Description

Heico common to class A spread…  (HEI minus HEI/A)

With the market acting too funky to happily take market risk, take a look at the $26.21 spread between Heico common at $133.25 and Class A shares at $107.04 (pricing as of July 1):

The only legal difference between the two classes of shares is voting rights.  With the common at normal voting of 1 vote per share, and the Class A at 0.1 vote per share.  Both get the same dividends, and the same treatment in a sale of the company. The spread can be expressed by shorting HEI and buying HEI/A on a 1:1 ratio. Both trade with good borrow availability at general collateral rates.

Historically the Class A shares were created in a warrant conversion in April 1998, as a tool to lessen voting dilution on merger consideration (rather than as founders shares to keep control, which is a difference from most dual stock class companies).  This happened at a time when the company had already been public for decades and was initially a class A stock dividend to existing holders in conjunction with a 3 for 2 stock split.  Today the Class A has the larger portion of total shares outstanding since it’s been utilized from time to time to pay for acquisitions.  

Because Heico is a frequent acquirer of tuck-in businesses, having made a great many small-ish acquisitions over time, such Class A use as an acquisition currency distinguishes these A shares from other similar issuances in the marketplace.  Most others consistently trade at tight spreads and generally are long-term parked shares that entrench management or founders.  In contrast, the currency aspect of these A shares creates trading when acquirees decide to exit.  Daily average trading volume of 286k class A shares provides liquidity at ~86% of par with the common shares.  This amount of trading is vastly different from most other vote impaired or super voting issuances, which often trade only a few thousand shares daily.  In addition, it is unusual for such shares to comprise a nearly equal portion of the market cap compared to the common.

For many years, the Mendelson family has very ably run this company, and insiders own 17.63% of the common and 1.45% of the Class A shares. Interestingly, issuances of stock as compensation, and insider buys have historically been in both classes, indicating no fear from insiders of impartial treatment.

For our non-market risk purposes, we can keep the descriptive info to a minimum.  Heico primarily makes aircraft engine parts and electronic avionic components for airlines, defense contractors and military agencies.  With a worldwide business that has ~65% of sales in the US, they are a major aftermarket parts supplier to the aircraft industry.

Below are graphs of the spread in dollar amount over time, followed by % of Common Stock price.  Note that the dollar spread got even larger for a brief period beginning in Q2 2019.  However, this coincided with the stock moving up nearly vertically during the initial stage of the 737-Max tragedy which attracted a whole new group of holders into aircraft aftermarket investments, and the spread disappeared just as quickly when covid hit.  There may also be an upward bias to the spread over time due to the rapid growth of the ETF space over the past decade.

Historically, the spread has opened wider as a % for brief periods such as in times of high market stress (like now) and always promptly disappeared.  

The spread is also subject to the temporary selling pressures of the former owners of acquired companies, who might be in a risk-off or delevering mode when there is major price action. This works when the stock is moving both upwards such as in 2019, and downwards such as in 2011 (and now). 

This common minus class A situation provides some market insulation with base-hit upside, as part of a portfolio trying to adjust to a risk-off world.  I’m seeking a spread reduction from $26 to ~$10. 

Catalyst

- Reversion to the mean spread by a calming of markets and sellers finishing risk-off or delevering transactions.

- A company sale would collapse the spread at closing.