Description

Much has already been written about Bel Fuse by starfox02 and LDMR and we don’t have much additional differentiated insight to offer about the fundamentals of the business. The opportunity we want to explore is the valuation disparity between the Class A and Class B shares and recommend a share-for-share long B / short A arbitrage.

Below are some charts that track the historical spread between the Class A and B shares over the last 10 years. As you can see, historically the Class A shares have traded in parity with, or at a slight discount to, the Class B shares. That spread has recently increased to the highest level ever on a $ spread basis.

Fundamentally, there are a few differences between the Class A and B shares:

• Class A is the voting class, and Class B has no vote
• Class B shares have significantly more liquidity and trading volume (~$5.5mm for Class B vs. ~$1.3mm for Class A for daily volume over the last month)
• Class B shares are entitled to dividends at least 5% greater than dividends paid to Class A shares. Functionally, this has translated to Class B dividends being roughly 1 cent higher historically. Excerpt from the 10-K:

A couple potential causes for the valuation gap between the share classes:

• Some investors have a preference (and sometimes a mandate) to buy only the voting shares
  • Anecdotally we have heard that there are some recent buyers that have this preference for buying voting shares. It is notable that one buyer meaningfully increased their position starting in Q1 2024 (according to the latest 13-F filings) and the Class A premium started materializing in late Jan / early Feb. We think it is likely that some of these long-only investors with a voting class preference buying into an illiquid share class had a meaningful impact on prices and drove up the premium.
• The Company started buying back shares in March 2024 under its first-ever $25mm public repurchase authorization. They allocated the share repurchase dollars roughly based on the # of shares outstanding for each. The issue is, the volumes on Class A shares are significantly lower than Class B volumes, so the # of shares the Company repurchased in March and April represented a larger % of Class A volumes than Class B volumes. This likely also put disproportionate buying pressure on Class A shares.
• The Class A shares were included in the Russell preliminary additions list released on May 24^th. Within days, the Class A premium increased from the ~$8-9 range to ~$16-17 per share as folks loaded up on it in anticipation of the scheduled index reconstitution and related ETF buying, which occurred on June 28^th, 2024.
  • The Class B shares have already been part of the Russell since June 2023.

Why we think the valuation gap is likely to converge:

• There is very little fundamental economic difference between the two share classes.
  • There is certainly value that can be ascribed to the voting power, but we believe it does not justify a 30% premium for Class A, especially when the Class A shares contractually earn a ~5% lower dividend than Class B into perpetuity.
• Class B shares have significantly more liquidity and trading volume (~$5.5mm for Class B vs. ~$1.3mm for Class A), and share classes with higher liquidity often trade with a premium.
• The abnormal buying pressure on the Class A shares may subside once investors that have a preference for voting shares reach their target position sizes.
• The last time the valuation disparity between Class A and B widened meaningfully was around mid-year 2021, and it took more than a year to close. However, volumes were much lower, sometimes 0 on certain trading days. Now that the Class A shares trade with ~$1.3mm daily volumes, it is possible to arbitrage for small funds.
• From the latest disclosures in the 10-Q, we can see that the Company essentially stopped repurchasing Class A shares in favor of deploying their repurchase authorization only into Class B shares starting in May/June, indicating a preference to buyback whichever class is cheaper. 
  • Furthermore, the Company confirmed that it may be possible to terminate the current Class A authorization in favor of expanding the authorization for Class B repurchases, if the Board decided to do so. Excerpt from the 10-Q:

Risks:

• There may be other major investors that also prefer the voting shares
• In the event of a market drawdown or poor earnings result, there may be significant deterioration in the company’s valuation, with Class B shares moving down more rapidly due to higher volumes and better price discovery

Catalysts:

• Investors that have a preference for voting shares reach their target position sizes
• The Company continues repurchasing Class B instead of Class A, and renews/increases the authorization for Class B shares once the current program is exhausted.

Disclosures

We currently have a position in Bel Fuse, and may trade or make investment decisions that are inconsistent with the views expressed. We are not obligated to update or revise any information presented herein.

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Catalyst

Investors that have a preference for voting shares reach their target position sizes.

The Company continues repurchasing Class B instead of Class A, and renews/increases the authorization for Class B shares once the current program is exhausted.