Idea Brunch with Dalius Tauraitis of Special Situation Investments
Welcome to Sunday’s Idea Brunch, your interview series with underfollowed investors and emerging managers. We are very excited to interview Dalius Tauraitis!
Dalius is the founder of Special Situation Investments, a site focused on event-driven opportunities and risk arbitrage. Before launching Special Situation Investments, Dalius was a strategy consultant at RBS and PwC and started a variety of businesses. Special Situation Investments tracking portfolio of picks was up 59% in 2020, up 53% in 2021, and is up 11% through August of this year.
Dalius, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background, why you decided to launch Special Situation Investments, and your love for off-the-beaten-path investing?
Edwin, thanks for having me — I’m really excited to be on Sunday’s Idea Brunch!
A bit on my background, in my early days I did some exciting entrepreneurial stuff such as founding a furniture import business in London and launching the first online car insurance brokerage in Lithuania. My finance ‘career’ took off during the Great Financial Crisis, but after three years in London in strategy consulting and investment banking, I was fed up. Climbing the corporate ladder wasn’t my calling. Luckily, during these three years, I accumulated some capital which gave me the freedom to explore new opportunities. I have always found investing and stock picking fascinating — a mixture of science, art, and luck. Over the next couple of years, I was eagerly digesting various value investing classics and other business books/biographies while also learning a bunch from stock pitches on VIC. I naturally leaned towards smaller cap companies and more obscure situations because I considered the average investor to be way smarter than me and thus had to dig in places where fewer people are looking. I was attracted to special situations with their pre-defined upside, limited number of potential outcomes, and short-term catalysts to unlock value. Spotting and picking up great businesses at reasonable prices is extremely hard and I think only a few bright minds are able to do that consistently. Whereas with special sits it is very different — the effort put into filtering ideas, research, and analysis has a much higher correlation with returns. Also, the feedback loop is way faster — bad investment decisions usually reveal themselves within months rather than years.
And that’s the start of Special Situation Investments (SSI). I launched the site back in 2014 and initially it focused just on the odd-lot tenders and split-offs. Over the coming years, I started researching and publishing various other types of event-driven trades and SSI gradually grew into its current form with a much wider scope and with 100+ well-researched actionable opportunities every year. The team behind the site also grew and now there are five of us sifting through markets on a daily basis trying to spot the next attractive setup.
“Special situations” is a broad category with hundreds if not thousands of potential setups at any given time. How do you sift through the noise to find the best trades? In your experience what are some special situation setups that have consistently done well?
You are spot on. Sifting through that noise and keeping tabs on a high number of potentially attractive setups is probably the hardest part of this. It was a rather chaotic effort initially but now we have rigorous processes for scanning various sources and tracking potentially interesting ideas. On a weekly basis, we run through a continuously expanding list of sources — regulatory filings, datasets, blogs, forums, other investment idea platforms, FinTwit, hedge fund letters, etc. — and dig deeper into the cases that pique our interest. Out of those we pick a few where it seems that the market might be mispricing the risks and where our research might give us an edge. That’s the starting pool of situations that we might eventually invest in and publish the research on SSI. Also, as is probably the case with other investors, over the years we have developed some pattern recognition on these special sits and that helps quite a bit with the initial filtering – you tend to have a gut feeling on which trades are worth paying more attention to.
In terms of what has done consistently well, the first thing that comes to mind is MLP buyouts by their general partners. These have exhibited a rather similar pattern over the last couple of years. The general partner keeps the MLP dividend payouts depressed, despite a strong recovery in underlying earnings and bright prospects ahead, and then opportunistically files a low-ball initial offer to buy out minority holders at minimal/zero premium to the prevailing market prices. Eventually, a far higher (+20% to +40%) offer surfaces within a few months after deliberations by the conflicts committee.
The other setups with rather consistent returns are small/micro-cap mergers, especially in industries that have fallen out of favor with investors or where institutional money is simply not looking. We have invested in and published on a high number of gold mining and cannabis industry mergers with twenties/high-teens spreads only to see these getting closed successfully a couple of months down the line. A similar pattern is seen with tiny community bank acquisitions, just the spreads are not as wide.
Also, I would highlight split-offs with odd lot provisions. I have played all 17 of these over the last decade, and so far not a single one has failed - albeit returns are also quite small in absolute dollar terms, ranging from a few hundred $$ to a few thousand $$ per account.
What are some common red flags that investors should look for when evaluating a special situation?
Not so much red flags, but rather two crucial questions investors should raise before putting any money on a particular special situation setup are:
Why does the setup/spread exist? Just randomly betting on wide-discount-to-NAV liquidations or the largest merger arb spreads is likely to leave you with a much thinner wallet. More often than not the spread exists for a reason and the market is pricing the risks correctly. I like the setups where after consideration of various potential risks the spread/discount still seems too wide, and I come to the conclusion that there is a high chance the situation exists simply because the market is not paying attention and my research might give me an edge. These types of setups are most often found in small/micro-cap space and almost never for the over-analyzed large-cap stocks.
What’s the downside? Betting for a 5% arb gain, when the losses in case the deal falls apart stand at -40%, is unlikely to be a consistently winning strategy. When the upside is capped and the eventual outcome is binary, as is often the case with special sits, it’s very important to pay attention to the downside protection of the trade and carefully consider the risk/reward. I always aim for the setups with heads-I-win-tails-I-don’t-lose-much characteristics.
You’ve been doing this for a while. Can you tell us some of the craziest special situations you’ve encountered?
The craziest are the ones where even with hindsight I struggle to understand why the opportunity existed in the first place. These kinds of setups keep me alarmed as I always think that I must be missing something very obvious — rolls of cash cannot be simply lying on the sidewalk for anyone to take. And when these close, you know you should have sized it bigger as there were no/minimal risks in the trade.
Take the Belpointe REIT (BELP) situation from autumn 2021. BELP was a $150m REIT that for no particular reason started trading at 1.5x NAV (at one point even 1.8x) despite having almost all of its balance sheet in cash. Importantly, its shareholders had already approved a structural reorganization whereby the company would get uplisted to NYSE and promptly begin a $750m issuance of new shares at NAV (which was fixed at $100/share). All this was supposed to happen within a period of a month and the company’s fillings as well as investor relations confirmed they were on schedule. So something that was clearly worth $100 was trading at $150+ with a very clear and hard catalyst to push it back to the fair value within a month. There was plenty of cheap borrow for short selling. Yet, the bid at $130-$150/share stood right there for anyone to take almost right till the uplisting. When the trading shifted to NYSE, shares promptly dropped to NAV (see ticker OZ) with arbitrageurs pocketing generous returns.
Another curious example is Ashford Hospitality Trust (AHT) and its offer to exchange preferred shares into common back in Oct-Nov of 2020. AHT – a hotel REIT – was severely hit by COVID, which resulted in a substantial cash burn and a tight liquidity situation. The company initiated the exchange offer to get rid of the preferred stock burden and ease its access to capital markets. Common shareholders were to be diluted by 90%. Management seemed to be very incentivized to get this done, and one by one waived pretty much all of the outstanding conditions that were obstructing the transaction. Nevertheless, the spread between preferreds and common persisted. Even with only a few days left till the expiration of the exchange offer the spread stood at an astronomical 100%+ for anyone to take. To this day I have no idea why.
A final example is actually a rather straightforward acquisition of Tyme Technologies by Syros Pharmaceuticals that closed in Sep’22. This one traded at a 40% spread initially and I could not find any explanations as to why — all the stars pointed towards successful closure within a couple of months. This merger was akin to an equity raise for the buyer (acquiring target’s cash only) and the buyer’s largest shareholders’ agreed to simultaneously inject a 2x higher amount of cash at premium prices. A huge vote of confidence from sophisticated pharma investors. There were no risks with shareholder or regulatory approvals. Anyone who put just a little effort to peek under the hood of this merger would have spotted the same things. Gradually the spread narrowed without much incremental news. But even on the last day of trading, when the companies clearly communicated that all conditions have been satisfied and the merger is closing tomorrow, this still traded at a 10% spread. Seems like microcap mergers are sometimes inefficiently priced right till the last day.
What are some interesting ideas on your radar now?
I’ll highlight a couple of cases that I think have strong near-term catalysts for re-rating.