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Dual-Class Arbitrage Idea 1 - Lennar

October 07, 2011 | About:
Dual-class arbitrage trading is a simple three-step strategy.

1) Identify two publicly traded stocks of the same company at different prices.

2) Short the high-priced shares (X) and buy the low-priced shares (Y). Pocket X-Y.

3) Sell Y and buy X when the price of X and Y are equal.

Lennar fits the bill. Lennar Corporation (LEN)(LEN.B), founded in 1954, is headquartered in Miami, Fla., and is a leading builder of quality homes.

My broker, IB, indicates there’s ample liquidity to short at least 1,000 shares today.

Lennar has 148,575,861 Class A shares and 9,661,358 Class B shares. All shares have equal cash-flow rights. The voting rights are different though.

Ticker Current price Voting rights Comment
LEN $ 14.1 1 votes Market cap of $ 2.3 B.
LEN.B $ 10.4 10 votes Negative value of voting rights !


Historical spread of LEN versus LEN.B.

1982069.jpg

So why do stocks with identical cash-flow rights trade at different prices?

1) The different classes are owned by different groups. Different groups behave differently causing short-term discrepancies. This is the case with Berkshire’s A-shares versus Berkshires B-shares.

2) Even though voting rights alone do not generate cash income, investors are sometimes willing to pay a premium for super-voting shares.

3) One class of shares may be included in an index while the other is not. This causes index-funds to temporarily bid up (or down) one class while the other is ignored.

Though there are examples of gaps persisting for decades, more often than not, a double-digit spread will close within a year. Research indicates the prices of all dual class shares will at some point reflect the underlying cash-flow rights.

Disclosure: This is not a recommendation to buy, sell or short anything. I had no position in any of the stocks mentioned at the time of writing.

About the author:

batbeer2
I define intrinsic value as the price I would gladly pay to own the business outright. With current management in place. For most stocks, that value is 0. As of September 2012, I'm the author of the monthly Buffett-Munger Best Bargains Newsletter. I can be reached at fvandenbroek AT gurufocus DOT com

Visit batbeer2's Website


Rating: 3.0/5 (8 votes)

Comments

Dr. Paul Price
Dr. Paul Price premium member - 2 years ago


You said...

3) "Sell Y and buy X when the price of X and Y are equal."

That 'simple' startegy has not been available for even one day in the entire time period shown on your chart (which dates back to 2007).

When was the last time you could actually have done your suggested unwind?

You show no evidence that it could ever have been done.
batbeer2
Batbeer2 premium member - 2 years ago
Hi Stockdocx99

The evidence you are looking for is in the article I linked to (p60). For Lennar they completed 4 trades in three years. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1338885

To answer your question....

The two classes traded at the same price a few times in 2006 as they fell. You can see this by plotting the closing prices here (LEN versus LEN.B, price, 5 years).

You make a valid point though. This one has been out of whack for a while. The charts have been defying the fundamentals since 2007. I'll be tracking this so we shall see what happens.


-EDIT-

Here's one that closed.... again..... and again.

Tecumseh

TECUA versus TECUB



Dr. Paul Price
Dr. Paul Price premium member - 2 years ago
The fact remains that nobody could have followed your #3 clause for about 5 years.

Being unable to execute a strategy for that long means "being wrong" .

Your regular readers are still waiting for your multiple recommendations to buy USG and WPO to pan out. It's beeen years on those now also and yet, using your definition, these were not mistakes only because you never said to sell them.

It's ok to be wrong. It's not ok to stay with bad decisions permanently to avoid calling them bad choices.

augustabound
Augustabound - 2 years ago


Your regular readers are still waiting for your multiple recommendations to buy USG and WPO to pan out. It's beeen years on those now also and yet, using your definition, these were not mistakes only because you never said to sell them.

It's ok to be wrong. It's not ok to stay with bad decisions permanently to avoid calling them bad choices.
Doc, give it up.
batbeer2
Batbeer2 premium member - 2 years ago
Hi Stockdocx99

>> Your regular readers are still waiting for your multiple recommendations to buy USG and WPO to pan out.

I don't recall ever recommending anything to anyone on this forum. I come here to share my thoughts and read what others care to share. Why do you come ?

Adib Motiwala
Adib Motiwala - 2 years ago
Firstly, batbeer, I value your contribution on GuruFocus. Please ignore irrelevant comments :)

Coming to the idea, I like arbitrage kinds of investments. (merger arb) and this share class arb is a new one for me.

I think one need not wait for the gap to close fully. That is, in point 3 you say to close the position when the prices are the same. Well, you can always exit as the spread reduces right? So a 25% spread becomes 10% or whatever and you can always exit at that point!! What am i missing? As per the chart, the spread maxed out at 32% in 2008 and came down to 16% in 2010. So, the 24% spread currently seems quite juicy. It may not come down to 16% any time soon, but one can exit when the spread narrows. In the case of LEN, is either class of shares in an index ?

batbeer2
Batbeer2 premium member - 2 years ago
Hi Adib,

Thanks.

There's no need to hold out till close. For the purpose of this article/series I'll keep it simple though. I'l be tracking a handful. This is the first one.

I believe LEN is included in many S&P 500 index funds.

Some of the funds with significant chunks of LEN are Vanguard index funds.

To be fair, some other Vanguard funds own LEN.B.

You'll note it's the nominal spread that counts. The pair could go to $ 1.40 & $ 1.00. A significant spread in percentage terms.

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