Contributed by David Baker, Managing Principal of Mercadyne Funds
Despite the New Year rally, we have now entered the expected choppy and grinding markets. To combat this situation, we believe that 2019 has the highest propensity to reward those investing in opportunities that are known as “special situations”. These investment opportunities do not depend upon a company merely improving its operating results or a rise in the equity markets or even money flow into a particular group or sector. They are, as they are called, special situations.
Examples of special situations include but are not limited to: Investments in companies that participate in secular trends (long term trends, e.g. expansion of a potentially ubiquitous technology across a global market, such as the proliferation of lithium ion battery technology) such that short-term economic trends have minimal lasting impact on their long term performance; or those companies with a truly disruptive technology (innovation that few or no other companies possess); a uniquely compelling, merger or acquisition candidate; a company conducting a spinoff where the sum of the parts is worth more than the whole, a capital structure dislocation; or even a company that is compelling, but its structural [read-capital structure] or operational complexity or market position, causes the market to not understand.
For such a company to generate shareholder value in today’s markets, it does not need the equity markets to go up, or the economy to stay stable. It does not need money flow into the sector. It just needs to continue to execute and tremendous value will be brought to its stakeholders, independent of market conditions. Special situations, whether acquisition candidates or those who will operate independently for the foreseeable future, tend to possess very large total available markets; usually so large that they will never be able to saturate the entire market that it is addressing. While special situations make up perhaps less than 10% of the capital markets, they do exist and they exist during all capital market cycles, including bear markets.