Applying Buffett’s Arbitrage Techniques to Infusystem

Written by

Jae Jun

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With InfuSystem (INFU) still sitting 9% below the lowest buyout offer of $1.85, there is growing concern among investors that the buyout won’t occur.

Well, the market seems to think so too. A spread greater than 5% is the market’s way of saying the probability of the deal is unfavorable.

What I want to focus on however, is what makes up good and bad info. Lanber wrote about this in the previous post on stock selling decisions and the bias of owning stocks.

More information can make you feel confident, and not just financially invested, but psychologically invested

Before I continue, I want to disclose that I now have a 10% position. That places me in a pool of all sorts of biases so tell me at the end whether you smell dark sweaty bias in this article.

What’s Not Important: The Stock Price

The stock price is not an indicator of anything. On its own, it is a single variable without context. A vanity metric that makes you feel good or bad about an investment.

Right now InfuSystem is priced at $1.70. The low ball buy out range is $1.85 to $2.00. What does this mean?

Will the buyout fail? Will Morris walk away? Will there be a long and dragging battle?

None of the above. It doesn’t mean anything. Price should be a measurement for whether something is a good or bad buy.

So let’s ignore price and try to look at this objectively, the way Buffett did arbitrage back in the old school days

Buffett Arbitrage Technique

In Buffett’s 1988 letter to shareholders, he wrote a section on arbitrage.

To evaluate arbitrage situations you must answer four questions:
(1) How likely is it that the promised event will indeed occur?
(2) How long will your money be tied up?
(3) What chance is there that something still better will transpire-a competing takeover bid, for example? and
(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

(1) How Likely Is It That The Promised Event Will Indeed Occur?

Morris owns 8.1%, launched an activist campaign, took the chairman position, got involved in day to day operations of the company for a year and has now offered to buy out the company.

From his actions and what he has said, he wants this.

This pictorial of his investing style also points towards a high probability of the buyout going through. He concentrates on investments and tries to own 10% of companies he invests in to get a big payday.

History of Morris’ Investments

(2) How Long Will Your Money Be Tied Up?

Morris first sent a letter to the board stating his interest in buying the company. That was May 13. Two months later on July 17, he sent his offer letter.

Tiny sample size, but I’m thinking it could take at least 1-2 months before his next letter. Then add on several more months for the whole deal to close. So that’s anywhere from 2-6 months.

2 months if the offer is increased and you sell out, 6 months if you wish to hold until the very end.

(3) What Chance Is There That Something Still Better Will Transpire?

Morris has the upper hand here. He knows that something better is unlikely to appear for InfuSystem. He is the only one bidding for the company. The previous move to shop the company around did not yield any results.

The details of how it was shopped around is not available, but if there is no interest from other companies, Morris has a good hand in this one.

What better possibilities are there though?

  • A competitor finally does appear – highly unlikely
  • Management decides to reward shareholders instead – extremely unlikely
  • Morris retracts his offer and wishes to increase shareholder value as a public company – possible

Not many other alternatives I can think of.

When you weigh it against the other possibilities, the current situation isn’t a bad one to be in for investors.

(4) What Will Happen If The Event Does Not Take Place Because of Anti-Trust Action, Financing Glitches, etc?

Morris certainly needs outside money to be able to take InfuSystem private. He wrote in his letter that he hopes to obtain private equity to help close the deal.

However, the main concern on the mind of other investors is whether financing the deal will be possible.

My take?

Morris has been featured on Bloomberg, he got the attention of Whitney Tilson and Zeke Ashton, received seed money from those two guys, and have other investors who think he is the next star fund manager. If he can shop himself around like that, he shouldn’t find it difficult to find a partner willing to get in on his deal.

So I don’t think financing will be as big of a concern as other investors fear at the moment.

Even if things were to go horribly wrong and the stock drops to $1, I still see a good floor at $1.85. $1 will represent a huge buying opportunity.

What is Important and What is Not

I don’t want to get into the whole conflict of interest argument and lack of fiduciary duty on Morris’ behalf. I admit that he is chairman and is trying to perform a guerrilla attack on shareholders by buying out InfuSystem on the cheap.

But, when it comes to this arbitrage, it doesn’t add value to the analysis. It doesn’t change the fact that he wants to take InfuSystem private.

However, there are glimmers of hope that this deal works out well.

When I first read the Bloomberg article, I quickly read through it. Going over it again a 2nd and 3rd time, I picked up these two tidbits which I’ll leave you to ponder on.

When Morris called [INFU] shareholders, some said, “Thank God you’re here.” Others were skeptical. How did they know that Morris wouldn’t raid the company for himself? “I was like, ‘I’m 27. I would be ending my career right now if I was going to do that,’

His long-term plan is to “cut my teeth with these small ones that I fix up and sell, and then you can start doing more interesting strategic stuff once you get bigger.” Eventually, he wants to merge companies, change operations, and make the big plays. But to get there, Morris needs more money, and more experience sitting across the table from executives and demanding a seat on a board.

What is your take on this situation?

How much of my bias are you detecting?



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