Hedge fund managers occasionally complain about the detrimental effect of portfolio size on their returns, yet they rarely mention the benefits of managing large sums of money. Last year Third Point’s Daniel Loeb filed a 13-D with the SEC regarding a tiny company compared to the funds Third Point manages: Emmis Communications (EMMS). According to the 13Fs filed by Third Point, Loeb developed a $7 million position in Emmis’ preferred stocks. Emmis’ common stock closed at $2.27 on July 13th, 2010, the day Loeb filed the 13D.
Months earlier Emmis’ CEO and large shareholder Jeffrey H. Smulyan offered $2.40 to take the company private. The shares were trading at around $1.15 before the announcement and shot up above $2.30 after the announcement. The buyout was almost a sure thing… sort of. Here is how Loeb explained why he initiated this position in his 13-D:
The Reporting Persons are aware that on May 25, 2010, the Issuer executed an agreement and plan of merger (the “Merger Agreement”), that if consummated would result in the Issuer being taken private by Jeffrey H. Smulyan, the Issuer’s Chairman, Chief Executive Officer and President. The Merger Agreement provides for a series of transactions, including (a) a cash tender offer for the Issuer’s Class A Common Stock, (b) an offer to exchange (the “Exchange Offer”) all outstanding shares of Preferred Stock for new 12% PIK Senior Subordinated Notes due 2017, and (c) a solicitation of proxies to amend certain terms of the Preferred Stock (such amendments or any other amendment or amendments that adversely affect the rights or preferences of the holders of Preferred Stock, whether or not proposed in connection with the Merger Agreement, are referred to herein as the “Proposed Amendments”). Adoption of the Proposed Amendments described in the Merger Agreement requires the affirmative vote of holders of at least two-thirds of the outstanding Preferred Stock, voting as a separate class.
On July 9, 2010, Double Diamond Partners LLC, Zazove Aggressive Growth Fund, L.P., R2 Investments, LDC, DJD Group LLC, Third Point LLC, the Radoff Family Foundation, Bradley L. Radoff, and LKCM Private Discipline Master Fund, SPC (collectively, the “Locked-Up Holders”) entered into a written lock-up agreement (the “Lock-Up Agreement”) pursuant to which, among other things, each of them agreed, subject to certain exceptions, to: (1) vote or cause to be voted any and all of its Preferred Stock against the Proposed Amendments; (2) restrict dispositions of Preferred Stock; (3) not enter into any agreement,
The 13-Fs don’t show all of a hedge fund’s positions. You can see their long positions in companies that are traded in U.S. exchanges, but you can’t see their short positions. Daniel Loeb stopped talking about his short positions but we can still speculate about his short positions. Insider Monkey, your source for free insider trading data, believes Dan Loeb was shorting the Emmis common stock while he was accumulating his preferred shares.
Dan Loeb and other holders of preferred shares were planning to force Jeffrey H. Smulyan to sweeten the deal significantly for them while keeping the deal unchanged for common stockholders. If they prevailed, then their shorts in Emmis common stock would appreciate only a few percentage points but their preferred shares (ticker:EMMSP) would gain at least 30% or so. So, they would come out ahead. If their offer is turned down by Smulyan, then they would proceed to block the buyout. In this case, Emmis’ common stock would probably fall at least 50%, going back to pre-announcement levels. Preferred shares would also go back to their pre-announcement levels, declining by about 30%. This means Dan Loeb would again come out ahead. Whatever the outcome, Daniel Loeb would stand to make at least 20% from this deal.
So what happened? The negotiations with Smulyan went on for a few months but they couldn’t reach a deal, so the buyout was cancelled. Emmis’ common stock declined to $0.78 by the end of September, a loss of around 65%. The preferred shares declined to $16 by the end of September, a loss of 27%. Daniel Loeb probably made about 40 percent from this riskless undertaking. A small investor couldn’t do this. Dan Loeb’s size enabled him to exploit the weakness in Smulyan’s buyout proposal.
Even though a small investor couldn’t do what Loeb did, they could still have imitated Loeb’s transactions. These opportunities don’t come every day, but when they do investors should take advantage of them. We will be covering hedge funds’ 13D and 13G filings more frequently, so that small investors can educate themselves about investing like a hedge fund pro. We also started sharing hedge funds’ 13F portfolios for free on our website. This is still a work-in-progress, so we will be adding more functionality in the next few weeks to make the filings more useful for you.