I’ve caught myself violating one of Benjamin Graham’s main tenets by ignoring his “margin of safety” principle. Here are the gory details on the two transactions:
Ergo Science Corp (ERGO or ERGO.OB)
Summary: This stock appeared in the Special Situations Investing site as a going-private transaction via a reverse/forward stock split. At the time, ERGO was trading for 0.80 and under the terms of the agreement, shareholders with less than 200 shares would be paid $2.10 per share after the split or a straight 162.5% gain (e.g. not annualized) and before transactions costs.
My moves: I purchased 199 shares at $0.80 too early, before the pre-14A filing was released saying that the transaction would apply to shareholders of record only, meaning the shares had to be in my name. Schwab charges a $50 fee to register stock shares in my name, and it was unclear to me how I would go about mailing or otherwise transferring these certificates to the company (potential additional transactions costs), so I decided the best course of action was to dispose of my shares. I sold 199 shares a day or two later at $0.70 for a net $39.80 loss.
Hyperfeed Technologies Inc (HYPR or HYPR.OB)
Summary: This stock appeared in the Special Situations Investing site as a merger. At the time, HYPR was trading for $0.80 and under the terms of a somewhat more complicated agreement, a parent company was planning on supplying the funds to merge HYPR with one of its subsidiaries and pay $1 per share to close the transaction.
My moves: After my limit order went unfilled for several days, I decided to purchase the bid offering of 2,500 shares at $0.80, seeing only a straighforward $500 return. Then I asked others at Contributor’s corner if they saw anything amiss (thereby violating another investing rule: research before you buy, not after!) at which point someone pointed out that the proxy never listed an expected closing date. I’d jumped in with blinders on, thinking that even if the transaction took a year to close, a 25% return was still decent. But really, being an unlimited merger, there was no reason I had to buy 2,500 shares rather than 100 or 1,000. Yesterday night, I received an alert that HYPR had filed an 8-K form stating, among other things, the following:
By letter dated November 7, 2006, Exegy Incorporated (“Exegy”) informed HyperFeed Technologies, Inc. (“HyperFeed”) that it was terminating the Contribution Agreement among Exegy, HyperFeed and PICO Holdings, Inc. … At this time, HyperFeed disputes Exegy’s right to terminate the Contribution Agreement and plans to vigorously defend its rights thereunder through all available legal means. … The Company currently believes that, as a result of Exegy’s actions to terminate the Contribution Agreement and the short-form merger, existing and anticipated capital resources, including cash and cash equivalents, accounts receivable, assets related to discontinued operations, and financing from PICO, which is currently the company’s only source of financing, will not be sufficient to fund its operations on a going concern basis.
It’s possible that the merger will be completed, but I decided the risk was too great to bear, especially given the last sentence above. I sold my position this morning at the market open at $0.60 for a total loss of $519.90. Update (Nov. 9, 2006 @ 3:30P PST): The company just filed another 8-K saying “HyperFeed’s Board of Directors today approved a resolution authorizing the immediate filing of a voluntary petition for bankruptcy under Chapter 7, Title 11, United States Code. In connection with the planned Chapter 7 Bankruptcy filing, HyperFeed will cease all business activity and operations.”)
So what happened? It’s pretty simple. In both cases, I didn’t look before I leaped and saw only attractive potential returns, ignoring the risks involved. With ERGO, I made what can only be described as a completely avoidable and dumb mistake by not checking the company’s filing stage. With HYPR I simply got greedy. In both cases, I could (and should) have waited until the companies had filed a Definitive Proxy statement (the safest stage for investing in special situations) before deciding to put my money in. Even though by waiting to this stage, returns may diminish, risk is also diminished as well. I should also have listened to some veteran investors at Contributor’s Corner to understand the risks involved in merger transactions because it was a completely new area to me.
Even though I don’t invest large amounts of money in my special situations portfolio just due to the nature of the transactions, that’s really no excuse for throwing caution to the wind, and my special situations investing portfolio is now down for the year.
I don’t want my decisions and experiences here to reflect poorly on the Contributor’s Corner, which remains a very good tool and the only one of its kind, to my knowledge. (In fact, I just renewed my subscription there for another year.) In most car crashes, it’s the driver’s fault that the crash happens rather than the car itself, and I’m certainly the one driving with blinders on in these cases.
However, I created this site in order to learn more about investing and since I believe strongly in transparency, I’m sharing the good with the bad. Hopefully others will be able to learn from my mistakes.
Bottom line: I’ve realized it’s time to get control over my discipline again, and my “real-world tuition” of $559.70 will serve as an effective reminder of what happens when I throw caution to the wind!