There are a lot of things in this world that just don’t make sense to me. Add to that very long list the relative prices of Blockbuster’s two classes of stock - the A (BBI) and B (BBI.B) shares. According to the Blockbuster Web site the B shares each have two votes vs. the A shares’ one vote. Otherwise, “there is no difference between the two classes except for voting rights”. Yet, the A shares closed at a 33% premium to the B shares yesterday. Go figure.
So I did some poking around to find out why this is and I came up pretty much dry. Some people talk about the greater liquidity of the A shares but the B volume is adequate at 234,000 per day for the typical retail investor and the spreads are no worse than the A shares. Therefore, you would expect the retail investors to jump all over the B shares and even the institutional guys could make some pocket change. Hmmm. Maybe there’s a stigma attached to something labeled B as opposed to A?
Of course, if you want to take advantage of something like this you need to have some reason to believe that the discrepancy will close in a reasonable timeframe. So I checked the historic premium between these two stocks and found that indeed the premium appears to be at an all time high.
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But notice that some premium has always existed. So, while the premium might dissipate over time it probably won’t go away entirely - unless of course Blockbuster goes bankrupt, which is a distinct possibility, given the industry changes that Blockbuster needs to get in front of.
However, as I was trying to figure out what drove the premium up I noticed that the increase in the premium pretty much coincided with the drop in Blockbuster’s stock price. In other words, it appeared that the premium might have actually been fairly constant in dollar terms but increasing in percentage terms as the denominator of the equation dropped. So I reran the premium in dollar terms.
Notice that the premium has fluctuated around $.30 - $.50 for the last 4 years and as of yesterday it closed at $.64, which is a bit high historically but not that much higher than it’s been in the past. So the dollar premium has not really fluctuated that much.
This has profound implications for the way one executes an arbitrage strategy on this company. If you buy and sell equal dollar amounts of the two stocks you will end up with more B shares than your short position in the A shares. This will work to your advantage if the percent premium returns to earth. However, in the event that the stocks continue their downward slide and the percent premium continues to increase you will get burned with this approach. For instance, suppose each class of stock declines by $1.00? In that case you will lose more on the B shares than you gain on the A shares.
I decided the better approach was to buy and sell an equal number of shares. This way the worst thing that could happen to me is that the current dollar premium persists and has no impact on my position. If the dollar premium drops then I will gain on every pair of shares I’m short and long. For instance, if Blockbuster stock goes to zero I’ll make $.64 per share or 33% on the value of my long position.
Of course, there’s other twist here. The A shares are difficult to short. Fidelity could have found me some but would have charged me 2.5 - 6.5% per year, which is not bad. However, I was able to short them through Interactive Brokers without, so I am told, any borrowing fee being charged. We’ll see.
But what about all those retail investors who own the A shares? Why don’t they just own the same dollar value of B shares instead? Clearly, they are bullish on the company. If the spread closes they will make more money than they would on the A shares. Even if the spread does not close they will make more money as the A shares and B shares move up in tandem, with the B shares increasing by a greater percentage from a smaller base.
I just don’t get it. If anyone out there can shed some light on this please help make my world less irrational.
Disclosure: Long: BBI.B, short BBI