Special Situations Alert: Details Behind Why I Bought PATH

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Jae Jun

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Did you notice the market drops the past few trading days?

It’s been a while since the market fell like this.

Feels like rain after a long drought.

One company that isn’t taking notice of what the market is doing is NuPathe (PATH).

When the market “fell” 2% last Friday, here’s what it did instead.

Before I continue, maybe you’d like to download a PDF version of this article so you can read it on the go.

Special Situation

NuPathe (PATH) Stock Info – Jan 24

So what gives? A reader saw my post about NuPathe on facebook and asked what my reason for buying was.


NuPathe is a special situations play.

After 2 years of being passive on the special situation side, I’m actively looking for more special situations to participate in this year.

Let me go over what special situations are about, and how to profit off NuPathe.

First, What is a Special Situation?

There are various forms of special situations. I have already written about the most common ones.

You can see that it’s not your typical going long or short.

Warren Buffett Loves Special Situations

Here’s what Buffett said about workouts (or special situations) in his 1969 letter.

Theses are securities with a timetable. They arise from corporate activity – sell outs, mergers, reorganizations, spinoffs etc. In this category we are not talking about rumors or “inside information” pertaining to such developments, but publicly announced activities of this sort. We wait until we can read it in the paper. The risk pertains not primarily to general market behavior (although that is sometimes tied in to a degree), but instead to something upsetting the apple-cart so that the expected development does not materialize. Such killjoys could include anti-trust or other negative government action, stockholder disapproval, withholding of tax rulings, etc.

The gross profits in many workouts appear quite small. It’s a little like looking for parking meters with some time left on them. however, the predictability coupled with a short holding period produces quite decent average annual rates of return after allowance for the occasional substantial loss. This category produces more steady absolute profits from year to year than generals do. In years of market decline it should usually pile up a big edge for us; during bull market it will probably be a drag on performance. on the long term basis, I expect the workouts to achieve the same sort of margin over the Dow attained by generals.

By taking advantage of workouts, Warren Buffett was able to make money in any market.

Here’s proof.

Warren Buffett Performance Portfolio

Warren Buffett Performance Portfolio

Simply put, special situations brought stability and outperformance to his portfolio as it works independently to the market.

A basic example is a merger.

Say Coca Cola is buying out a new energy drink company EnRG for $20/share. Since the market is confident of KO’s due diligence and ability to pay up, EnRG is going to trade close to $20/share on the news. The next day, even if the entire market fell 3%, EnRG is going to trade close to $20.


Because the value has already been set and it would be foolish for anyone to sell their shares at $18 when you know it’s going to close at $20.

That’s the beauty of special situations.

The value and time are given so there is more predictability.

Warren Buffett – The King of Special Situations

In fact, one of Warren Buffett’s cornerstone strategy was to invest in special situations.

Warren Buffett Portfolio Allocation - 1969

Warren Buffett Portfolio Allocation – 1969

In 1969, this is how Warren Buffett built his portfolio. Buffett always called it workouts, but you can see that he dedicated 23% of his portfolio to it.

Now Back to NuPathe (PATH)

Teva Pharmaceutical (TEVA) is buying NuPathe (PATH) for Zecuity, which is the world’s first migraine treatment patch.

Here’s the deal.

  • Buyout price of $3.65 per share in cash
  • NuPathe shareholders will receive rights to get additional cash payments of up to $3.15 per share if sales milestones of Zecuity is achieved

NuPathe has a maximum of 9 years to meet the goal and sales must come in four consecutive quarters.

  • If net sales of Zecuity is between $100m to $300m, shareholders receive $2.15 in cash first
  • If net sales of Zeucity is greater than $300m, shareholders receive the remaining $1.00 cash payment

Getting into NuPathe’s Special Situation

I’ll base the scenario off the latest closing price of $4.10.

  • If Zecuity sales is less than $100m, no cash payment received
  • If Zecuity sales is between $100m and $300m, $2.15 is received
  • If Zeucity sales is greater than $300m, an additional $1.00 is received

Stock purchase price: $4.10
Initial cash payment: $3.65

Immediately, I’m starting down $0.45 ($4.10-$3.65=$0.45).

If Zecuity is a complete flop, then I get no payment and I lose $0.45 which is an 11% loss.

But even if that is the case, there is still 9 years for this investment to work out.

Plus, there are a few things going for this deal.

  1. Zecuity is the first ever migraine treatment patch. Already approved by the FDA and patent protected of course.
  2. Zecuity solves the problem with side effects that occur with migraine pills and prescriptions.
  3. Huge market size. More than 37 million suffer from migraines.

NuPathe didn’t have the funds to market and commercialize Zecuity which is why they were looking for a partner.

Now that TEVA has solved its cash problem, I’m guesstimating a scenario of 2-3 years to receive the first payment of $2.15.

Don’t take my word on this, but I’m going to just bet that it won’t take more than 5 years to achieve $300m in sales.

The Juicy Risk vs Reward

When it comes to special situation deals like this, always calculate the percentage of loss versus reward to understand what you are getting yourself into.

I got lucky with my INFU downside estimate so let’s see if I can get lucky with this one too.

Here’s the breakdown of the downside vs upside.

Special Situation NuPathe Odds

Special Situation NuPathe Odds

The “total invested amount” is the money that you really end up tying up to this special situation. It’s not $4.10 because you get back $3.65 once the deal closes.

So to make this worthwhile, a large upfront purchase is required.

Example Scenario For this Special Situation Workout

Say you buy 1,000 shares @ $4.10.

The total upfront cost is $4,100 but once the deal closes you get $3,650 back so you really only end up spending $450.

The most you’ll lose is $450, which is a maximum of 11%.

The first milestone scenario will net you 280% on your $450 investment.

And the best scenario is a 500% return on your $450.

NuPathe Special Situation Scenario Odds

NuPathe Special Situation Scenario Odds

I’ve never seen such low risk, high returns before. The time frame is much longer compared to a regular workout, but a possible 280% – 500% over a 5 year span is phenomenal.

But $450 is chump change for a lot of you.

So if you have a $100k portfolio and you want the final allocation of this workout to be 3% of your portfolio, you will need to buy about 6,500 shares for a total initial cost of $26,650.

That way, when you get back the $3.65 per share, you are left with about $3k invested for the remaining cash rights.

Calculating a 3% Allocation Scenario

Calculating a 3% Allocation Scenario

Finally, Some Important Points

  • Special situations can boost your portfolio in volatile and difficult markets. Keep your eyes open for the various types that you can partake in.
  • Don’t make my mistake of buying too little at first and then having to buy more.
  • Don’t chase the price too much. Set a limit of how much you are willing to lose. At $4.10, max loss is 11%.
  • Don’t expect to see your final invested amount for at least 5 years.

Download the spreadsheet below and test the scenarios for yourself.

excel download

Next time, I’ll show you how I found this opportunity and how you can do the same thing.

In the meantime, got any special situations that you have an eye on? Let me know in comments.



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23 responses to “Special Situations Alert: Details Behind Why I Bought PATH”

  1. Daniel Victor says:

    Nice analysis – but is there not some risk however small – that the takeover fails ?

  2. J says:

    Daniel Victor makes an important point. Expected return on merger arbitrage must factor in risk of deal not closing in which case your 11% downside would be larger.

  3. b says:

    Hi, I think you have an error in your calculations. If you lose the whole 450, then you are down 100% according the way you are looking at it, not 11%. Otherwise, you’d need to adjust your up 288% profit calculations..

  4. Anonymous says:

    When you say the downside is losing only -11% on initial $0.45/share investment, it is really -100% loss on the invested amount of -$0.45/share. You are comparing two different original amounts invested which incorrectly skews the risk/reward. In the loss scenario you say the amount invested is $4,100 to get -11% loss, but in a win scenario you say the amount invested is only $450 to get +277% gain. It should be -100% vs. +277-500%.

  5. good point on that. Will have to readjust the numbers.
    If that is the case, then the total profit on the initial number is 41% for $2.15 payment and 66% when including the final $1.

    Obviously much less than the original.

    So it’s 11% downside with 41% and 66% upside.
    or 100% downside with 277% and 500% upside.

    Probability that the deal wont close. Highly unlikely.

    Now it comes down to the sales number.

  6. good catch. Comment above ^

  7. When you look at the deal, the buyer and the seller, it’s highly unlikely. Teva has the cash, they want to expand. They outbid a competitor to buy PATH. Zecuity is already approved so Teva isn’t taking any additional risk.

    I think the only risk here is whether the sales can be met.

  8. Oren says:

    Does the 3.65 pre or after tax?

  9. MM says:

    A hallmark of value investing, of course, is a meaningful margin of safety. I’m not sure I see that here. And while special situations can be great, I think one is wise to measure them, at least on the downside, by that same yardstick, among others. Given the basic facts that, as of the latest Q, this company hadn’t produced so much as a dime in revenue and had a per share book value of roughly $0.23 (however relevant or irrelevant one might consider that metric for a development-stage technology company), paying current market ($4.00, or thereabouts) seems decidedly derelict when it comes to something as basic as a margin of safety.
    It would appear that your decision to invest here was predicated on an assumption that the $3.65 piece is a done deal. Perhaps your analysis of the risks presented by the pending merger potentially not closing was considerably more rigorous than what you’ve explained, but it does seem from what you’ve explained to have been superficial at best. To me at least, a review of the various termination provisions in the merger agreement reveal that it may, indeed, be something less than a sure thing.
    But even assuming the deal closes and holders get their $3.65, they still need the company to at least hit the first sales target before they’re made whole and come away with a gain. And while that may certainly happen, I see two reasons for concern in this regard. First, it is common in deals structured like this (called “earn-outs” in the vernacular) to have built into them certain provisions relating to the downstream financial commitments of the parent that serve to provide at least a certain degree of assurance that hitting the numbers will be within the realm of realistic possibility of the company once acquired. In this case, there aren’t any, and the board of the acquiree will be controlled by the parent, leaving one to wonder (at least us cynical types) whether they’ll starve the sub of marketing muscle every 4th quarter simply in order to avoid having to pay holders of these pay-out rights. Second, while the last K contains lengthy disclosure relating to most of the typically covered aspects of Zecuity, conspicuously absent is any substantive information about the market for the product. I don’t know why this information is not included, but there’s enough market and marketing related information set out in the risk factors section of that report to leave one thinking that hitting those targets may not be so easy.
    I’m not saying that investors won’t make out well with this opportunity; they may. My only point is that I think a favorable outcome is far less certain than you’ve suggested.

  10. nedv says:

    when the revenue target actually gets hit affects your return

  11. Thanks for the comments.

    With any blog article, there is just a limit to how much I am going to write so that’s why i don’t go over every detail.

    Your comment has great merit. But keep in mind that this is a special situation. I’m honestly not concerned about the buyout closing for several reasons.

    However, you make a good point about the extra info, so I’ll leave some extra concise info here.
    My view is always that concise information is best, which is why I don’t try to write about every detail.

    I’ll probably write whatever I write from here in another post.

    This deal is akin to playing odds at a casino.
    With a 55% chance of winning, do you take the bet or leave?

    Probability says you go for it each and every time until the cows come home.

    The probability of failure is less than 50% by my calculations.

    Teva has a solid track record, of takeovers, they have plenty of cash at just less than $3B. This is a drop in the bucket for them as they try to get more drugs in their sales funnel. Documents already state that financing isn’t an issue. There are no other blocking issues here so that’s why I’m confident in saying that the deal is going to go through.

    The cash milestone payments is actually what Endo offered. Teva just upped their price because they wanted it.

    And as for manipulating the marketing, that’s something I highly doubt. I don’t see the point in sabotaging yourself every year for 9 years just to say 5-10% of the cash.

    I get this figure because Teva currently has $2.8b. The total amount after all milestone payments is $270m. That’s about 10% of cash.

    NuPathe’s projections are so much higher than that, over 9 years. Again, to save 5% of the remaining cash and subject themselves to litigation costing even more is close to zero probability.

    The only thing this deal hinges on really is the sales volume.

  12. anonymous says:

    One other writer says that the payment date is nine years from when the targets are achieved. Is that accurate?

  13. Max says:

    this is the problem i see with a lot of jae’s decisions…he doesn’t really practice what he preaches – value investing. he looks for coin-flip home-run stocks and looks for excuses to buy them. maybe a stock meets some of his value metrics, but the story is awful. or maybe the story is positive, but then the metrics are awful. he likes to dabble in obscure stocks rather than apply value investing strategies to blue chips or mid-caps where margin of safety actually means something. i’ve largely stopped following him for these reasons. all the metrics in the world won’t help you if you can’t see the big picture.

  14. Max says:

    “This deal is akin to playing odds at a casino.
    With a 55% chance of winning, do you take the bet or leave?

    Probability says you go for it each and every time until the cows come home.”

    Jae, as a value investor, a 55% chance of winning is pretty crappy, and you shouldn’t be in a casino in the first place. As a value investor, you should be looking for something like 80%+ odds. And you only do that by finding solid companies with good metrics -AND- a good story/business.

    And by “good story,” I don’t mean a long, obscure set of conditions a company must meet in order for its stock to go up; I mean it should be relatively simple to describe how this company makes money, how they will continue to make (more) money, and how they will protect their business.

    Reading some of your recent posts, I’m sure you understand the principles. But why even publicize this “special situation” when it goes against your “old school value” mantra is a curiosity. It does nothing but damage your brand.

  15. Actually I don’t think it goes against it. If you read Buffett’s letters you’ll note that he participated in a lot of special situations. They didn’t all have 80% odds of winning. He specifically said to do a lot of them to diversify.
    As a value investor, its important to be opportunistic, and as an asset allocator, this is a low risk high return opportunity.

  16. Rmgillis says:

    When are Nupathe shareholders going to be paid ? It’s been three weeks since the deal was consummated. I bought through TDAmeritrade btw.

  17. No idea. Just need to wait.

  18. Rmgillis says:

    Actually, that is helpful in that it appears you haven’t received your 3.65 per share yet either. Thanks for your rapid reply!

  19. hahaha yes I havent been paid.

  20. Dan says:

    I will disagree with you here Max. John Templeton mentioned that even the best professional investor won’t be right two thirds of the time (or 60%, I can’t really rmb). So the thing is to have a 80%+ odds is very very rare. Come on if you can have 80%+ odds all the time your record will smash Warren Buffett 20% annual returns. How is 55% odds chappy? That’s a 10% return on your investment. It is not the best but it’s something. If you can have more than 60% odds consistently you are already better than Warren Buffett.
    Honestly Max, your tone sucks, and worse of all your statistics sucks even more. I will have to defend Jae here even though I don’t agree with all his posts. A small investor make use of every opportunity he or she can find. Someone rigid in the thinking like Max will continue to be in his own world.

  21. Dan says:

    *smart, not small. Typo.

  22. T says:

    Have you got paid from teva yet?

  23. Not yet. Expect it around April 20th.

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