Special Situations: Bankruptcies, Spin-offs, and Recapitalizations
Corporate events that force indiscriminate buying or selling create some of the most reliable mispricing Klarman's approach looks for.
Klarman devotes real attention to a specific category of opportunity: corporate events — bankruptcy reorganizations, spin-offs, recapitalizations — that force certain classes of investors to buy or sell for reasons entirely disconnected from a security's actual value. A spin-off, for instance, often gets dumped by index funds and institutional holders of the parent company who never wanted the smaller new entity and sell it indiscriminately the moment it starts trading, regardless of its underlying quality.
The common thread across these situations is forced, valuation-indifferent selling: the seller's decision is driven by a mandate, a policy, or a structural requirement, not by an assessment of what the security is worth. That indifference is exactly what can create a genuine, temporary mispricing available to an investor willing to do the analytical work of figuring out what's actually being sold.
| Situation | Who's forced to sell (or buy) indiscriminately |
|---|---|
| Spin-offs | Index and institutional holders of the parent who never chose to own the new, smaller spin-off entity |
| Bankruptcy reorganizations | Original bondholders who receive new equity in the reorganized company but have mandates against holding stock |
| Recapitalizations / index changes | Funds tracking an index forced to buy or sell purely because a security entered or exited that index |
These mispricings tend to correct once the forced selling is finished and the security starts trading based on its own merits again — meaning the window to act is limited to the period of indiscriminate selling itself. Capturing the opportunity also requires genuine analytical work most investors skip: a newly spun-off company, in particular, often has thin analyst coverage and limited trading history, so there's real work involved in independently valuing it rather than simply noticing that a lot of shares are for sale.
A large, well-known company spins off a smaller division into its own separately-traded stock. Many index funds that held the parent company are mandated to sell the new spin-off shares immediately, regardless of price, since the spin-off doesn't meet the index's own inclusion criteria. In the days following the spin-off, this indiscriminate selling can push the price well below what the new company's own earnings and assets would justify — an opportunity available specifically to investors who did the work of separately valuing the spin-off before the forced selling finished and the price normalized.
- Spin-offs, bankruptcy reorganizations, and index-driven trading all create windows of forced, valuation-indifferent selling (or buying) — a structural source of mispricing distinct from ordinary market sentiment.
- These opportunities are temporary by nature — they tend to correct once the forced selling is finished and normal price discovery resumes.
- Capturing them requires real, often tedious analytical work (valuing a thinly-covered new spin-off, understanding a reorganization's new capital structure) — the same durable-edge-through-effort principle from the previous chapter, applied to a specific category of event.