Tuesday, May 06, 2014

Usefulness of Hedge Funds

Hedge funds can be of some good, right? Not for the reasons that media fools might say like liquidity, but behind the scenes. On the advice of a friend, I'm currently invested in a penny stock play. I'm not sure how bad that sounds and if I should be scared of myself simply by the fact that I'm writing sentences like that. The stock is DOLNQ, and this is not advice, just looking at how things work. Basically, I invested a wee bit in a company whose price had taken a big hit but where I thought there was a decent possibility of recovery to match the risk as my friend pitched it. Pure gamble play really. Last month it looked like that gamble had backfired on me completely. The company filed for Chapter 11 and the way in which they did it would have had the common stock expire worthless. Shares plummeted. Instead of selling and recouping my last couple of hundred bucks by selling for one or two cents a share, I decided to hold on and teach myself a bit of a lesson (by in theory losing every dollar). Fortunately, hedge funds are big enough muscle to combat insider duplicity.

I thought the way in which they had agreed to the bankruptcy filing was a bit odd, but I'm no expert. Apparently though, there are some much more savvy (rich) investors out there, i.e. hedge funds, who thought the same thing. Five hedge funds formed an equity committee and have sought to challenge the bankruptcy ruling. They think the company is fudging numbers and that stock holders should be getting a payout. There was a hearing yesterday where the company sought to have a judge disband the equity committee and let the prepackaged bankruptcy plan forge ahead. Judge told them 'No way. The equity committee stays intact and you need to work something out with them'. Apparently, this is quite out of the ordinary as equity holders almost always lose out. Long time investor and financial blogger, Bill Cara, has spun yarns on bankruptcy shenanigans screwing over equity holders. This might be a case where the courts help shareholders, probably because bigger fish are involved and not just the little guy. Now the two sides have until May 27 to reach an agreement. This is what the hedge funds were angling for all along. The thought is that there is about $50 million worth of equity that the shareholders should be entitled to and that there are 30 million shares outstanding, meaning a payout of over $1.50/share in an optimum outcome.

That to me is what makes this an interesting investment. It's not about whether the company will perform well or not, it's about how the world of big money works and what a bunch of lawyers get together and negotiate. There are some rich hedge funds that realized the company was trying to take advantage of the system by filing for a bankruptcy plan that helped out a very small group of creditors and offer lavish payouts to a couple of executives that violate terms agreed to beforehand. Instead of letting that happen, they are buying up all the shares after the stock crashed and then using their lawyers to force the company to let the hedge funds share in the spoils of their taking advantage of the system by saying "if you want us to go away and let you proceed, you need to pay us". I find it intriguing because to me, there is no way that these hedge funds are doing this for a small gain. They must believe that they are going to be able to get a hefty portion of that $50 million they believe is out there.

The stock has been run up in the last week and a half from a penny or two up to about $0.14. This seemed to be the level the hedge funds were comfortable with before knowing the outcome of the hearing yesterday. So, I'm trying to figure out just how sure of a bet this is or if it's sure at all. Based on what I know, things seem legit and there will be a nice payout. $1.50 per share seems to be the high estimate but most folks believe that the payout will be north of $1/share. I can still buy at around $0.14. I've made a decent sized play already. How confident am I in the outcome? Because if I'm confident in what I've put down already, why shouldn't I take advantage of the situation and try to increase the payout? If we're talking buying at say $0.15/share and getting a payout at $1, that's a nearly 700% return.

Something about pigs get slaughtered is coming to mind and making me uneasy but I am very intrigued by the idea of a BIG payout. Also, 'too good to be true' is nagging at me. I will kick myself if I miss the opportunity though. I seem to have a found a niche (short track record though it may be) of winning on the stocks when my play is not performance based but based on the practices of big money. The Russian OTC stock where the two billionaires were struggling for control and did a stock buyback played out well for me (Norilsk Nickel). This would put them both to shame. I feel like if I don't play in situations like this (high risk-high reward), I'm missing out on the only real chances I'll ever have to accumulate real FU money. Regular shareholders like you and me do not have that muscle, but hedge funds can pull together resources to fight cronyism for their gain and to help some fellow travelers. In short, fight on hedge funds because some small time greedy bastards are holding on like barnacles.

Real reporting on the issue here. This is NOT advice.

1 comment:

Hal said...

Hedge funds are socially acceptable to the extent that 1) they neither expect or receive bailouts when they fail (this has mostly held true, with some exceptions), 2) they obey the law, and 3) the owners have a big chunk of their own personal wealth in their own funds (this is usually the case). I can respect people who take risks and accept the consequences, and speculation is a legitimate part of an investment ecosystem. Issues arise when the funds break the law or abuse the system to make money (like many HFT funds, or Steve Cohen and his insider trading networks) or when the managers become wealthy enough to put a thumb on the scales of the political process (fund managers tend to use elaborate tax-avoidance schemes, and supposedly were influential in getting gay marriage passed in New York over the will of the voters). I would certainly be in favor of punitive tax rates for anything beyond $1 million/year or so, there is a strong public interest in keeping individuals from becoming too absurdly rich.