Thursday, March 26, 2009

The Berkshire Arbitrage--Over

At least for now, the Berkshire arbitrage we posted about back in February is over. We linked to Felix Salmon blogging about it, back then, and we will link to someone else discussing the issue now.

Ravi Nagarajan, at Rational Walk, has an excellent post on the movement in Berkshire A and B stock over the past month. This is a blog to keep an eye on for sure.

An excerpt of his thinking at the start on the arbitrage that's gone au revoir follows:

Based on my research, on February 20, a record high spread developed between Class A and Class B shares. On that day at the close of trading, it was possible to purchase 32.26 B shares for the same price as a single A share. Any A shareholder was free to sell a single A share and purchase 32 B shares plus pocket the change represented by the fractional 0.26 B share.

By doing so, the A shareholder would effectively increase his economic interest in the company by 7.53% (including the retention of the cash equivalent of the fractional share).

Granted, the A shareholder would now only have a fraction of his prior voting rights, but that appears to be the only downside, aside from potential tax implications related to the A sale which could be significant. A long position would be maintained with significant addition to the shareholder’s economic position.

It would also have been possible to make a move that would not bet on the direction of Berkshire’s stock price but only on the eventual narrowing of the historically wide A/B spread. By shorting one A and purchasing 30 Bs, an investor could effectively bet on an eventual closing of the historic spread.

Regardless of the direction in which Berkshire shares trade, the investor could profit when the spread returns to more typical levels. At that time, the A share would be repurchased with the proceeds of selling the 30 B shares. The main risk here would be if the spread widens further and does not narrow again in the future.

For the rest, including a comment on efficient market theory, click here.

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