A Hidden Opportunity for Stock Riches

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I love special situations. And you should, too, because they offer a hidden opportunity to profit in the stock market.

Special situations are investments that rely on transactional events to create profit for us. The classic example is a spinoff of a fast-growing but small division from a slow-moving giant. Investors would love to own that rapid growth, but they can't buy it separately until the spinoff. When that spinoff happens, though, investors can suddenly access that value and drive the stock price higher.

In other words, the value in such special situations is obscured by technical reasons, not fundamental ones. As Joel Greenblatt details in his book You Can Be a Stock Market Genius, special-situation investing led him to 50% annualized returns for a decade. That type of return transforms a $1 investment into $52 in just 10 years. These situations can be superficially complicated, but it's this transactional complexity that often creates value for agile investors.

Here are two examples of how this worked recently with CVR Partners LP (NYS: UAN) and Frontier Communications (NYS: FTR) . Then I'll show you another stock I'm currently watching for similar reasons.

Two special situations
I identified a great special situation in CVR Partners LP, which was spun off by CVR Energy in April. When it came to market, CVR Partners was unknown, but a quick look through the filings showed that the company expected to distribute $1.92 per unit in the upcoming year, giving the stock a yield of about 10.7%. But that information was unavailable on almost all public finance sites. With such a high yield, the stock could be expected to run up in order to bring that yield in line with peers'. In fact, since April the stock is up more than 50%.

I did a similar trick with Frontier Communications following last year's acquisition of lines from Verizon (NYS: VZ) .

Frontier acquired millions of access lines from Verizon in 2010, taking on billions in debt in the process. As part of the payment, Frontier issued some 700 million new shares to Verizon, which agreed to distribute the stock to its shareholders. Those new shares tripled Frontier's share count.

Not surprisingly, when Verizon investors received those Frontier shares, they sold them, for a variety of reasons. Institutional owners might have been forced to sell because they would violate their charters by owning a midcap stock (Frontier) when they had to be invested in large caps (like Verizon). Investors who wanted a growing wireless giant probably weren't interested in a slowing wireline company. So the price movement of Frontier's stock was entirely predictable.

With hundreds of millions of shares coming into the market over a short period of time, the stock was bound to drop. But despite trading five to 10 times its normal volume for about three weeks, the stock never closed below $7 and shares yielded more than a 10% dividend. When the selling abated, it was time to buy, and the stock climbed 30% in the following six months.

The hidden opportunity
The hidden opportunity I mentioned involves Mosaic (NYS: MOS) ; 64% of its shares were recently owned by Cargill, a private agriculture company. For reasons unconnected with Mosaic's high-quality business, Cargill had to dispose of its substantial interest. That news sent Mosaic stock down immediately, as the market realized that more shares would be sold by people who didn't really want or need to own Mosaic. That drop was entirely unrelated to the fundamentals of the business.

Nevertheless, the Mosaic deal was structured to help mitigate the issue you saw above with Frontier, where a massive number of shares hit the market all at once, bottoming out Frontier's share price. The deal allowed only a certain number of shares to come to market this year -- increasing Mosaic's publicly available float by 50% in late May -- and next year should see another huge tranche of shares coming to market, meaning we could see a better price yet.

The fertilizer space where Mosaic operates has been hot recently, as developing economies need to produce increasing amounts of food. That has made the relatively few fertilizer stocks of particular interest. Resources behemoth BHP Billiton (NYS: BHP) tried to acquire PotashCorp (NYS: POT) last year, with no success, and there's speculation that other resource players want in on the space because of its strategic and economic attractiveness. Shares of peer Terra Nitrogen (NYS: TNH) have been on a tear as well.

Currently, Mosaic looks reasonably priced at a 9.0 EV/EBITDA multiple. But there are a couple of other catalysts that could drive the stock higher. Because more than 50% of its shares were previously not publicly floated, Mosaic couldn't be included in the S&P 500. Future inclusion would force all the S&P 500 copycat index funds to buy shares. And, of course, there's the potential interest of bigger players to move into fertilizer .

Special deals like this are being struck all the time, if you know where to look.

Want more ideas like this?
If you're intrigued by special situations like these, then you'll probably be very interested in Motley Fool Special Ops, an exclusive service that looks for such hidden values, telling you just when to buy and sell and how much. In the next few weeks, the service is being opened -- the last time this year -- and you'll receive an invitation and an investing kit if you enter your email in the box below.

At the time this article was published Jim Royal, Ph.D.,owns shares of Frontier. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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