Dieselgate, Dividends & Special Situations

Judge Charles Breyer has officially signed off on Volkswagen’s proposed ~$15 Billion (with a capital B) settlement of civil litigation involving its emissions-cheating 2.0 liter TDI “clean diesel” cars.

Which means LibreWagen, our “speculatively” purchased 2009 Jetta SportWagen TDI, has officially become a profitable investment, a money maker we can shake for the next two years depreciation-free, and a killer ride for tossing around town and crossing state lines.

In April I purchased LibreWagen according to several specifications I set out to take advantage of the brewing settlement agreement. The particulars of what I was looking for in an affected vehicle, as well as the relevant numbers associated with the deal (including purchase of the car, financing/leveraging considerations, and buyback calculations) are included in this earlier FinanciaLibre post.

I later outlined the car’s day-to-day performance for Team Libre. Which is described in this little ditty here.

Depending on how one accounts for the value of getting to drive a nice and efficient car with no risk of depreciation for two years, in addition to the straight-up cash profit of ~$3k, not to mention the leveraging benefit, the overall financial return of this maneuver is at least $6k or $7k in value (but probably not more than $10k).

In addition to yielding some nice dolares, the experience is also useful as a discussion topic for some general reflections on “special situations” and how they might prove profitable to you.

Dieselgate, Dividends & Special Situations
Dieselgate, Dividends & Special Situations

Special Sauce

Although Benjamin Graham is probably the first to really talk about “special situations,” and even though I think he had a more specific definition in mind when invoking the term, I’ll use the phrase with a broader meaning: A “special situation” is any in which unusual circumstances arise that can provide opportunity for profit. Sometimes these occur because valuation becomes more difficult than usual, or because of unprecedented external events that alter risk profiles, or just because of widespread emotional reaction to stimuli by most people.

When things get even a little messy, there’s room for advantage.

And the LibreWagen example neatly illustrates.

For most car buyers and sellers, including dealers, used car valuation is a pretty simple game. There’s something like an underlying “fundamental” value that relates to the car’s relative health/capabilities/desirability, and then there’s a “delta” value used to amend the basic value in bargaining. The delta value captures stuff like negotiating strength of the parties transacting the car, geography considerations, etc.

The interplay of “fundamental” and “delta” helps explain why there’s some distribution of transaction prices surrounding an average rate for substantially similar cars.

When I bought LibreWagen in April, that essential valuation construct was arguably still relevant, but it had been modified by the pending Dieselgate settlement. At that point, the judge had said VW would be on the hook to repair or repurchase (at the car owner’s discretion) affected vehicles and that owners would be entitled to “substantial” cash remuneration in either event.

The settlement was hardly finalized at that point, but federal judges – and especially highly respected ones like Charles Breyer – are not known for making broad statements that carry no weight. So this “promise” altered the valuation schema for used TDI cars. It complicated things a little because now there was this cash remuneration issue, uncertainty relating to the repair/repurchase program, risk that any proposed settlement would fail and things would get dragged into a full-blown courtroom showdown, etc.

There was also, importantly, a somewhat more technical valuation issue relating to the particulars of the buyback – i.e., what VW would have to pay owners for their TDI cars to get them off the road. Specifically, what value would the buyback reflect? Would it be the then-current and depressed “market value” of affected cars, or would it be the pre-impacted value of cars before the emissions scandal broke?

These were very different numbers since, after news of Dieselgate spread, many TDI owners reflexively sold their cars and flooded the market with TDIs for sale. So prices slumped, falling in some cases by around 20 percent.

In a post-mortem, it’s clear that the buyback values would have to be pegged to the pre-impacted value of the cars. (After all, a failure to link the buyback value with pre-impacted car value would shortchange owners and arguably allow VW to profit from the repurchase program. Both are obvious no-nos in the world of equitable litigation settlements.) But that issue nonetheless remained somewhat uncertain when I bought my TDI. And market values for the used cars from April through even the last month or so seemed to not fully reflect this fact.

So with LibreWagen, the common valuation tools were no longer fully applicable, and imposition of the proper valuation construct seemed to evade most people in the relevant market, all while risk and emotion were tangled up in the gears.

Which is a “special situation” indeed. But specialness doesn’t imply rarity. These sorts of things happen all the time. And they even happen in the most ostensibly efficient of all markets – that for U.S. equities.

Meatloaf

So what to do about all this?

1. Keep a lookout for loose change.

If your eyes are open and you invest just a tiny amount of insight and thoughtfulness in most undertakings, there’s profit there for the taking, even if it only seems like loose change here and there.

A long time ago, as a little kid, I was at a birthday party held at an arcade. You had to buy tokens to play games, and I’d been given a dollar by my parents. (Money wasn’t something handed out willy-nilly during my childhood since often there wasn’t much to spare.) Which meant I got just four tokens. Bummer.

But I also noticed something interesting. The tokens were darn close in size to nickels. So I traded my four tokens to a friend for one of his dollars and changed that dollar for nickels. And got to play 20 games. (If only I’d known about leverage back then, I could probably still be playing Pac-Man or whatever.)

Loose change? Sure. But a 5x multiple ain’t bad.

2. Be a little (or a big) contrarian.

Because everybody knee-jerked their offensive TDIs to dealerships when the Dieselgate news broke, it was unpopular and irreverent to go out and buy one. Which is, in part, why doing so paid off.

If everybody’s zigging, it’s precisely the time to zag. Everybody’s flipping out about Brexit? Buy those Euro stocks. When Brexit happened I plugged and chugged into some high-yielding and very healthy bank stocks in Europe that just got cratered by the vote. They’re now up around 20 percent; they’re still undervalued by some measures; and they spin divvies like crazy.

A really smart person could have taken advantage of Brexit before it happened by entering some inexpensive short positions and wagering the Brexit vote would pass. It’s been convincingly argued the market never got even close to fairly pricing in the risk of Brexit before the vote (after all, if it had, the “Yes” vote wouldn’t have decimated stocks the way it did), which is what would have enabled this kind of trade.

(Note: I’m no stock picker. And that’s the point. This stuff can be obvious as all hell and still be profitable.)

3. Channel your inner librarian.

Patience and a willingness to be un-sexy are key ingredients in making special sauce pay meaty returns. If you’re anxious and looking for immediate payoff, you’re likely thinking just like everybody else. Which means there’s not much room for profit in your approach. And if you’re only after the glitzy bets, then you’re paying attention to where everybody else is already looking.

VW’s aren’t especially sexy cars. After all, Right Said Fred could easily have subbed a People’s Car in for the Alfa Romeo used in their “I’m Too Sexy” music video. But they made the (uncharacteristically) wise choice to stick with the Spider. Had the Dieselgate thing involved cars featured in music videos, I doubt there’d have been much room for big returns.

Similarly, earlier this year I stumbled across a very un-sexy Tennessee-based paper products company called WestRock. Their recent 10-K at the time mentioned they’d soon spin off of their specialty chemicals division into a separate publicly traded firm, at which time owners of 6 shares of WestRock would be awarded 1 share of the new company, named Ingevity. At that point, WRK was seemingly under-appreciated, and what particulars of the spinoff I could figure out suggested not even close to all the value of NGVT was being encompassed by WRK’s current valuation.

So I bought some shares (a multiple of 6) of WRK and waited a couple months while the companies did their thing. WRK’s value meandered around for awhile. Then the spinoff occurred. As of this writing, WRK’s up around 30% from my purchase price, not including divvies, and NGVT shares are up over 70%. In the absence of some patience and a willingness to be super un-sexy, this investment wouldn’t have paid. Nobody’s pickup line at a party starts with, “So, I’ve got a long position in paper and chemicals and a VW wagon parked outside. Wanna jet?”

Now, readers of FinanciaLibre know I’m not one to really chat about stock trades, primarily because I think trading stocks is stupid. And I’m an avowed boring and lazy index investor; the sorts of specific types of investments described here represent a tiny fraction of my portfolio, and I wouldn’t recommend otherwise.

I do nevertheless dabble in trades as an intellectual exercise and to test out little theories from time to time. My overall record’s not bad, but if my only pursuit in these types of investments were profit, I’m not sure they’d be worth the work. Profit comes in money, sure, but I value the brain-massaging experimentation more.

(Disclosure: I currently hold long positions in WestRock and Ingevity. And I’ve got a VW wagon. Wanna jet?)

All of which suggests to me that there’s far more “trading profit” in our daily lives out there than most of us recognize – both in financial and intellectual terms. And just being aware of that fact is a giant first step in exploiting special situations that arise here and there in the everyday.

In fact, my feeling is that just thinking about things from the perspective of an investor or as someone expecting to find inefficiencies or little cracks here and there is the biggest first step in profiting from all the craziness that goes on in this world.

And being able to do that, Luchadores, is very special.

Luchadores, how have you profited from “special situations” or unusual circumstances that arose, when most others might have failed to see the opportunity?

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