U P D A T E
Since Monday morning the “A” Share / “B” Share spread has fallen from $2.40 to $1.54. This decline is indeed significant, but anything lesser would also have yielded an infinite return on capital.
The author of a recent TheStreet.com column suggests purchasing one “B” Share for every “A” Share sold short. This would generate a large loss if Mueller Water were to advance, regardless of whether the spread narrows. (Consider what would happen if MWA and MWA.B were to double from their current quotes.) The correct procedure is to purchase and short sell an equivalent dollar amount of both classes.
T H E S I S
Mueller Water “B” Shares are roughly 30% cheaper than the comparable “A” Shares. This spread—almost historically high—may have resulted from forced selling by arbitrageurs. Of course the impersonality of the securities market makes it difficult to identify causation in such a case.
“In your investing life you will have one or two opportunities that can’t go wrong. For example, in 1998 the New York Fed offered a 30-year Treasury bond yielding less than the 29-½ year Treasury bonds by 30 basis points. LTCM put a trade on at 10 basis points and it was a crowded trade; they were 100% certain to make money but they could not afford any hiccups. I know more about human nature; these were MIT grads, really smart guys, and they almost toppled the system with their highly leveraged trading. This was definitely a good time to act.”
-Warren Buffett
What degrees of sucess did everyone(anyone) have in borrowing the A shares? I was unable to get a borrow at Schwab, but had better luck at DB. I am not sure why Schwab couldn’t have gotten the borrow from DB, but that was my experience. Anyone else?
It probably has to do with the in-house supply of marginable shares available for borrowing. Perhaps DB just happened to have more available than Schwab. Not everyone has a margin account.