Overview: The Grupo Prisa convertible non-voting B shares are a superior security to the A shares but trade at no premium. I think the B shares deserve at least a 20% premium and currently offer an attractive relative valuation.

Note: While the share price in the header represents the ADR price, all other figures represent the Spanish listed stock quoted in Euros.

Grupo Prisa SA is a Spanish media conglomerate that operates TV stations, radio stations, and publishes various education material, magazines, and newspapers. The B shares were required as a result of Prisa's acquisition of Liberty Acquisition Holdings, a SPAC, in December 2010. The SPAC purchase brought in €650M in cash and was completed as part of Prisa's plan to delever after it had taken on a heavy debt load (~8x EBITDA) in order to finance numerous acquisitions. As a result of the SPAC acquisition, some recent sales of minority stakes of various businesses, and a debt refinancing, Prisa dramatically improved its balance sheet but is still a highly levered company (~4.3x EBITDA before B share dividends).

Prisa equity has the opportunity to appreciate if advertising spending rebounds from the recession, Prisa succeeds at its effort to expand to other Spanish area markets like the Americas, and as the company continues to delever. But substantial downside still exists as the business is generally in secular decline and its balance sheet does not leave the company with much room for error. I think the business is about fairly valued at these levels but the common A share price could move dramatically in either direction as a consequence of the high leverage. I think the A/B share relative value discrepancy is more interesting than just going long the B shares at the current valuation of Prisa (€2.24/~7.75 EV/EBITDA) so I not going to focus on the company here, but investors with a positive view of Grupo Prisa will likely find the B shares an attractive absolute value as well.

Security Description:

Both the PRIS (A shares) and PRIS-B shares represent 4 shares of the Spanish listed stock. Each underlying B share receives a yearly minimum dividend of €.175, for a total of €.70 to the ADR. The dividend will be a yearly payment paid most likely in early July after the annual meeting. The dividend will be paid for the preceding fiscal year, so this July's dividend will be only €.06/ADR (B shares only existed 1/12 of the year). The B shares are also entitled to receive any dividends paid to the A shares, although I don't expect there to be any. Any A share dividend would not be payable until the B share dividends have been paid in full. The B share dividends are cumulative. The B shares can be converted into A shares on a one-to-one basis at the end of each month, and will be automatically converted into A shares around May 2014. The B shares will retain the right to the 2013 dividend and the accrued 2014 partial year dividend after their mandatory conversion.

The B shares are non-voting but receive equivalent A share voting rights during any period that the minimum dividend is not fully paid. Any amendment of the bylaws of Prisa that affects the rights of the B shares must be approved by resolution of a majority of the convertible B shares voting as a separate class.

The B shares also offer additional protection upon their automatic conversion where the 1-1 A to B share exchange ratio is adjusted in order for the B shares to receive €2 (€8 to ADR) in value, subject to a maximum of a 1.33-1 ratio. This means that if the A share price falls below €1.50, B shares will receive a maximum of 1.33 A shares. B share dividends can be paid from distributable profits (roughly equivalent to net income) or from premium reserves in an event of a shortfall of distributable profits. In the event of a company liquidation, the B shares receive any cumulative unpaid dividends, the remaining premium reserve, and proceeds up to the stated value of the B shares before any distribution is made to the A shares. While Prisa will not have a very good coverage ratio for the dividends (~2), with an estimated premium reserve of €1.47/ADR, the dividends should be able to be fully paid between the sources of net income and the premium reserve.  

It is a hard to imagine a scenario in which the B shares are not worth at least a modest premium to the A shares. The B shares have a higher yield and greater downside protection. Trading volume is similar for both securities. The only real negative of the B shares is that they are non-voting, but this shouldn't require any real discount as 1) the shares can be converted into A shares monthly and 2) the company is effectively controlled by the Moreno family anyway, who have around 35% stake in the A shares and chair the board.

Valuation

I think the premium the B shares deserve to trade at should be calculated as the present value of the dividends plus some value for the protected downside based on the probability of the A shares falling below €2. I think the premium should be between 20-30%. Below is a list of the present value of the dividends based on various discount rates:

While there are no catalysts for the justified premium to develop, the valuation will correct itself over time as the B share dividends are paid and the B shares are automatically converted into A shares in mid 2014. And the spread won't go negative or you could just convert your B shares into A shares for an easy profit every month.

Below is a list of the possible scenarios that could happen to the PRS.MC shares and the resulting relative difference between the A/B share ADRs. In the worst case, profitability declines, and the debt load forces the company to liquidate with no value remaining for either equity share class. In this highly unlikely scenario, the pair trade gains by only the interim dividends received before liquidation, which I estimated to be 2 years of full dividends. The best case scenario would be for PRS.MC to be right around the maximum conversion ratio of €1.50 in 2014, allowing for the B share differential to profit from the downside protection offered by the adjusted exchange ratio. In any case, the pair trade should be profitable.