Description

We believe that we have identified a sizeable illogical dual class stock dislocation.  This write up will be short and to the point since the arbitrage opportunity involves no fundamental company business analysis.  It is simply a bet on the narrowing and eventually reversal of the spread between two classes of stock.  

THE ARBITRAGE OPPORTUNITY

SunPower, a solar products manufacturer/distributor, has two classes of common stock that trade on the Nasdaq - SPWRA and SPWRB.  Both the shares have equal rights to the dividends and rank equal in priority at the time of liquidation. The only qualitative difference between the two classes of stock is that the B shares have 8 votes/share while the A's have only 1 vote/share.  Other than that these two classes of shares are identical.  The B shares (42 million) trade at $24.76 while the A's (44 million) trade at $27.89.  The shares with the fewer voting rights trade at a premium of 11.2%, which seems completely illogical. Over time, we expect that this spread will narrow down and eventually the B shares should actually trade at a premium to the A, not the reverse.  We recommend shorting the A shares and going long the B.

POSSIBLE EXPLANATIONS

We have spoken to numerous analysts as well as the company to inquire about the share price difference.  The equity analysts we have spoken to in general find the dislocation vaguely interesting but are not overly focused on the arbitrage and instead concentrate on the fundamentals of the business.  Sensibly, those that recommend owning SunPower suggest the B shares over the A.  Some of the chatter regarding explanations for this dislocation in the two classes include:

Explanation 1:

• The A shares are expensive and hard to borrow. This is partially true. There is a negative rebate on the shares; yet at levels of at least 1 million shares (we did not check for a higher amount) shares are borrowable.

Explanation 2:

• The B shares are the byproduct of the spinoff of Cypress Semiconductor's ownership in SunPower. The theory is that the spinoff led to heavy selling by investors not interested in holding the pure play solar stock. This may have happened to some extent; however, the spinoff occurred on September 29^th so this effect should presumably have played itself out already. We have examined the SEC filings to determine the turnover of the larger shareholders which is displayed in the appendix. There has been some selling and also some new positions established. Our view is that to the degree this effect is still playing out it is favorable to the thesis since over time it should reverse.

Explanation 3:

• The B share price is a byproduct of the unwinding of a popular stub trade that created ownership in Cypress Semiconductor for essentially nothing. This trade has been written up on VIC a few times and called for a long position on CY and a short position on the then CY-owned SPWR which accounted for almost all of the market cap of CY. The shares shorted in this trade were the A shares. The unwinding of this trade would call for the reverse which should, in theory drive the price of the A shares up disproportionately. The short interest on the A shares is currently 9.3 million (21.2% of shares outstanding) which has come down significantly over time (see Table 1 in appendix) lending credibility to the hypothesis. Similarly to Explanation 2, this idea is plausible and favorable upon its reversal, although plenty of time has passed for the effect to play out.

Explanation 4:

• Insiders own a disproportionate level of B shares suggesting they a) control the company and therefore are able to control execution of any measures to narrow the gap, b) are unlikely to approve any measures such as the dissolution of 2 classes into 1 which would reduce their voting rights. This would cause the B shares to trade at a discount to the A. The bottom line is that insiders do own B shares but not a huge amount. They also own A shares though again, a relatively small amount. Thus insiders don't control the vote. See the appendix for insider ownership information.

Explanation 5:

• Collapsing the dual classes into one constitutes a recapitalization of the B class which would jeopardize the tax free status of the B share spinoff (according to section 355 of the tax code) and create a $1.5 billion SunPower liability. This limitation lasts for two years. While true, the company is actively pursuing an "early release" waiver from the IRS on this limitation. In speaking with SunPower we were referred to the MetLife spinoff of Reinsurance Group of America and the early release grant given to RGA by the IRS as an example of what they are targeting.

COMPANY COMMENTARY

Since the B shares started trading on September 31, 2008 the company has held one formal earnings call (on January 29^th 2009).  One caller (Morgan Stanley) asked whether the company was "making any progress with the IRS on possibly collapsing the dual share structure ahead of the 2 year time frame window that was previously discussed?" The company responded by saying that they cannot give an update on this but that "to our B shareholders, we take it very seriously, and we are doing the things we can to pursue, to rectify the gap between the two shares, the value gap between the two shares."

When we spoke with the company's IR representative, he primarily focused on the expensive/hard to borrow A share theory as an explanation for the discount, but admitted that the differential was irrational.  He also indicated that he receives "at least 8 calls a day" from class B shareholders inquiring about the discount. 

CONCLUSION

Short the A's and go long the B's in an equal dollar amount and hold until the gap narrows and actually reverses to a level that makes logical sense.

Appendix

Table 1: Monthly Short Interest in Class A Shares

Table 2 (a): Shareholder Turnover of Large Shareholders - A Class

Table 2 (b): Shareholder Turnover of Large Shareholders - B Class

Table 3 (a): Pro forma Ownership of Class A Shares Post Spin Off as of Aug 12, 2008

Table 3 (b): Pro Forma Ownership of Class B Shares Post Spin off as of Aug 12, 2008

• Less than 1%

Catalyst

Narrowing of spread