A couple of years ago I found a new Superinvestor that I decided to follow and potentially clone. His name is David Abrams. I think I saw he was a 10% owner in some company I was looking at and then I Googled him and found this great Wall Street Journal profile of him. I decided to put him into my cloning universe and follow him because a) he has an amazing track record and obviously knows what he’s doing, but more importantly b) his investing style and personality seem to mesh very closely with mine and because of that, I decided I would follow him from quarter to quarter and see what I could learn.
In the first quarter of 2021 I saw that be bought Change Healthcare and it was a medium size position in his portfolio. I decided to clone him on this investment, doing what I call a direct clone. Just a straightforward clone where I don’t do any of my own work upfront, I just quickly jump in behind my Superinvestor at a price that’s the same, better, or just slightly worse than they bought the stock for.
Abrams then increased his position in Change Healthcare in the second quarter by 12%, and just recently we found out he increased his position by another 21% in the third quarter. Change Healthcare is now his 6th largest holding in his 13F and makes up about 8% of what we can see in the 13F. It’s a real position, and the fact that he has bought it three quarters in a row tells me he is high conviction.
The stock has basically gone down slowly over the course of 2021, and during this year, across the three quarters, Abrams has likely bought at prices around $22 to $21. The price today is $21.
After I cloned, with about a 3% bet, I just kind of forgot about Change Healthcare, and after an initial look, I hadn’t really followed up on it. When I looked at it briefly, nothing jumped out at me as anything obvious that I could find out about their business and why he might have bought. There wasn’t anything like a ton of net cash, hidden real estate, a super low PE, a high cash flow yield or anything like that. Just a normal, growing business with a PE of 15 to 20, a lot of debt, and nothing really special with the financials. On top of that, this healthcare technology business seemed super confusing, I couldn’t figure out what they do, and it seemed like something that would take more time than I had available to figure out and get into my circle of competence, so I just left it alone and decided it would be a direct clone.
Well, it turns out that I had missed something obvious. This is an acquisition arbitrage play.
In early January of this year, a unit of UnitedHealth Group announced they were going to buy Change Healthcare for $25.75 a share. And I guess what Abrams had been doing this year was judging the likelihood of that acquisition going through versus the discount on the stock price. When acquisitions get announced, the price of the company that’s being purchased goes up, but there is often a discount between how much the price goes up initially versus the purchase price, and over time, as it gets more likely that the acquisition will go through, the gap closes and the price gets closer to the acquisition price. And in the interim, investors can buy the company getting acquired as an arbitrage play and make a nice, small profit (but quickly) once the acquisition goes through. The risk of course is if the acquisition fails to go through and the price of the company that was going to be acquired drops back down. So the edge here, is one’s ability to handicap the likelihood of the acquisition going through versus the discount on the price. I had read that Buffett used to employ this strategy earlier in his career, and I also read that John Paulson was a specialist at this before be became know for his huge housing bet during the Great Recession.
My cost basis in Change Healthcare in $21.47. The acquisition was supposed to finalize in late 2021, and now they’re saying early 2022. Change Healthcare shareholders approved the merger with 99.9% of the vote. And now I think we’re just waiting on regulatory approval. My purchase was in August of this year. If I get paid $25.75 a share in March, I will have gotten a 20% return and annualized it will have been a 31% return due to the short holding period. And if I buy more today at $21 and I get back $25.75 in March, it will be an annualized return of 63%.
What are the odds that the acquisition will get approved? I don’t know.
What will happen to Change Healthcare’s stock price if the acquisition doesn’t get approved? I don’t know.
The fact that David Abrams bought three quarters in a row at similar prices to where I was able to buy and to where it is today, and the fact that it’s a meaningful position for him and not that consequential of a position for me (at least right now), is all enough for this shameless, intense, and ferocious cloner to feel fine about the investment.
I’m definitely going to keep holding this small position and see what happens in early 2022 with the acquisition. And I might add to my position in the interim.