Things my pappy told me about bear markets (part 3 of a series)

Written 2023-05-03 - “The Ike Street Journal – the weekly diary of the American nightmare”

Warning: None of the following is investment advice. Do your own research and make your own decisions! Also, CVRs can have rather complex tax consequences, so be sure to consult your tax advisor before investing!

This is sort of a continuation of my previous piece, in which I suggested special situations (for example, mergers and liquidations) as an interesting hunting ground during bear markets: Link to part 1.

In this installment, I’ll cover what I think is an interesting offshoot of some special situations – CVRs. So, to begin with:

Just what the hell is a CVR? It’s a special type of investment, typically created to tie up a loose end in a merger or liquidation. There may be some pending uncertain event for the company that’s being sold or liquidated – for example, some asset with an uncertain value that may or may not be monetized in the future. In order to get the deal done now, it’s structured as a combination of a payment you get now, plus a Contingent Value Right (CVR) that entitles you to another payment if the future event pans out the right way.

Typically, in order to save on regulatory expense, CVRs don’t go through the usual security registration process, and can’t be traded. In fact, they can’t even be given away except by inheritance. So, usually the only way to acquire a CVR is to buy the stock of the company being taken over or liquidated before the deal happens; when the deal does happen, you’re then left with the CVR – in fact, you’re stuck with it until it either pays off, is wound down, or you die.

So why might CVRs be an interesting area to look at? There’s a well known strategy from value investing of looking at investments that, for one reason or another, most investors don’t want to own. Of course, the idea is that these investments may then trade at a bargain price. For example, in One up on Wall Street, Peter Lynch suggests looking at companies in businesses that are boring or unpleasant to think about (i.e. funeral homes). As another more recent example, the SEC put out a rule a few years ago that created a class of so-called dark stocks that are a big pain in the ass to trade (effectively off limits to most investors). Some investors I follow have suggested these dark stocks as a good hunting ground, and that makes sense to me, though I haven’t yet jumped through the needed hoops to trade them.

However, it strikes me that CVRs may be the ultimate example of this idea (unwanted investments). I mean, they’re no fun at all – you can’t trade them, they probably won’t be listed as having any value on your account statement, and you can’t even give them away unless you die – who the hell would want to own these?? The only thing you can do with them is wait a few years and see if you get paid!

Finally, I’ll repeat the warning about taxes above – CVRs may have uncertain/complicated tax consequences since it may not be clear how to treat the initial receipt of the CVR, as well as what type of income to classify any subsequent payments under. So, if you do decide to look at CVRs, be sure to consult your tax advisor before investing!