I am a huge fan of special situation investing.
Situations that involve unusual buying activity by insiders or corporate activists, merger arbitrage and bidding wars, and other unusual events can offer the opportunity for outsized profits no matter what the markets might do.
Sir John Templeton once remarked that it is impossible to beat the market if you do what everyone else does. If you are part of the thundering herd of Wall Street, the best you could hope to do is to match the market’s rate of return.
Of course, matching the market’s rate of return over the last ten years has been profitable, with the S&P 500 turning in returns above 13%. However, the decade before that offered annual returns of just 6%, and that’s assuming investors had the fortitude to hold stocks through the Great Financial Crisis and eventual recovery.
Many did not, selling out as prices of the major indexes fell by over 50% peak to valley.
Readers of a certain age may remember that from 2000 to 2009, the S&P 500 made no money at all. Investors who owned the well-known large stocks had as much money at the end of the decade as they did on New Years’ Day, 2000.
Given the high valuations and the low level of interest rates, major Wall Street firms’ projection models suggest that returns from the broader market going forward will be very low.
Even Vanguard is suggesting the 3-4% compounded returns might be the best outcome investors can expect from owning the large-cap, popular stocks of the day.
Adding special situations to your portfolio can help you grow your nest egg at high rates regardless of what the broader indexes may do over the next decade.
Today I want to share a special situation that I have run across recently that could give you significant gains regardless of what the stock market does in the weeks and months ahead.
Play AGS (AGS) makes slot machines and gaming tables for the casino industry. They also have an online gaming platform that some of the biggest online casinos use.
Most of the time, the business generates massive cash flows. It slowed some during the early days of the pandemic as casinos were shut down, but casino business is booming again and Play AGS is once again producing cash.
Play AGS was bought out by Apollo Global Management (APO), a leading private equity firm, in 2013 for about $100 million. Apollo later kicked in another $52 million to help fund the acquisition of Cadillac Jack, a company that sells gaming machines to the Native American casino markets.
Apollo took out about $100 million in 2019 it they did a secondary stock offering after the company’s 2018 IPO. It still owns 8.2 million shares, or about 22% of the company.
The shares plunged in 2020 to as low as $2.25. They recovered as high as $10 in 2021, but pulled back to the $5 level in this year’s market decline. And last week, Inspire Entertainment (INSE), a competing gaming machine company, offered $10 per share (in cash) for Play AGS.
Play AGS quickly rejected to offer as too low. After an initial pop in price up to $8.40, shares of AGS have pulled back to below $8.
If Inspire Entertainment wants to close the deal, it will need to come back with a much higher offer.
Plugging the numbers into my valuation calculator, I cannot justify a price for this company under $15.
Play AGS is seeing outstanding operating results. The pandemic is no longer a business consideration in most states. Casinos are open and running full throttle. As a result, there is strong demand for Play AGS products, and its newest products have been well received.
The company’s most recent earnings were well above the Wall Street consensus. As investors notice the momentum of the business, the stock will likely trade above the levels of the Inspire offer by the end of this year.
Given the amount of time it has owned a significant stake in Play AGS, I am sure that Apollo will want a price higher than one that would barely get them out at above breakeven.
The offer has pushed the stock into the limelight. As a result, I think we will see a higher bid, and the stock will move higher.
Even if the $10 deal ends up being accepted for some reason, we will end up with a $30% profit on the deal.
It is not out of the question, now that an offer has been made, that Apollo will begin shopping for higher bidders among its long list of contacts in both gaming and the private equity industry. The $10 offer should be a floor for a potential acquisition.
I don’t see much downside to the stock at this price, as the offer has bought Play AGS stock to Wall Street’s attention as a potentially undervalued company with outstanding growth prospects.
