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IFB100: What happens if you own stock in a company that gets bought out?

Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners lead by Andrew Sather and Dave Ahern to decode industry jargon, silence crippling confusion and help you overcome emotions by looking at the numbers. Your path to financial freedom starts now.

Dave:                                    00:35                     All right folks, we’ll welcome to the Investing for Beginners podcast. This will be our podcast episode 100 Ooh; we made it. That’s awesome. All right, so today we’re going to talk about the basics of spinoffs and acquisitions, and we’re going to, we’ve talked a lot about these from the aspect of the company buying, but today we’re going to kind of go over some generalities of the other side. So the company that’s being acquired or spun off. So Andrew, why don’t you go ahead and take us off. I know we have a listener question regarding this as well as some are our general thoughts on this.

Andrew:                              01:12                     Yeah, so that fits right in and yeah, episode 100 let’s do something not special at all and just treat it like any other episode. I’m down for that. Had a question from a  listener to the podcast, and this is about acquisitions. So Hi Andrew. Just started listening to your podcast and the impulsively dove into the stock market through the Robin Hood and Mobile App.

Andrew:                              01:35                     We should slap this person on the wrist. I’m cautiously putting it in a mere $600 into a variety of stocks. I was wondering if you could cover how a company’s stock gets affected if they get acquired by a larger company. Is it a good time to buy when that happens? Is it the worst time to buy? So something that you know we can cover and then we’ll try to keep it short because these things can be very, very complicated. But it’s important to know just as a generality what goes on in an acquisition if you’re the company being acquired and also what happens in spinoffs so you can kind of lump them all together because they are these special situations that you’ll see with stocks for a company being acquired. Let’s say you’re a shareholder. And you know, I believe when I did the back to the basics series episodes ago, right?

Andrew:                              02:28                     Which is a place to start or if you’re a beginner for sure. Uh, but back in the episode 43 is wearing back to the basic started, I used the example of Disney acquiring Fox. So let’s pretend we’re shareholders of Fox. Now, what happens in that situation is it depends on how the acquisitions being made and what the terms are. So a simple way to see it happen is let’s say we’re Fox and Disney is acquiring us, and let’s say it’s a shame. It’s a complete share for share transactions. So what that would mean is as a, basically your shares of Fox will be paid out.

Andrew:                              03:10                     In one way or the other. So, you know, it’s not like your money goes away and you never see it ever again. Um, you’re going to get something for your shares.

Andrew:                              03:20                     If it’s, you’ll either get stock in the new company or you’ll just get paid out in cash, or you’ll get a combination of both. So,

Andrew:                              03:30                     Basically what you get Kansas, it’s depend on the terms. That can also depend on how a company is paying for the stock. So like we, we, we dedicate an episode on dilution deletion the shares.

bought out

Andrew:                              03:43                     If, if a company is using their own stock to acquire a company, then you know then there are shares outstanding is increasing there, you’re likely going to get shares in the, in the new company. So as far as how that relates to the share price of the businesses involved, of course every situation is different.

Andrew:                              04:07                     I’ve been a part, I’ve worked in the business or in a company where news broke out that they were going to be acquired. And so over the next six months, up until the close, we definitely saw the shares of that company go up higher. And you’ll tend to see that because a lot of acquisitions just as a generality kind of happened at higher prices, higher valuations anyways. And so to answer the listener’s question, how will the company stock and effect if they get acquired by a larger company, usually on the news and leading up to the actual actual acquisition and and finalization date, those sheriffs tend to go higher because as a general rule, acquisitions tend to be done, uh, high premiums compared to maybe how they might trade in the stock market. Cause you have to think as a, you know, if we’re, if we’re owning the stock, maybe we’re the board of directors is voting on whether we should be acquired. They’re not.

Andrew:                              05:13                     Why would you sell your business when you can? Just like if you have the unissued stake. Well I can, if I don’t like to own this business anymore, as, as a board member, let’s say I own, I don’t know, $1 million worth of shares. If I want to sell out, I can just sell those shares and get what the market’s paying for it. Right? So if, if my accompanies at $25 a share, I can sell it now for $25 a share. So maybe that’s like my floor. And then if another company comes in, we’ll says, hey, we can actually acquire your company for and we’ll pay $35 a share. Well maybe in that situation, yeah, I will agree to be acquired because I’m getting that payout and, and I’m gonna I know I’m going to get $35 a share rather than the 25 that that’s trading at in the market now. And that’s, you know, that’s not always exactly the case, but as a general kind of thing, that’s maybe how you can think of an acquisition when you’re the company being acquired.

Andrew:                              06:08                     As far as like what happens. So the second part of his question, is it a good time to buy when that happens? Is it the worst time to buy? You’re going to have to look at what company is acquiring it. So I’m assuming there’s these question, these two questions are talking about after the news broke, which I mean you can’t really predict when an acquisition is going to happen. So that’s kind of where it makes the most sense. Is it a good time to buy or the worst time to buy? You’re really going to have to look at what’s the company being acquired. Um, the company, who’s acquiring them. Is that a company you would like to hold anyway?

Andrew:                              06:48                     And also like whether the terms, so the chances are pretty small, especially as like a small time investor like us, the chances are pretty small that you’ll actually be able to pet the capitalize on what’s called arbitrage. So arbitrage is where you kind of take advantage of these little discrepancies in the market. Um, so like if as an example, if we were investors at $25 a week, somehow heard the news right away that that the acquisition is going to happen. What’s going to happen that $35? Well, if we could buy in at 26 that’s an easy $9 a profit because we know for a fact you’re going to get at least $35 a share once the acquisition closes. So if you can somehow get really fast on that news and trade into it, that that would be like arbitrage, right? So if you knew that the company is trading at 25 we know it’s going to close at 35 that’s an arbitrary situation that we can capitalize really quickly. Chances are as as a regular investor like us, you’re not going to be able to take advantage of that.

Andrew:                              07:49                     What you really have to think about is you’re going to see that share price jump up towards 35 really quickly because that’s basically the floor. I mean you buy the stock at 30 and you know it’s going to close at 35 that’s a $5 profit no matter what. Now there is still a little bit of risk when you talk about an acquisition like that. There is a risk that the acquisition doesn’t end up going through, even though it was agreed to go through at 35 and so there could be so many different factors that make that happen. So you won’t see the stock perfectly trained at 35 most likely in the last six to 12 months before the acquisition gets finalized and everything gets kind of settled. There might, the stock may trade at like 34 34 50 and that’s because there’s just still uncertainty there.

Andrew:                              08:36                     There’s still a chance the deal won’t go through as you go through the logistics. And so it’s not a guaranteed floor, but it’s a, it’s, it’s safe if you’re going to, if you want to bet on the fact that that acquisition will happen. So I hope that kind of gives a general overview of what an acquisition looks like from the viewpoint of the company being acquired. Now there’s also another situation that’s a special situation that you might run into when you’re buying stocks. And that’s kind of the opposite of an acquisition, which would be a spinoff. So in the sense where in an acquisition you have two companies becoming one as spin off is more of one company becoming too. There’s a lot of different reasons why I spin off might happen. One that’s kind of easy to understand and easy to explain would be if you have a business that is like a cook glomerate so maybe a owns multiple businesses and maybe it has one segment of its business that’s very profitable, doing very well and very healthy and that has another business segment that’s really not doing well.

Andrew:                              09:46                     So if I were to use an example, let’s say we had a company called conglomerate company and then we, it has a candy business and a ice cream business. So we have candy company and Ice Cream Company. Let’s say candy company is really well run, it’s very, very popular. They have great brands sell out all year round where the ice cream company, maybe it’s kind of lost its allure or maybe it’s the brand’s not as popular anymore. Maybe it’s all of a sudden really expensive to make ice cream and so that business is maybe not as profitable. Maybe it has a lot of debt and so you know, it’s making conglomerate, it’s earnings look bad, making their balance sheet look bad because it’s reporting bather needs. And actually the company company, the Candy Company itself is actually really good. So in that case, the management might spin off the bag company, keep the good company as its own company.

Andrew:                              10:44                     And so that’s where you’ll get a spinoff. The logistics behind that is if I’m a shareholder in conglomerate, I might get let’s say three quarters of a share into candy company and a quarter of a share into ice cream company. So if we’re going to assume that emerges and spins off into those too. So it’s not something where you’re, you’re getting like a good company for free. Like you’re not just shedding the fat for free, right, because you had your one Sharon. Now, if it’s, if it’s just a fraction of that, if it’s like three quarters of a share. Now with this new company, while you know you’re, you’re, you will, you could sell the share of the ice cream company and so you, you get some cash and then maybe you can use that to buy more shares of the Candy Company. But you know, you still, you still kind of have that split. So my point there is if it doesn’t happen for free,

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Andrew:                              11:49                     What tends to happen with spinoffs, and this is something that Joel Greenblatt talked about, one of his books, Joel Greenblatt’s, huge hedge fund manager manages over $1 billion of assets under management this time he talks about how he loves to buy into spin offs because the way that the shares can work, the share prices can work during the spinoff is you might see it decline because um, demand just isn’t there. And then they might recover over time. And that tends to happen a lot actually. So if we think about the logic of why that might happen, it can make sense for us and we can see why that’s the case. So let’s say again going back to our example, let’s say I was a shareholder of conglomerate. Let’s say I really liked the candy business and that’s the reason why I bought the stock, but they never really cared for the ice cream part of its business.

Andrew:                              12:44                     So one the spinoff happens, I get my three quarters of a sharing candy, maybe I keep the shares and maybe my core, their share of an ice cream company and I just sell it right away. So if you have a lot of different shareholders who are kind of thinking along the same lines where they never bought conglomerate company for the ice cream brand, so they’re just going to sell those shares once they receive them, then you know that could make the ice cream company shares fall law after the spinoff. Cause there’s a lot of people selling it. You can say the flip side for Candy Company, you know there could be a lot of the fans of the ice cream company and maybe they’re very bullish on that feature but they don’t like the candy company cause it’s old and boring. So maybe those shares will will also get depressed after the spinoff.

Andrew:                              13:32                     So that can definitely happen. You also have to keep in mind, kind of going back to what we talked about uncertainty wise is there is uncertainty involved in the spinoff. So you don’t know, you know, yes the Candy Company did very well as a part of conglomerate, but now that it becomes its own entity, is it really going to be able to compete in the marketplace just as well as it did without the financial resources of conglomerate? There’s uncertainty there. So B, because investors don’t like uncertainty. Wall Street never likes uncertainty. There is a chance that yeah, the business could go not as smoothly as it used to and so investors might shy away from such a situation. So you have multiple forces that as a general sense, that tend to contribute to the share price falling after a spinoff. And so that can make a great buying opportunity.

Andrew:                              14:26                     It’s the same concept as buying low, selling high. If we see value, if we do valuation, and when we calculate the margin of safety on each of these businesses before the spinoff, I, you know, I like to wait until annual, an annual report has been released, but maybe now we can look and after a spinoff we can buy because we wanted to buy the financials of that business. And then we had the added effect of that share price being depressed temporarily. And then after that we can see some share price appreciation from, from the, the dust settling on the spinoff and kind of business returning more back to normal. And that can be a nice source of return. Joel Greenblatt, going back to what he wrote about spinoffs, he talked about how he found that as a fantastic strategy to literally just as, as a general rule to even buy a company’s other spinning off and within a year or two, three years, uh, they would appreciate and he said a strategy like that could beat the market.

Andrew:                              15:30                     So I’m not advocating that whatsoever. I think every special situation is special and you need to, if you’re going to be somebody who’s going to buy into that, you need to definitely do the research. But there is opportunity there. So as an example, Trinity Trinity Industries is one of the stocks have, and I have talked about a lot, railroad stock. Uh, it recently went through spinoff, so it spun off different segments of its business. I liked, you know, as I liked trinity and I was considering buying it and it was definitely on my watch list, but I knew a spinoff was happening soon. Kind of going back to the, the Seeking Alpha thing we talked about last week, I was aware of some of the news that was surrounding the company both recently and in the past. So I knew a spin off had been announced and was in the works.

Andrew:                              16:24                     I wanted to see how that played out and also that gave time for those shares to fall. Like, like I’ve said about how they can fall after a spinoff. So I did and I waited and I was hoping that it would be one of those more clear cut and dry. Um, one company is, is a great spin off and the other is kind of like the, the bad apple, right? That that wasn’t really the case with Trinity. I kind of saw them as equal divestitures, equal spinoffs and not one wasn’t necessarily better than the other. So I didn’t end up pulling the trigger on either of those after the spinoff. But that’s just kind of one example of how you, you, you kind of want to wait and, and maybe you want to see a year after the spinoff until the financials for each business are available to you.

Andrew:                              17:15                     And then you can make like a smart decision. You can make a smart valuation and a smart analysis on, on how you see the financials I think and on, uh, so that kind of covers the logistics of acquisitions from the quiet, the, the being acquired side being bought outside. That kind of covers the logistics of spinoffs. And so how do we apply that, right? As a beginner, somebody listening to our podcast, somebody who I’m assuming is going to have the same values as us, the same principles buy low, sell high, but at the same time look at ownership of a stock as ownership of a business. We wanted to be in there the long for the long term. We don’t want to do all the work. We want these businesses to compound the capital for us and we just wanted to be in the right situation.

Andrew:                              18:04                     So we’re going to be diversified. We’re going to hold for the long term hold through the ups and the downs, dollar cost average. Um, so we’re doing that consistently, whether the market’s up or down and reinvest in their dividends. So we can see that compound and we get compound interests and that will compound their capital faster as the company compounds our investment faster. So with all those things in mind, you know, how much, how much attention do we really need to give to special situations? I’ll say as we’re recording this now in the middle, about the middle of 2019, I’m 2018, 2019. It’s been pretty busy for acquisitions on Wall Street. Um, earlier years like 2016, 2015 not so much. So if you’re a nerd like I am and you like to dig into financial statements and you like to read about these, these things and you like to kind of estimate how it’s going to play out and you kind of know the terms and you’re not scared of the press releases, that could be a great opportunity.

Andrew:                              19:07                     But you know, maybe you’re not that extreme and maybe you just, you like the idea of buying and holding and you like the idea of you know, you understand the basics and that’s important. The principles of, of good longterm investing, buying stocks for the long term but you don’t want to get into that nitty gritty so you can do just fine and do just as well. I think in, if I think about the stocks I owned throughout 2018 there was maybe two that had a special situation happened to them. One was actually both, they were the acquiring company but in most of the other years I didn’t really have anything like that happen with the businesses that I bought. I think I had another stock that eventually did get acquired. I sold a little bit before that happened. So you know we’re talking about the, the just in the investing I’ve done in the leather, which, which has a real money portfolio that we’ve, we’ve talked about frequently.

Andrew:                              20:04                     So as just as you go along in your investing career, you probably won’t see them and you special situations and might happen. You know, once a year, maybe once every couple of years. But it’s not going to be something where if you have a portfolio of 20 stocks, you know, base historically and what we’ve seen, chances are it’s not going to be, you’re not going to have a special situation like this every single year with every single stock. So I think a good grounded investor with the right principles and the right ideas can do just fine without knowing anything about special situations. But hopefully this is kind of given you so at least when you hear that something like that’s going to happen, whether that’s an acquisition or spin off, you will feel more comfortable, you’ll feel more at ease, you have a general sense of what’s going on.

Andrew:                              20:55                     And then if you want to use that, if you want to try to play the arbitrage game, if you want to try to um, pick up a couple extra percentage points and maybe outperform based on timing these things, you certainly can. I would say don’t make a special exception for these special situations. Make sure their stocks that you wanted to buy anyways, but it can be another catalyst or a driver to extra return and then that can be a nice thing to depending on your skill level, depending on how involved do you want to be. So keep all of that in mind. That’s what I see with spinoffs and being acquired, being bought out. That’s why you can expect to happen to shareholders and it’s just another valuable thing to know as as you go through the stock market. But I just just just want to reiterate, you know, don’t worry too much if it seems overwhelming of this whole episode where the over your head just don’t even worry.

Andrew:                              21:50                     You can be invested over the longterm and know that in a diversified portfolio of stocks, you’re betting on the economy, you’re betting on businesses continuing to innovate and grow over time and you believe business will continue to be done. And so with a port, the forest five portfolio stocks, you are owning a good share of of the business that’s happening in the world and so you’ll be fine. You might have a stocker too that gets acquire. Maybe a stock does a spin off, whatever the case may be, you know, maybe you get acquired, you have a cash payout and now you have more money to invest somewhere else. That was like the big consequence of, of what happened there. Maybe there’s a spinoff and, and, and you, you had one stock, now it’s too, maybe you like one and, and you saw the other. That’s something that’s again, another practical solution. That’s a very easy, that’s not any more involved in the regular type of investing you’ll do. So hopefully that helps and hopefully you’ve learned something from it. And that’s really everything I think I’ve got to say about that.

Dave:                                    22:55                     All right folks. Well that is going to wrap up for discussion for tonight. I hope you enjoyed Andrew’s dissertation, acquisitions and spinoffs. I know I certainly did. So why don’t you guys go out there and invest with a margin of safety. Emphasis on safety, have a great week and we’ll talk to you on next week.

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