On July 16, I wrote up a merger arb investment for a tiny nanocap with a $7mn market cap, where you could grab a huge spread within weeks. The company’s name was SunLink Health, merging with Regional Health. The deal is now closed, and those who participated have banked their share.
This isn’t a full recap of the investment case, since you can read the linked writeup. Rather, I’m writing this update to show you the ridiculous opportunities that occasionally pop up in the forgotten corners of the stock market. This investment was almost risk-free and offered a 66-140% return in a single month.
A quick recap: SunLink Health was a net-net consisting of a four-unit pharmacy chain and a fat cash pile. The share price was trading 41% below its net current asset value. Were it not for Regional Health coming along, SunLink would likely have been liquidated, and shareholders would have been handed back a tidy profit.
But Regional Health, a larger healthcare REIT for nursing homes and long-term care facilities, did come along, and the company was in dire need of cash. Regional Health owned 12 properties across five southern U.S. states that were triple-net leased, while operating some of these facilities itself. That latter business was a cash-draining mess, burdening Regional’s already troubled history of severe debt and piled-up arrears on its preferred stock. Regional was highly distressed, and creditors’ coffers were shut. It desperately needed SunLink’s cash box.
The deal was complex and largely flew past the shareholders of both firms, who had long given up caring about what would happen to these businesses. That was the opportunity. While SunLink was a $7mn company and Regional a $5mn company, the joint proxy statement was a full 311 pages plus exhibits of a couple hundred pages. The proxy was mailed to shareholders. With one peek at the chunky document plopped on their doorstep, I guess no one bothered to open it. That’s why I read the proxy cover to cover.
Obviously, you shouldn’t sit around reading every single proxy statement for every deal that comes around in public markets. You’d never leave your seat and would never make an investment decision. In this case, however, you could quickly scan the deal consideration, make a few scribbles on a napkin, face a jaw-dropping spread, and then get to work to make sure you weren’t missing anything. That’s the bulk of the process in any excellent investment: If you can’t see value quickly, you shouldn’t waste much more work; if you can, most of the work you do from then on is to debunk your own thesis and biases.
Okay, here’s the deal. Regional was going to pay SunLink shareholders in both Regional common stock and preferred stock. The common stock, which was already listed, was going to pay $0.60 per share for every SunLink share, which itself was trading at $1. So, 60% of your outlay was covered by Regional’s common. And although Regional’s common stock was volatile, potentially affecting the common stock consideration by some ± $0.20 per share, the value of the preferred stock you’d get was by far the kicker in the deal. There was just one problem: you didn’t have a market price for the preferred, as it was yet to be listed.
Long story short, given Regional already had another (senior) preferred issue listed, you could roughly infer what sort of pricing the new issue was going to get. (Of course, the details here are more intricate, since the two issues differed in terms and rights, which I delve into in the writeup.) And the margin of safety was mouthwatering. Even the proxy statement said this was a no-brainer deal for SunLink shareholders, pegging the total deal consideration at $1.70 per SunLink share. (I gave it a haircut.) All you had to do was crack open the joint proxy filing and scroll to page 8:
And that’s exactly what I did before concluding SunLink was worth spending time on. If you then proceeded to read the full filing, you’d pull out two more nuggets:
- The deal terms allowed SunLink to pay out a full $0.10 per share dividend to shareholders before the deal, which you could add to the deal consideration.
- If the deal were to fall through, the SunLink board had more than once discussed liquidating the company. Remember, SunLink itself was trading more than 40% below net current assets.
You couldn’t lose. And I found out about all this stuff a couple of weeks before the shareholder vote. The whole thing took me a day’s work.
As I discovered the deal, I quickly assumed this opportunity was out of reach for institutions and fat wallets. I wrote that $10-30k of volume changed hands per day. But lo and behold, as the deal approached the vote, the market woke up, and liquidity shot up to $300-500k volume days. However, due to the deal’s complexity or whatever other confusion, SunLink’s share price pinballed between $0.95 and $1.35 per share. On August 4, the deal was voted through. But the opportunity wasn’t gone. Even after the deal was voted through, with ten days before the share exchange, you could have grabbed SunLink shares at ~$1 per share (post the $0.10 per share dividend)! It was nuts.
Then shares changed hands. You got $0.50 of Regional common stock per SunLink share + the $0.10 per share dividend from SunLink if you bought before the ex-date. The Regional preferred, which you got one share of for every five shares of SunLink, closed at $5.30 per share on its first day of trading, hitting a high of $9 per share. This equals $1.06-$1.80 per SunLink share, adding up to a 66-140% return in one month from a $1 per share investment.
Opportunities like this shouldn’t occur, but they do. They just won’t appear in the news or in any of the stocks you hear about from friends, strangers, or financial advisers. They only appear once you roll up your sleeves and do what no one is bothered doing, when everyone else concludes that the $100 bill lying on the street isn’t real. These things exist because nobody works on them.
And the reality is that special situations like these are few and far between. You won’t find them running screens. You gotta crack open and slog through hundreds of filings to discover stuff like this. “Start with the A’s,” as Buffett said. Turn every rock, and flip every page. I love it.
I’m currently writing up a paywalled deep dive on Lindbergh SpA, to be published by Monday. This Italian microcap, pivoting from a niche MRO logistics business (which is way sexier than it sounds) to an HVAC rollup, won’t be a special situation, but this is a writeup on a business I liked studying and would probably buy at the right price. So keep an eye out for my email on Monday (or possibly Sunday).
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