You probably noticed that I often use the term “Information Arbitrage” (InfoArb) to highlight free or easy money opportunities hidden in corners of the microcap universe that investors can overlook.
An information arbitrage exists when a disconnect between stock prices and available public information on a company is noticeable, and monetarily worth pursuing. Sometimes, the mispricing of microcaps can be substantial.
Some of my own team members criticize my use of the term “InfoArb” because they think I could lose some credibility from sophisticated investors who understand what “arbitrage” means in its most literal sense. In its purest form, a financial arbitrage refers to situations that can result in a relatively risk free profit.
In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. In principle and in academic use, an arbitrage is risk-free;
For example, such a scenario can arise when a company’s stock price that trades in the U.S. via American Depository Receipts (ADRs) is priced at a discount or premium to its homeland traded stock price, taking into account fees and exchange rates (i.e. U.S. ADR vs China Ordinary shares). You could lock in the “arbitrage” by shorting the relatively higher price stock and going long the cheaper priced stock. Over time, the prices should converge.
There Is No Free Lunch, But Easy Money Does Exist
There may not be enough free lunch classic arbitrage scenarios in the stock market to feed your portfolio, but if you look hard enough you will find that stocks are on sale every day with multi-bagger or mega-bagger catalysts not noticeable to the naked eye. While I’ve suffered enough investment losses to know that InfoArb is not risk free arbitrage, it’s as close as you can get to easy money.
Keeping It Real
From the onset of my full-time investment career around 30 years ago, I made it a point to favor practical investment strategies over vague ones. That is not to say I avoid complicated opportunities if the payoff is attractive. But all things being equal, I am more interested in lining my pockets with easy profits than with building my ego at a fancy Wall Street pow wow with dueling stories of “reverse condor spread option tactics”.
This is why I like InfoArb so much: the concept allows any level of investor to buy cheap stocks with simple stories that are about to be discovered or seemingly complicated stories that are actually simple. An added benefit of this strategy is that at times you are dealing with an over 90% chance of success, and the moves in prices can be swift. This gives you less time exposure to the market than other types of investment strategies. For this reason, it’s even a great investment tool for traders. Frankly, I believe it’s the easiest way to make money in short periods of time. These chances are best found in the microcap space where the flow of information through the masses happens at a slower pace than in larger capitalized stocks.
Information Arbitrage Case Studies
Eight microcap and nanocap #CalltoAction Alerts we sent to GeoInvesting Premium Members over the last 10 years illustrate how InfoArb could have “showed you the Kwan”.
Three of these companies ended up being acquired for large premiums. In a future article, I will show you how InfoArb could have saved you some pain.
- The Acquisition Discount
Companies that are in the process of consummating acquisitions will usually trade at a discount to where they would trade if current valuation multiples are applied to the combined financials, assuming the acquisition closes (or I some cases has already closed). The “acquisition discount” prices in the possibility that (1) the proposed acquisition may not close, (2) there will be execution risk or (3) there is overall uncertainty on what the sales and earnings will look like after the acquisition. From my experience, this discount can be as high as 10% to 20%.
Acquisitions that are accretive to earnings enable small microcap companies to gain market share and accelerate growth. If the microcap stock has a low outstanding share count and does not issue too many shares to complete the acquisition, I become very interested. This is especially true if a proven management team is leading the charge. On the heels of 26 acquisitions, Patrick Industries (NASDAQ:PATK) has been the best performing listed microcap stock since 2009, up over 44,000% from post-recession lows of $0.17 and up over 3700% since we alerted members that we were beginning to track shares in August of 2010 when the stock was trading at ~$2.00.
Unfortunately, we only captured a small part of this epic run during 2012. Trepidation by some investors towards buying microcap stocks that have an acquisition on the plate is a great way to experience quick returns.
GTT Communications (NYSE:GTT) and Gain Capital Holdings (NYSE:GCAP) are two stocks we wrote about and bought in 2013 that we believed would fill a valuation gap created by the stock market’s failure to reward shares with accretive acquisitions.
|Symbol||Industry||GeoBargain||Premium Member Alert Price||Target set by GeoTeam||Time to Target Range||Holding Period High Return||Source Link|
|Gtt Communications Inc. (NYSE:GTT)||Network Solutions||7/31/2013 – 9/19/2014||$4.30||$7.50 to $13.50||3 Months||211%
|Gain Capital Holdings Inc. (NYSE:GCAP)||Currency Trading Services||6/6/2013 – 8/12/2014||$5.30||$9.40 to $12.50||3 Months||175%||Article|
- Changes in Poison Pill Terms
Staying with the theme of acquisitions, The Board of Directors of many public companies approve amendments commonly knows as poison pills to:
- Prevent a hostile takeover
- Prevent a takeover that does not maximize shareholder value
- Make sure management is compensated in the event of a takeover (Golden Parachutes)
Basically, poison pills can increase the hassle and expense to a potential acquirer (also referred to as the “Suitor”).
The InfoArb tactic here involves searching for companies that have put in a poison pill for the first time or changed the terms of an existing one already in place. That could mean that a takeover is imminent or that shares are so cheap that management with low stock ownership or disliked by its shareholder base is fearful of a hostile takeover.
|Symbol||Industry||GeoBargain||Premium Member Alert Price||Target set by GeoTeam||Acquisition Price||Time to Acquisition Event||Holding Period High Return||Source Link|
|Merrimac Industries Inc (AMEX:MRM)||Circuit Board Assembly||6/30/2009 – 12/24/2009||$7.70||$14.00 to $17.50||$16.00
|5 Months||107%||History of Research|
|(NASDAQ:MKTG)||SaaS Email Marketing||4/10/2013 – 1/2/2014||$6.42||To Be Acquired||$27.00||10 Months||320%||Original Article|
I could not believe the opportunity presented in these two cases. Out of the blue, Merrimac Industries (MRM – no longer public) issued an 8-K with no press release outlining management compensation in the event of a change in control.
“On December 10, 2009, the board of directors of Merrimac Industries, Inc. (the “Company”) approved a bonus for Mason N. Carter, the Chairman, President and Chief Executive Officer of the Company, in the event that the on-going process of investigating strategic alternatives for the company results in a sale of the Company or similar transaction. The bonus would be based on a percentage of the sale price of the Company and the estimated range of the bonus is $300,000 to $1,200,000.”
MRM was essentially telegraphing with near 100% certainty that the company was about