Wednesday, July 22, 2009

Value Investing Arbitrage Pays!

A few weeks ago, we described an arbitrage situation involving two value stocks (both traded at discounts to net current assets, had minimal debt, and were generating earnings). One of these potential value stocks, TAT Technologies (TATTF), was buying the other, Limco-Piedmont (LIMC). But what reduced the risk of this transaction enormously was the fact that TATTF already owned 60% of LIMC, suggesting the deal would go through.

The transaction did close, with LIMC shareholders receiving half of one share of TATTF for every share they owned of LIMC. However, even one month before the scheduled close of this transaction, shares of LIMC were trading substantially below half the share value of TATTF ($2.90 vs $3.50), offering high returns relative to risk using the following transactions:

1) Short X number of TATTF shares for $7/share
2) Use the proceeds to buy 2X shares of LIMC at $2.90/share

The above transactions left the investor with $1.20 for every share transaction, despite the fact that the share positions in both 1 and 2 above were to be identical in just one month's time! No matter how the shares were to move in the interim, the above transactions would be profitable as long as the transaction closed.

When the transaction did close on July 2nd, shares of TATTF plummeted while shares of LIMC rose marginally, resulting in hefty returns for those who took advantage of the circumstances.

In an efficient market, one wouldn't expect opportunities like these to exist. But an opportunity this was, as the stocks had low enough spreads and high enough liquidity to make outsized returns, and the risk was muted due to the fact that the acquirer already owned 50%+ of the target. If you come across other value arbitrage plays of this nature, we would be happy to hear about them!

Disclosure: The author is long shares of TATTF


Anonymous said...

Hi Barel,

It's been almost a year since your last posts mentioning TAT.
Any remarks concerning the latest news about this company? Still long? ;)

Great blog again!


Saj Karsan said...

Thanks, G!

I do still think it is a good long-term investment.