Tuesday, February 24, 2009

The Berkshire Hathaway Arbitrage (BRK.A: BRK.B)

As a followup to yesterday's "Buffet Urges Investors to Read Graham’s Chapters 8 and 20 in Times of Financial Crisis (but wait, there's more!)", Market Movers brings a pair trade to our attention (it's not a classic arbitrage as the "B" shares are not good delivery for the "A"):

...Now the B shares have 1/30th of the economic value of the A shares, but only 1/200th of the voting rights. They began the week worth about 1/31 of an A share, and ended it worth less than 1/32 of an A share. Given that the seeming arbitrage persisted all week, the market might well be starting to value those A-share voting rights.

"In my opinion," says Warren Buffett, "when the B is at a discount of more than say, 2%, it offers a better buy than the A." Right now the discount is a whopping 7%. So if you want to take Buffett's advice, start buying up B shares. If, that is, you want to buy his stock in the first place. Which is a different matter entirely....SOURCE

We are conversant with the issue. From Berkshire Hathaway (oops, just noticed that Mr. Salmon has the link to the memo, here it is anyway):


From: Warren Buffett
Subject: Comparative Rights and Relative Prices of Berkshire Class A and Class B Stock
Date: February 2, 1999 Updated July 3, 2003

Comparison of Berkshire Hathaway Inc. Class A and Class B Common Stock

Berkshire Hathaway Inc. has two classes of common stock designated Class A and Class B. A share of Class B common stock has the rights of 1/30th of a share of Class A common stock except that a Class B share has 1/200th of the voting rights of a Class A share (rather than 1/30th of the vote). Each share of a Class A common stock is convertible at any time, at the holder’s option, into 30 shares of Class B common stock. This conversion privilege does not extend in the opposite direction. That is, holders of Class B shares are not able to convert them into Class A shares. Both Class A & B shareholders are entitled to attend the Berkshire Hathaway Annual Meeting which is held the first Saturday in May.

The Relative Prices of Berkshire Class A and Class B Stock

The Class B can never sell for anything more than a tiny fraction above 1/30th of the price of A. When it rises above 1/30th, arbitrage takes place in which someone ¾ perhaps the NYSE specialist ¾ buys the A and converts it into B. This pushes the prices back into a 1:30 ratio.

On the other hand, the B can sell for less than 1/30th the price of the A since conversion doesn’t go in the reverse direction. All of this was spelled out in the prospectus that accompanied the issuance of the Class B.

When there is more demand for the B (relative to supply) than for the A, the B will sell at roughly 1/30th of the price of A. When there’s a lesser demand, it will fall to a discount.

In my opinion, most of the time, the demand for the B will be such that it will trade at about 1/30th of the price of the A. However, from time to time, a different supply-demand situation will prevail and the B will sell at some discount. In my opinion, again, when the B is at a discount of more than say, 2%, it offers a better buy than the A. When the two are at parity, however, anyone wishing to buy 30 or more B should consider buying A instead.