A primer on "for sales"
TL;DR: this post is meant to serve as a quick primer on “for sales” and why I don’t like them; my hope is that it’s both educational and that I can build on it in multiple future posts / ideas I have planned (spoiler alert: I’m interested in two “for sales” right now, including one I’m publishing on the premium side ~concurrently with this post, so this primer was very much written with those situations in mind).
I generally hate “for sales.”
A for sale is when a news outlet (WSJ, FT, Bloomberg, etc.) reports that a company is in late stage talks to sell itself. An investment in a for sale is pretty simple: you see the rumor / news article, and you buy the stock hoping that the company will announce a definitive deal to get taken private and the stock will go up. It’s a pretty simple (and very event-y) premise, and I will admit that I find myself investing in / trading these more than I probably should.
So if I find myself continually drawn to these, why do I say I hate these?
The honest answer is they’re too simple / there’s just nothing weird about them! I mentioned this in my piece on NVRI1 (Edge, Alpha, and the Enviri Strategic Review: What Actually Counts as Unique Insight?), but I’m always trying to isolate edge or differentiation in an investment, and it is just really hard for me to see any type of edge / differentiation in a for sale situation2.
I think a hypothetical will show why edge is so hard here. Say company XYZ is trading for $10/share, and then the WSJ turns it into a “for sale” by publishing an article that says “company XYZ is in late stage talks to sell for $15.50/share to Company ABC.” The stock is probably going to gap up to ~$14/share. If a deal is announced at $15.50, the stock will probably trade for ~$15/share to account for the time value of money and the odds the deal breaks, so at $14/share the market is placing ~80% odds of a deal happening3.
If you decide to “play” the for sale and buy the stock, you are betting on one of five things:
Better deal odds: The odds of a deal happening are actually higher than the market is pricing in (i.e. you think there’s a 90% chance of a deal, not 80%).
In our example: The stock is trading at $14/share for an 80% chance of a deal; you think it should be trading at $14.50/share for a 90% chance of a deal.
Better bid: Sometimes a “for sale” article will not include a potential price, and the market will have to make an assumption. Perhaps you’ve followed the industry, and you think the market is assuming too low a price.
In our example: If the WSJ article hadn’t included a price, and the market was just assuming the bid was likely to be $15.50/share…. maybe you know the industry really well, and think the actual price will be more like $20/share. If that’s the case, the market is way underpricing the odds of a deal (at $14/share, the market is assigning ~40% odds of a deal happening if a deal would come at $20, not $15.50)
Competitive bidder: perhaps this is a strategic asset, and the rumor the asset is about to be sold spurs some competitor to lob in a massive bid at the last second. This is basically scenario #2 (better bid), but on steroids, because it’s not unheard of for two people to get into a bidding war / pissing match when a strategic asset is on the line and multiple parties decide they want it.
In our example: the WSJ says “XYZ in late stage talks to sell to ABC for $15.50/share”….. company DEF realizes they’re about to see a strategic asset slip away, and calls up XYZ’s bankers and says “hey, $18/share, all cash, no conditions” and on Monday XYZ shareholders wake up to a very pleasant surprise (or maybe ABC takes their bid even higher!).
More deal certainty: The deal will close faster than the market is estimating (the merger agreement will be super tight, the company will offer more clarity on regulatory, etc), so the stock will trade tighter than the market expects (and thus the market’s implied odds of a deal are lower).
In our example: The market is pricing the stock to trade at $15/share on a deal; you think the merger contract will be awesome and the deal will sail through regulatory hurdles and the stock will trade for $15.25/share when the market realizes it will only take ~3 months for the deal to close, not six. Assuming an 80% chance of a deal, the stock should be trading at ~$14.20/share, not $14.
Better downside: The stock was at $10/share before the bid…. but perhaps you think the downside will be higher after the bid. Perhaps the company has been under some activist pressure, so you believe that if a deal doesn’t materialize the company will be forced to announce some type of big capital return or something.
In our example: You believe a big capital return would come alongside a “no deal” announcement, and the stock would trade to $12, not $10. 20% odds of no deal to $12, 80% odds of a deal sending it to $15 = the stock should be $14.40, not $14.
So, when you’re playing a for sale, you’re implicitly betting on one of those scenarios / one of those positive outcomes.
I don’t think there’s any real edge here, but I do think just breaking down the scenarios reveals something interesting: the odds and upside are very, very skinny for scenarios #1 (better deal odds), #4 (more deal certainty), and #5 (better downside). For all of those scenarios, you are betting the stock is 1-3% undervalued. The scenarios where the stock is dramatically undervalued are #2 (better bid) and #3 (bidding war); obviously the outcome is influenced by the high price I painted, but in those scenarios the stock is significantly undervalued (if the market is assuming a bid at ~$15 and an 80% chance of a bid, and the actual bid is $20, then the market is pricing the stock ~$4/share too cheap, or ~30% below expected value on a ~$14 stock). I still think for sales are a very difficult place to play, but that analysis suggests that if you are playing for sales you really only want to be playing them when you think they can announce a truly blowout price, not when you think the market is underestimating the likelihood of a deal.
PS- the sibling to playing a “for sale” is playing a “strategic announcement” when a company announces it is evaluating strategic alternatives (read: trying to sell themselves) and you buy the stock (basically betting that a deal is more likely to happen than the market thinks and/or that a deal will come at a higher premium than the market expects). I like those a little more than for sales. Why? Two reasons:
The market tends to put a much lower odds of a deal happening in these situations, leaving more room for you to “read the tea leaves” and be rewarded if a deal is likely to happen
The range of prices / premium a company can sell for is huge, and if you have a lot of industry knowledge and think a company will be more in demand / have a lot of competitive bidders / go for a much bigger premium than the market thinks, you can often get much better odds in a “strategic announcement” play than a “for sale” (particularly because a “for sale” often includes a leak that provides some guidance on price)
Disclosure: I’m long a small position in NVRI
Yes, I realize how trite that sounds! But trite doesn’t mean it’s not meaningful or effective
20% chance of a deal break and the stock going back to $10; 80% chance of a deal announcement and the stock trading to $15 = $14/share expected value.