Event Investing For Alpha (Eyes On Saudi Arabia)

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Includes: ADM, BA, BAESY, BG, BP, F, FOX, GD, GLNCY, GM, IBM, KHC, LLL, LMT, NOC, RTN, TM, TWTR, UL, UN
by: Henry Miles
Summary

It is generally appropriate for investors to take a medium-to-long-term view in building and managing their portfolios.

Complementing this approach, investors and their advisors should consider “event investing” that can deliver alpha-level results.

Illustrated with five recent examples, this article demonstrates the power of, and provides a context for, event investing.

Most investors are appropriately advised to assume a medium-to-long-term posture in building and managing their investment portfolios. Complementary to this approach, investors may be able to boost their returns by successfully anticipating and acting upon developing events. These circumstances can be long or short in coming and specific unto a corporation or affecting many companies. They can arise for various reasons, including politics and legislation, geopolitical actions, environmental catastrophes, earnings announcements, mergers and acquisitions, and other events. They can be out in the wide open or camouflaged in the background. They can be entry points for starting a position or adding to one, or they can be viewed as opportunistic. Let's dive right into five actual examples to demonstrate the potential of "event investing".

Example #1, Military Defense

I began building our military defense portfolio in early 2015 after the election a few months earlier in which the GOP took control of both houses of congress. That was an event that I reasoned would end sequestration (for a while) and release funds for the obvious purpose. Eighteen months later, in mid-2016, I wrote my first SA article on the subject arguing that it was time to "re-up" in military defense as both candidates for president were considered hawkish. Not long after that, following the election, I wrote my last piece on the subject. From my vantage point, military defense was playing a significant role in the so-called "Trump Rally".

These two election events suggested to me that military defense might do very well especially given global terrorism and mounting geopolitical tensions. The companies I mentioned were Boeing (BA), BAE Systems (OTCPK:BAESY), General Dynamics (GD), L3 Technologies (LLL), Lockheed Martin (LMT), Northrop Grumman (NOC), and Raytheon (RTN). To demonstrate how event investing in these stocks has paid off, let's look at the following data points: a) their prices as of election day 2014 and 2016, and their prices just last week on the close of business November 3rd, b) the level of the Dow Jones Industrial Average as of those same dates, and c) the percentage price appreciation of each stock, and the average of all of them, compared to the Dow:

11/4/14 11/8/16 11/3/17 14 to 16 14 to 17 16 to 17
DJIA 17,384 18,333 23,539 +5.5% +35.4% +28.4%
BA $125.84 $142.20 $261.72 +13.0% +108.0% +84.1%
BAESY $28.85 $27.18 $31.41 -5.8% +8.9% +15.6%
GD $140.79 $153.78 $204.00 +9.2% +44.9% +32.7%
LLL $122.60 $137.73 $186.52 +12.3% +52.1% +35.4%
LMT $190.79 $239.19 $309.99 +25.4% +62.5% +29.6%
NOC $138.57 $229.87 $301.66 +65.9% +117.7% +31.2%
RTN $105.10 $136.51 $184.71 +29.9% +75.7% +35.3%
Average $121.79 $152.35 $211.43 +25.1% +73.6% +38.8%

These statistics leave no doubt that had one invested in these companies on, or soon after, the last two US elections, they would have seen extraordinary results. Taken as a group, their stocks outperformed the Dow by multiples or very substantial percentages whether you held them between the two elections or between either one and the present.

Knowing that alpha-level events don't last forever, I recently scaled back my military defense positions. I continue to hold Boeing, given the ongoing consolidation of its market position (with one eye on China), Lockheed given its dominance in missiles, including THAAD and tidal turbine technologies, and in Raytheon, given its prowess also in missiles as well as in guidance systems and cyber-security.

Example #2, Three Hurricanes

This example connects to an article I wrote two months ago entitled, "Hurricane Lessons". In it, I documented six companies whose stocks, when taken together, rose 3x more than the S&P 500 in the wake of hurricanes Harvey, Irma, and Maria. They included ABB (ABB), Emerson (EMR), General Electric (GE), Siemens (OTCPK:SIEGY), Fluor (FLR), and Jacobs Engineering (JEC). These are major electric and engineering concerns whose equipment and expertise might have been reasonably expected to be required, following the destruction of infrastructure across the Caribbean, though US territories, and onto the mainland. In fairness, stocks of other companies also rose following the hurricanes, including those of automobile manufacturers that would be replacing the million+ vehicles destroyed by flooding.

As I have discussed elsewhere, it is often difficult to nail down the causal link between an event and the movement of a stock's price. This is especially true when events are not "self-contained" unto a company as they are with earnings announcements, regulatory approvals, dilution, or mergers and acquisitions. However, with respect to the three hurricanes, we can now provide some direct evidence of cause-and-effect in: a) Ford (F), General Motors (GM), and Toyota (TM) that reported sales spikes following the storms, and b) the Army Corp of Engineers that recently awarded contacts to Fluor, mentioned in my earlier article, to help rebuild Puerto Rico's shattered power grid. Incidentally, the end-point reporting date in my hurricane article was September 22nd. In the six weeks to close of business on November 3rd, FLR rose from $40.93 to $46.86, or 14.5%. The S&P 500 and the Dow rose 3.4% and 5.3%, respectively, during this period.

Example #3, IBM's Q3 Announcement

A few weeks ago, I had a premonition - based on a mini-series of events - going into IBM's (IBM) release of its Q3. By way of background, over the last year or so, I have written two SA articles that made heavy reference to IBM. The first was on the extraordinary challenges of cyber-security that keep coming at us; most recently, Equifax (NYSE:EFX) and Deloitte. My second piece was on blockchain where I feel that IBM is also uniquely positioned to help major companies/clients. Disappointed by its protracted transformation, I am still bullish on the company, and I own a full position in its shares.

My optimism notwithstanding, I was down few percent on the stock while waiting for evidence that the company has turned the corner. And I waited, and I waited, and waited until right before its Q3 earnings announcement when I sensed that upbeat news was coming. Why? Because the week before that event, NASDAQ, based on history, estimated that IBM would release on Thursday, October 19th. Then, over the previous weekend, I saw that IBM would announce on Monday, the 16th. Then, on that day, I saw that its numbers would come after-the-close on Tuesday, October 17th. Perhaps this was Big Blue, again, just not being able to get its act together. However, I thought it was odd for any company, much less one of IBM's stature, to be bouncing around on something as routine as a quarterly earnings announcement date. Moreover, I felt that there was no need for all the falderal should another lackluster quarter be in the offing.

So, on that Monday, the day before IBM was to report after the close, I bought calls. Specifically, for $2.88 per share, I bought 20 contracts (representing 2,000 shares) at-the-money expiring not even two weeks later, on 10/27. For two reasons, I buy only very short-dated options: a) They focus my thinking on the event for which I'm buying them, and b) They're cheap - for a relatively small investment I can control a sizable chunk of shares meaning significant potential upside with downside "limited" [sic] to the loss of my entire investment in the calls.

Again, that was on Monday morning, October 16th. Tuesday night, following its earnings announcement, IBM was trading sharply up in the aftermarket. Even though the company is still not revenue-growth positive, "the market" perceived that things are turning. Having closed on Monday at $146.50, with its Q3 in now in full view, IBM opened Wednesday, October 18th at $157.12, +7.25%. I promptly closed half my calls for $11.00 per share, a 282% gain. As the stock continued to trade up during the day, before market close, I exited the other half of my position for $14.00, a gain of 386%. Two days, an overall pre-tax gain of 334%, not quite $20K, from informed, but not riskless, event investing. Helpful.

Options can be extremely risky which is why brokerage firms require that you be preapproved for them. My inclusion of this example is not to be construed as any kind of recommendation that retail investors should be, "doing options". Rather, the case is only intended to provide another example of the power of event investing. As accomplished as I believe I am as an investor - having worked in and around the financial services industry for 40 years - I only do options occasionally, and I have enough respect for their leverage that I execute trades through a seasoned full-service expert in middle-office security operations. I purposefully do not do options on my own through my discount broker. I want another set of eyes on these trades.

Examples #'s 4 and 5, M&A

A few months ago, I wrote a piece on M&As from the vantage point of acquirees. In it, I drew attention to Kraft Heinz's (NASDAQ:KHC) rebuffed takeover attempt of Unilever (NYSE:UL) (NYSE:UN). On Friday, February 17th, Unilever shares opened almost 15% up on the initial news of the acquisition. However, within four days, Unilever's CEO, Paul Polman, blew off Warren Buffett and, on Tuesday, February 21st, UL gave back half the gain and opened at $44.47. I promptly bought the shares reasoning that in Unilever's desperation to remain independent it would begin to drive shareholder value in earnest. That is exactly what happened. Had investors bought UL right after Polman pushed Buffett away, as of close of business this past Friday, November 3rd, they would have seen appreciation of 25.6% compared to the S&P 500 that rose 9.9% during that time. Once again, alpha results from event investing.

And finally, the still developing example of Bunge (BG). Earlier this year, Swiss mining and trading company, Glencore (OTCPK:GLNCY), "informally approached" the agribusiness giant about a takeover. The May 23rd news popped Bunge's share price from $70.07 to $81.07 in one day (although it had been trading at the higher level earlier in the year). Bunge demurred, and over the course of the summer, its stock fell back to the high $60s with weakening grain prices. Then, on October 13th, Glencore and Bunge announced that they had entered into a standstill agreement preventing the former from attempting a hostile takeover until early 2018. BG promptly jumped 7%. I own the stock for broader reasons, but this second event suggests that a deal may still be in the works, and Bunge may trade higher especially if grain markets strengthen.

Okay, okay, permit me one flight of fancy. If Glencore really wants to think big, simultaneous with consummating its deal with Bunge, it would move to acquire Archer Daniels Midland (ADM). Then, it would turn over integration of the two ag giants either to a joint management team or to Bunge executives outright. They, in turn, should: a) extract ADM from the ethanol business, and b) rationalize all supply-chain, logistical, and processing operations of the two firms. These moves would propel Glencore into probably the number two spot in global crop-handling, ahead of Louis Dreyfus but behind Cargill.

As these five examples demonstrate, event investing can yield alpha-level results: a) military defense benefiting after the turnover of the US legislature in 2014 and again after Trump's election in 2016, b) electric and engineering stocks rising with the unfolding of hurricanes Harvey, Irma, and Maria, c) IBM's earnings announcement that was better than normal/expected, and d) one failed M&A between Kraft Heinz and Unilever, and another that is work-in-process between Glencore and Bunge. In all these cases, the respective investment outcome could have been reasonably anticipated before or during-the-fact although, in the example of IBM, the event registered only as a faint blip on my radar and could well have been a false-positive.

Coming Events - Saudi Arabia?

We know from the examples above that some events drop unexpectedly out of the blue while others approach from the horizon with some level of predictability. I'm looking up and looking out. However, if I had to pick one area that could be ripe for event investing it would surround Saudi Arabia. Due to competition from fracking, over the medium term, the Saudis cannot maintain oil production AND prices; the equation is out of whack. If the Kingdom is to survive and thrive, the House of Saud has no choice but to monetize some of their reserves and find better ways to reinvest that capital.

My last SA article was on the subject of clean energy and pointed to the fortunes amassed by dirty energy companies that are being redeployed toward wind, solar, etc. Saudi Arabia's IPO of Aramco could be such event and a gargantuan one at that. Depending on how much of the enterprise is sold, and at what price, in exchange for oil in-the-ground the deal could generate a trillion dollars of cash on the table. The question arises, "What will the Saudis do with it all?" Well, there is some evidence to suggest that they are preparing to spend a chunk - $500 billion, perhaps - on a "new city" relying completely on renewables.

At the same time, the Kingdom's arrest/purge of princes may foretell the coming confiscation and sale of financial assets. For example, in the last few days, Prince al-Waheed bin Talal, the "Arabian Warren Buffett", was detained. He is reported to be the 45th richest man in the world with substantial Western holdings including in Apple (AAPL), Citigroup (C), News Corp. (NWS), and Twitter (TWTR). The coming of progressiveness?

And, finally, we have the broader regional mess. Unfortunately, it is likely that event investment opportunities will arise from escalating tensions in and around the Arabian Peninsula involving Qatar, Yemen missile attacks, and the unresolved situation with Iran. As with the other items above, we don't know how any of this will unfold, but we have plenty of evidence that Saudi Arabia is worth watching into 2018. What for actual or perceived disruptions in the supply of sweet crude, I will continue to hold my integrated oil company investments, including in British Petroleum (BP), Royal Dutch Shell (RDS.A) (RDS.B), and Total (TOT).

I take the mission of Seeking Alpha seriously which is why I choose to present ideas that may outperform the market and then to circle-back to see if they have, or not. I also strive to keep my field of vision open to new opportunities arising on the cusp of old and new, from paradigm shifts, and with respect to corporate, national, global, environmental, and other investment events that could be the next alpha.

Disclosure: I am/we are long BA, LMT, RTN, ABB, GE, SIEGY, FLR, JEC, TM, IBM, BG, BP, RDS.B, TOT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Always do your own due diligence in consultation with a licensed and competent financial adviser who puts your interests ahead of their own. Remember, there are added considerations in owning foreign securities including those associated with ADR sponsorship, buying and selling the pinks, foreign withholding taxes on dividends, and fees. (All my proceeds from contributing to SA go to charity.)

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.