread, but the target is unregistered and trades only on a whim. But the investment that is the distillation of everything that I like for a brother-in-law suggestion is WP Stewart (OTCPK:WPSL).

    The basics

    Cost: $12.06 to purchase WPSL equity.

    Payout 1: Alliance Bernstein (NYSE:AB) offer to pay $12.00 in cash at deal completion. We assign a 95% probability of getting $12 back.

    Payout 2: AB will pay $4 in a CVR (contingent value right) if WPSL, as part of AB, increases assets under management to $5 billion from current AUM of $2B within 3 years from the closing which is estimated to be in 3-6 months.

    Thoughts

    AB manages about $444 billion in equity and fixed income products. They are better known for their fixed income products, and equity performance has been lackluster. Most clients are in managed portfolios, and most brokers will follow the firms models on how much to allocate to each strategy/manager.

    WPSL would be the only concentrated growth product on the platform.

    WPSL would be "new" to the platform, and "new" gives brokers something to talk about.

    WPSL does not need to bring in $3B of new capital to AB. The CVR would pay out, at least based on current reading, if existing AB clients move assets into the WPSL products.

    Risk: WPSL CEO will be leaving the firm within 1 year of the deal closing. He does not actively participate in day to day portfolio management, but could affect client perception.

    Expected Value analysis shows that market is pricing in about a 10% probability that CVR pays out. If current assumptions hold, I think that the market is significantly undervaluing the CVR.

    More to come when SEC filings are posted and we get more details on the CVR.

    Market Implied Probabilities

    Preliminary conclusion

    The odds of the CVR paying out are significantly higher than the market implied probability. What's more, if the deal closes as anticipated, then the brother-in-laws will be getting $12,000 back for each 1,000 shares that they buy. Their cost basis for the CVR will be only $60 per 1,000 shares. This is only $20 per year over the life of the CVR. If the CVR expires worthless, they probably won't even remember. If they get a check for $4,000 someday, they'll be happy.

    Update

    (click to enlarge)

    Stocks: AB, WPSL
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Comments (24)
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  • Acme Capital
    , contributor
    Comments (73) | Send Message
     
    Another great write up here:

     

    http://bit.ly/14HYLp5
    22 Aug 2013, 03:04 PM Reply Like
  • bgoud007
    , contributor
    Comments (80) | Send Message
     
    Not sure how you came to a 10% probability of payout. Using a probability-weighted payout of $0.40 in early 2017, the IRR on this investment would only be 4.5%. Seems like investors would want more than that to lock up their money for 6 months with a large possibility of making no money.
    22 Aug 2013, 04:43 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » That was the market-implied probability. I think that the probability is higher than the market does. That is the opportunity.
    22 Aug 2013, 07:13 PM Reply Like
  • bgoud007
    , contributor
    Comments (80) | Send Message
     
    P.S. My IRR was based on a completed deal. Based on your assumption of a 5% chance of the deal falling through and losing $5, the IRR falls to 1.2%. To get to a more reasonable 10% IRR, you get about a 31% probability that the CVR pays off. That seems rational, maybe even generous, given the goal for AUM growth.

     

    Personally, I would need an IRR of at least 15% given that the potential payoff is asymmetric to the downside, which pushes us up to a 46% chance of CVR pay off. I wouldn't make that bet.
    22 Aug 2013, 04:55 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » Okay.
    22 Aug 2013, 07:13 PM Reply Like
  • bazooooka
    , contributor
    Comments (3663) | Send Message
     
    Many might conclude that the probability of the CVR making a few dollars is much greater than one losing a few dollars on this trade. I'd think the CVR payout might be a 25% chance and a FAIL scenario of getting less than $12 (lets say it falls to 8) might be a 2.5 chance. In that world it'd be a fun punt especially for those who know they will have their spec money in cash till Winter anyhow. Truth is nobody knows the real probabilities on this one other than that it VERY likely a safe play if you buy at or below $12. Also its only for those who like the lottery nature of a CVR. Much more fun than Vegas - imo.
    22 Aug 2013, 06:39 PM Reply Like
  • rootbeer
    , contributor
    Comments (321) | Send Message
     
    http://bit.ly/1870C7W

     

    The way in which you present the possible upside against the downside is very appealing. Personally, I have wasted much more than $20 per year over 3 years and have never had the chance to get $4000. In reading one of the AB blogs, the author seems to think that DOW 20,000 is within reach. The article makes the point that people with fixed income investments should consider allocating more of their portfolio to equities. Will existing AB clients read the blog on their own website and follow the advice? Thank you for the idea.
    22 Aug 2013, 08:46 PM Reply Like
  • drands10
    , contributor
    Comments (12) | Send Message
     
    Given that the two parties have only reached a definitive agreement on this one and nothing is unconditional I think makes it a little more opaque than I would like 4-6 months out from closing.

     

    I'm going to keep my eye on this one and monitor how things play out over the next couple of months. But 30%+ on the downside is quite a heft swallow if the deal does indeed fall through and these things trade back to pre announcement levels. I find it hard to assign just a 5% probability of that event happening. A lot can go wrong in 6 months especially in these markets.
    23 Aug 2013, 09:09 AM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1357) | Send Message
     
    Chris, thanks to your article I learned of this opportunity. I bought today at 12.05.....I am extremely comfortable with the risk/reward and hope to be pleasantly surprised in a few years....
    29 Aug 2013, 02:08 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » If you lose $0.05 per share prorated over the next 36 months, please don't mention it. If you make $3.95 per share within the next few years, you can take me to lunch. Maybe crispy beef at Shun Lee in midtown.
    29 Aug 2013, 02:12 PM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1357) | Send Message
     
    Deal! I live in Manahttan and could take you there (which I have been to and like a lot) or a few other hidden gems.
    29 Aug 2013, 02:32 PM Reply Like
  • Squeeky Wheel
    , contributor
    Comments (350) | Send Message
     
    How do taxes work on these things? If I buy for 12.05, merger closes at 12 and I'm left with CVR. Is the basis for the CVR 0.05?
    18 Sep 2013, 10:10 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » Yes, that is my understanding.
    18 Sep 2013, 11:00 AM Reply Like
  • Eric Milner
    , contributor
    Comments (34) | Send Message
     
    Chris, pardon me for being dense but could you explain how one can profit from a reverse stock split?
    19 Sep 2013, 10:08 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » It has been quite unpopular among investors already exploiting this strategy for me to simply reveal this publicly; so, what I am doing instead is offering these to my investors and potential investors. So, qualified investors should contact me directly for an explanation.
    19 Sep 2013, 10:21 AM Reply Like
  • Eric Milner
    , contributor
    Comments (34) | Send Message
     
    I completely understand. I'm nowhere close to being qualified at the moment but thanks anyway. I've learned more from your writing than almost anywhere else.
    19 Sep 2013, 10:33 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » A thought that might both point you in the right direction and also benefit investing research generally: go back to the documents. Read and reread the disclosures filed publicly with the SEC. Read the footnotes. Opportunities are buried in plain sight for anyone who reads enough to find them.
    19 Sep 2013, 10:43 AM Reply Like
  • Eric Milner
    , contributor
    Comments (34) | Send Message
     
    Will do. I never thought to look at these but I will figure it out. Thanks again for sharing your thoughts.
    19 Sep 2013, 12:20 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » The deal was successfully consummated. WPSL AUM was just over $2 billion as of the deal's close. The CVRs will not be listed, nor will AB facilitate a market. Investors can buy or sell in private transactions through a broker dealer. For further information, there is a section on the CVR in the Proxy statement: http://bit.ly/1bJOivr
    16 Dec 2013, 07:38 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » "As of December 31, 2013, the Assets Under Management were approximately $2.2 billion." - http://bit.ly/1iOZXjp
    12 Feb 2014, 10:56 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » Post updated with current CVR status above.
    13 Aug 2014, 09:20 AM Reply Like
  • bazooooka
    , contributor
    Comments (3663) | Send Message
     
    Chris,

     

    Thank you for the update. What do you think the real odds of the CVR payoff are now?

     

    Not great AUM growth in 2014 but still looks like they may get to a near double of the AUM when comparing end of 2013 to end of 2016. I for one am hoping for an AUM over 3B next August when you update this one again.
    13 Aug 2014, 07:52 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10284) | Send Message
     
    Author’s reply » On December 12, 2013, we acquired WPS, an equity investment manager that managed, as of December 12, 2013, approximately $2.1 billion in U.S., Global and Europe, Australasia (Australia and New Zealand) and Far East (“EAFE”) concentrated growth equity strategies for its clients, primarily in the U.S. and Europe. On the date of the WPS Acquisition, each of approximately 4.9 million outstanding shares of WPS common stock (other than certain specified shares, as previously disclosed in Amendment No. 2 to Form S-4 filed by AB on November 8, 2013) was converted into the right to receive $12.00 per share and one transferable contingent value right (“CVRs”) entitling the holders to an additional $4.00 per share cash payment if the Assets Under Management (as such term is defined in the Contingent Value Rights Agreement (“CVR Agreement”) dated as of December 12, 2013, a copy of which we filed as Exhibit 4.01 (“Exhibit 4.01”) to our Form 10-K for the year ended December 31, 2013) in the acquired WPS investment services exceed $5 billion on or before December 12, 2016, subject to measurement procedures and limitations set forth in the CVR Agreement. See the definition of AUM Milestone in the CVR Agreement filed as Exhibit 4.01. The foregoing description of the CVR Agreement does not purport to be complete and is qualified in its entirety by the full text of the CVR Agreement.
    18 Feb, 04:13 PM Reply Like
  • Squeeky Wheel
    , contributor
    Comments (350) | Send Message
     
    The important part is the next line:

     

    "As of December 31, 2015, the Assets Under Management are approximately $4.0 billion. Accordingly, management has determined that the AUM Milestone did not occur during the fourth quarter of 2015"
    19 Feb, 08:43 AM Reply Like
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