| name | special-situations |
| description | Evaluate spinoffs, merger securities, post-bankruptcy orphan equities, corporate restructurings, stub stocks, recapitalizations, rights offerings, and LEAPS/warrants in extraordinary corporate events. Use this skill when the user asks about a company undergoing a corporate change, mentions a spinoff, merger consideration, post-reorg stock, going-private transaction, Dutch auction tender, rights offering, or corporate breakup, even if they don't name the event type explicitly. |
Special Situations
Framework from You Can Be a Stock Market Genius by Joel Greenblatt.
Strategy Tier List
| Tier | Strategy | Edge | Rule |
|---|
| S | Spinoffs | Forced index/institutional selling; 10%/yr outperformance (Penn State 25yr study) | Wait for spinoff listing document; largest gains in year 2 |
| S | Merger Securities | Recipients sell foreign securities without reading proxy | Read "Merger Consideration" section; non-cash <10% of total = near-certain forced selling |
| A | Post-Bankruptcy Orphan Equities | Creditors don't want stock; outperforms by 20%+ in first 200 days | Only buy AFTER emergence; never common stock DURING bankruptcy |
| A | Corporate Restructurings | Division sale/closure unmasks hidden earnings | Division must be material relative to whole |
| B | Stub Stocks / Recaps | Leverage + tax shield | Rare post-1990; prefer leveraged spinoffs instead |
| B | LEAPS | Leverage + limited loss + 2.5yr runway | Never >10-15% of portfolio |
| C | Rights Offerings | Complexity deters participation | Only if insiders exercise fully |
| D | Risk Arbitrage | Spread capture | SKIP — too competitive, too much monitoring |
| D | Bankruptcy Debt | Distressed debt mispricing | SKIP — vulture investor territory, full-time job |
1. Spinoffs
Formulas
Equity / Enterprise Value = Market Cap / (Market Cap + Total Debt - Cash)
Debt per Share = Total Debt / Shares Outstanding
Equity/EV < 0.15–0.20 = high leverage spinoff: small enterprise-value moves → large equity moves.
Parent post-spinoff earnings change = (Debt transferred × Interest rate) − Forgone operating income
If positive, the parent may rise on distribution date — markets value reported EPS.
Selection Checklist
Score 1 point each. ≥5 = compelling.
Valuation Screen
- Extract pro-forma EPS from spinoff listing document.
- Identify industry P/E range from comps (industry data services or peer data).
- Apply low-end P/E to compute floor price.
- Read "Business of the Company" section for undisclosed positives (new customer wins, market share, assets hidden by depreciation).
- Compare floor price to actual post-distribution trading price.
Parent Company Play
Check if parent becomes more valuable post-spinoff:
- Is it shedding a volatile/loss-making division?
- Will reported EPS increase? (See formula above)
- Does the simplified entity become a takeover target?
2. Merger Securities
When to Look
Takeover consideration includes anything beyond 100% cash or 100% common stock.
Computable Checks
Non-cash ratio = Value of non-cash consideration / Total consideration
Non-cash <10% → near-guaranteed forced selling (too small to care about).
For each security in "Merger Consideration" section of scheme documents:
- Face value vs. expected trading price: Compute discount to face value.
- Warrants: Can exercise price be paid with face value of other merger securities trading at a discount? Compute:
Exercise cost = Face value needed × Market discount %
- CVRs: Compute floor value =
Max(Payout, 0) at current stock price. Compute upside if stock exceeds guarantee level.
- Zero-strike warrants: Free equity alongside management insider group.
Going-Private Signal
Management buying the company — strongest insider conviction signal. Going-private scheme documents have enhanced disclosures (management projections, fairness opinions). Verify management is keeping (not selling) pre-transaction stake and receiving equity, not cash bonuses.
3. Post-Bankruptcy Orphan Equities
Hard Rules
- NEVER buy common stock of company still in bankruptcy protection (shareholders bottom of totem pole).
- NEVER trade bankruptcy debt unless full-time.
- ONLY buy new common stock post-emergence.
Selection Filter
Business quality (filter first — most fail):
Valuation:
Stigma discount = Industry P/E − Post-reorg P/E (normalized to same leverage)
If stigma discount >20% of industry comp and business quality passes → attractive.
Disclosure Statement: Contains management projections (more informative than IPO prospectus). Discount projections 25–40%. Compare discounted EPS to post-reorg stock price.
Selling Heuristic
Bad business + bargain purchase → Trade it (sell when coverage starts / story is out).
Good business + bargain purchase → Invest (hold long-term).
4. Corporate Restructurings
Hidden Earnings Formula
Revealed EPS = (Profitable segment earnings + Loss-making segment losses reversed) / Shares outstanding
If a division with $X loss is sold/closed at no net cost:
Post-restructuring EPS = Reported EPS + |X|/Shares
Implicit Pre-Restructuring P/E = Price / Reported EPS
Post-Restructuring Price (same P/E) = Post-Restructuring EPS × Implicit P/E
Plus: sale proceeds → special dividend or debt reduction → additional value.
Agent Check
From annual report segment reporting, extract each segment's operating income. Compute:
Hidden earnings = |Sum of loss-making segment operating incomes| / Shares outstanding
The gap between revealed EPS and reported EPS is unmasked value.
Dutch Auction Tender Signal
- Management tendering zero shares → bullish
- Shares repurchased >20% of outstanding → high conviction
- Accretion check:
(Intrinsic value − Buyback price) × Shares repurchased / Remaining shares
5. Leveraged Equities
Recapitalization Math
Value created = StubPrice + DebtDistributed − OriginalPrice
Pre-recap: After-tax EPS = Pretax × (1 − TaxRate), Price = EPS × P/E_pre
Post-recap: After-tax EPS = (Pretax − Interest) × (1 − TaxRate), StubPrice = EPS × P/E_post
P/E_post < P/E_pre (higher risk, typically 8–9 vs. 12)
Gain driver: interest is tax-deductible; dividends are not. Tax shield creates ~$4 per $100 of debt distributed at 10% interest, 40% tax rate.
Stub Leverage Computation
Equity multiplier = 1 / (Equity / EV)
1% EV change ≈ Equity multiplier × 1% stub change.
LEAPS Risk/Reward Test
Upside = (TargetPrice − Strike − Premium) / Premium
Downside = 1.0 (lose entire premium)
Require: Upside ≥ 3.0
When LEAPS beat common stock: Binary outcome with catalyst within expiration window; high-conviction idea where you want to limit downside.
Options on Corporate Events
Option pricing models use historical volatility. Corporate events (spinoff distribution dates, merger closes) create future volatility models miss.
Spinoff option play: Buy parent calls expiring after spinoff distribution date. Both entities trade independently post-distribution; parent may re-rate as simplified company.
Merger option play: Buy acquirer calls expiring 1–2 months after merger close. Risk-arb short-selling pressure lifts after close.
Free Cash Flow
Greenblatt's default valuation metric when amortization charges are large.
FCF = Net Income + Depreciation + Amortization − Capital Expenditures
FCF Yield = FCF per Share / Stock Price
Use FCF over P/E when:
- Amortization >10% of net income (broadcasters, cable, serial acquirers)
- Depreciation consistently overstates/understates maintenance capex
- 3yr average FCF > 3yr average NI → value on FCF multiple instead
Portfolio Rules
- 5–8 positions sufficient — diversification beyond ~10 stocks doesn't meaningfully reduce annual volatility
- Diversify across asset classes (cash, bonds, real estate), not within equity portfolio
- Never allocate money needed within 2–3 years
- LEAPS never >10–15% of portfolio
- No margin debt without substantial experience
Regulatory Filing Map
Key documents to locate for each event type (jurisdiction-specific names vary):
| Event | Document | Contents |
|---|
| Spinoff | Listing document / information statement (US: Form 10, AU: Information Memorandum, UK: Class 1 circular) | Pro-forma financials, business description, reasons, incentive plan, capital structure |
| Merger | Scheme booklet / merger proxy (US: S-4, AU: Scheme Booklet, UK: Scheme Document) | Merger consideration, fairness opinion, projections |
| Going Private | Going-private circular + independent expert report (US: 13E-3) | Enhanced disclosures, management projections, conflicts |
| Self-Tender | Buyback offer document (US: 13E-4) | Strategy, management participation disclosure |
| Activist | Substantial shareholder notice (US: 13D, AU: Substantial Holder Notice, UK: TR-1) | Stake %, purpose, plans |
| Bankruptcy Emergence | Reorganisation plan / disclosure statement | Reorg plan, new cap structure, projections |
Spinoff listing documents: the summary section (first 5–10 pages after contents) covers key points. Read "Reasons for the Distribution" and incentive plan disclosures first.
Quick-Reference Scorecard
Red Flags (automatic skip)
- Common stock of company still in bankruptcy protection
- Risk arbitrage spread <5%
- Spinoff with no management stock incentive plan
- Post-bankruptcy company in secular decline
- LEAPS >15% of portfolio on any single idea
Green Flags (highest-probability setups)
- Major-index parent spinoff with management incentive plan >10%
- Merger security <10% of total consideration
- Good business in bankruptcy due to overleverage, not bad operations
- Dutch auction where management tenders zero shares
- Parent EPS increases after spinoff (debt interest shifted > forgone income)
- LEAPS upside:downside ≥3:1 with catalyst inside expiration window
