Friday, 11 November 2016

Post Mortem on Cleco

In the comments, I was asked to update my thoughts on Cleco. I happily comply with this post. Shortcut: In the end this roller-coaster-investment worked out fine.

It is really important in this kind of arbitrage situations not to invest when everyone expects the deal to close at the lower end of the timeframe given by management. I had no clearcut expectation when this would close and entered the position at about an 11% discount with an upside of 12% on 11/12/2015 for the blog. These are gross and not annualized returns. It is at times not worth it to go for high annualized IRR with low absolute return given the risk involved. For example writers an seekingalpha often tout annualized returns, but ignore the downside risk. For me it is important how far the stock would fall when the deal breaks. With Cleco we had a profitable company, but for me it was overvalued as a standalone and so the price would drop if the deal breaks.
When we look at the chart, the timing was great at the beginning. Then the unexpected happened. I wrote:
"I have decided to hold on to the position after the sale was rejected by the commision. The hearing was webcasted and I listened to it. Should have sold the position with a small gain as soon as I realized a negative outcome is probable. The decision process looks very non fact-based to me. Although the decision to reject may be right. It looks like it played a role that the buyer was not American..."
 It might have been a mistake not to increase the position at the trough around $45. Although I thought short-term downside was limited from there, I was just not comfortable holding more of a company, which could get problems with decentral electricity generation and definitely is not in a growth market (those are long-term problems). The price was not low enough. On the other hand compared to interest rates the cashflows did not look too expensive. I did nothing. Best would have been to sell after the 40c dividend and buy-back in March, but that is easy to say with hindsight.
The end result was an IRR of about 31% in dollar terms (as you can see on the portfolio page).

I just added the gross dividend to the take-out price. The correct calculation would have been to add the dividend with the date one would have received it, which would have increased the pre-tax IRR slightly.

In the end I should have sold the position during the webcast. It was a mistake and more luck than skill that Cleco worked out for me in the end. Of course, the professional full-time arbitrageurs are no better either. (I even like to avoid stocks most favoured by professional arb funds, when looking at special situations like merger-arb.) One gets uncorellated returns and that is exactly what I wanted in this relatively expensive market. OK: It would be best to have only positive, uncorellated returns and never negative ones, but I am learning and avoiding a lot of fees by investing myself.

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