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Special Situations Alert: Details Behind Why I Bought PATH
Posted by: Jae Jun (IP Logged)
Date: January 28, 2014 07:56AM
Did you notice the market drops the past few trading days?
It’s been a while since the market fell like this.
Feels like rain after a long drought.
One company that isn’t taking notice of what the market is doing is NuPathe (PATH).
When the market “fell” 2% last Friday, here’s what it did instead.
NuPathe (PATH) Stock Info – Jan 24
So what gives? A reader saw my post about NuPathe on facebook and asked what my reason for buying was.
NuPathe is a special situations play.
After 2 years of being passive on the special situation side, I’m actively looking for more special situations to participate in this year.
Let me go over what special situations are about, and how to profit off NuPathe.
First, What is a Special Situation?There are various forms of special situations. I have already written about the most common ones.
Warren Buffett (Trades, Portfolio) Loves Special SituationsHere’s what Buffett said about workouts (or special situations) in his 1969 letter.
Quote:By taking advantage of workouts, Warren Buffett (Trades, Portfolio) was able to make money in any market.
Warren Buffett (Trades, Portfolio) Performance Portfolio
Simply put, special situations brought stability and outperformance to his portfolio as it works independently to the market.
A basic example is a merger.
Say Coca Cola is buying out a new energy drink company EnRG for $20/share. Since the market is confident of KO’s due diligence and ability to pay up, EnRG is going to trade close to $20/share on the news. The next day, even if the entire market fell 3%, EnRG is going to trade close to $20.
Because the value has already been set and it would be foolish for anyone to sell their shares at $18 when you know it’s going to close at $20.
That’s the beauty of special situations.
The value and time are given so there is more predictability.
Warren Buffett (Trades, Portfolio) – The King of Special SituationsIn fact, one of Warren Buffett (Trades, Portfolio)’s cornerstone strategy was to invest in special situations.
Warren Buffett (Trades, Portfolio) Portfolio Allocation – 1969
In 1969, this is how Warren Buffett (Trades, Portfolio) built his portfolio. Buffett always called it workouts, but you can see that he dedicated 23% of his portfolio to it.
Now Back to NuPathe (PATH)Teva Pharmaceutical (TEVA) is buying NuPathe (PATH) for Zecuity, which is the world’s first migraine treatment patch.
Here’s the deal.
Getting into NuPathe’s Special SituationI’ll base the scenario off the latest closing price of $4.10.
Initial cash payment: $3.65
Immediately, I’m starting down $0.45 ($4.10-$3.65=$0.45).
If Zecuity is a complete flop, then I get no payment and I lose $0.45 which is an 11% loss.
But even if that is the case, there is still 9 years for this investment to work out.
Plus, there are a few things going for this deal.
Now that TEVA has solved its cash problem, I’m guesstimating a scenario of 2-3 years to receive the first payment of $2.15.
Don’t take my word on this, but I’m going to just bet that it won’t take more than 5 years to achieve $300m in sales.
The Juicy Risk vs RewardWhen it comes to special situation deals like this, always calculate the percentage of loss versus reward to understand what you are getting yourself into.
I got lucky with my INFU downside estimate so let’s see if I can get lucky with this one too.
Here’s the breakdown of the downside vs upside.
Special Situation NuPathe Odds
The “total invested amount” is the money that you really end up tying up to this special situation. It’s not $4.10 because you get back $3.65 once the deal closes.
So to make this worthwhile, a large upfront purchase is required.
Example Scenario For this Special Situation WorkoutSay you buy 1,000 shares @ $4.10.
The total upfront cost is $4,100 but once the deal closes you get $3,650 back so you really only end up spending $450.
The most you’ll lose is $450, which is a maximum of 11%.
The first milestone scenario will net you 280% on your $450 investment.
And the best scenario is a 500% return on your $450.
NuPathe Special Situation Scenario Odds
I’ve never seen such low risk, high returns before. The time frame is much longer compared to a regular workout, but a possible 280% – 500% over a 5 year span is phenomenal.
But $450 is chump change for a lot of you.
So if you have a $100k portfolio and you want the final allocation of this workout to be 3% of your portfolio, you will need to buy about 6,500 shares for a total initial cost of $26,650.
That way, when you get back the $3.65 per share, you are left with about $3k invested for the remaining cash rights.
Calculating a 3% Allocation Scenario
Finally, Some Important Points
Next time, I’ll show you how I found this opportunity and how you can do the same thing.
In the meantime, got any special situations that you have an eye on? Let me know in comments.
Stocks Discussed: PATH, TEVA,
Re Special Situations Alert Details Behind Why I Bought PATH
Posted by: coybarnes (IP Logged)
Date: January 28, 2014 09:26AM
This is an interesting idea, but if I was considering an investment in PATH I would make a few adjustments when calculating profit/loss. If the true investment amount is $.45 and the entire amount is lost that would be a 100% loss, not 11%. Also, even if it is highly unlikely, the chance that TEVA does not go through with the acquisition does exist. I don't have the expertise to calculate odds or degree of loss in that situation, but I think it must be considered. Thanks for your time.
Stocks Discussed: PATH, TEVA,