Description

Thesis

In an environment with few attractive long opportunities, one area for low risk reasonable return opportunities is in share class arbitrage. We recommend investing in the Under Armour share class arbitrage (long 1 UA share short 1 UAA share) as the spread remains wider than other companies that have recently done non voting share splits. Management has been taking proactive measures to tighten the spread with some significant tightening in the spread over the last 4 months. The UA/UAA spread currently at 8% should compress to the 1-3% range of similar situations over the coming months as borrow in UAA has freed up, trading liquidity in UA and UAA is now comparable, and voting rights are functionally worthless since CEO Kevin Plank has super voting shares that give him control.

Background

On June 15, 2015, Under Armour announced plans to create a new share class of non-voting Class C common stock. The new Class C shares would be distributed on a one for one basis for each Class A and Class B share outstanding. The Class C shares would have the same economic value as the Class A (the other publicly traded shares) and Class B shares (super voting shares owned by Kevin Plank that have 10x the voting rights of Class A shares) but have no voting rights.

Under Armour has a provision in its corporate governance documents that the Class B shares would lose their super voting provisions once Kevin Plank owned less than 15% of the total Class A and Class B shares outstanding. We believe that Under Armour did this transaction in order to give Kevin Plank the ability to sell stock without diluting his control of the company and to help the company to continue to issue stock compensation for employees (and stock consideration for acquisitions) without risking Plank losing control of the company in the future.

On October 15, 2015, two days after UA’s COO/CFO announced plans to depart in early 2016 (to become CFO of Blue Apron), Kevin Plank entered into a 10b5-1 plan to sell up to 1,250,000 shares of Class B stock for himself and his foundation. The plan also allowed for the sale of 1,500,000 shares of Class C stock. Under this plan Plank sold 1,062,500 shares of Class A (converted Class B shares) stock in November 2015.

On March 16, 2016 Under Armour finalized the dividend of new Class C “non-voting” stock. Originally the new class C shares were given the ticker “UA.C” and the voting shares of Under

Armour were given the historical ticker of “UA.”

In April 2016, Plank sold 1,000,000 shares of Class C stock under the October 2015 10b5-1 plan.

On June 3rd, Under Armour announced the payment of a $59 million dividend to holders of Class C stock in satisfaction of shareholder litigation related to the creation of the Class C shares. The company distributed 0.007098 Class C shares for each Class C share held.

On September 2, 2016 Kevin Plank entered into a 10b5-1 plan to sell 2.1MM shares of Class C stock (1.9MM for himself personally and 200k shares for his charity) over the next 9 months. Plank currently owns 135k Class A shares, 32.6MM Class B shares and 28.7mm Class C shares. Plank owns 15.9% of the total Class A and Class B shares but given how close this is to the 15% threshold he is unlikely to sell further Class A or Class B shares. This makes him highly motivated in the price of the Class C shares as it is the only way he can continue to monetize his stake in the company while retaining control.

In late November 2016, the spread between UA and UAA stock blew out to 25% on no news.

In response the company on November 28th announced that it was changing the ticker of the Class A voting stock from “UA” to “UAA” and changed the ticker of the Class C non-voting stock to “UA” from “UA.C.” Management also planted an article in the Wall Street Journal highlighting the widened gap between the voting and non voting shares (https://www.wsj.com/articles/a-double-digit-return-is-hiding-in-plain-sight-at-under-armour-1480273380 .) At the time the spread blew out, average daily trading volume of the Class C shares was roughly ¼ the average trading volume of the Class A shares.  

Since the changing of the tickers in early December, liquidity has nearly tripled in the Class C shares, and the spread between the Class A and Class C shares has narrowed to near 8%. The average daily trading volume in the Class C shares is now roughly 75% of the average daily trading volume in the Class A shares. The Class C shares trade 3.5 million shares a day and over $60 million a day, a level of trading liquidity that should not be responsible for the spread remaining as wide as it currently is.

On January 31, 2017 Under Armours CFO Chip Malloy announced he was leaving the company for “personal reasons.” Under Armour currently does not have a permanent CFO.

So what should the spread be

Under Armour is not the only company that has done a non-voting share dividend in recent years. Both Zillow (Z and ZG) and Alphabet (GOOG and GOOGL) have done similar transactions in recent years. While the spread was volatile initially after each share class dividend, the equilibrium for the spread has been 1% at Zillow and roughly 3% at Alphabet. We don’t see any reason why the spread in Under Armour shouldn’t settle in a similar 1-3% range.

As the price of the Class C shares is how Plank gets liquidity for selling down his stock, he appears to be reasonably focused on minimizing the spread between the Class A and Class C shares in order to maximize the value he gets on the sale of his Class C shares.

Catalyst

Management continues to highlight the wide spread between the Class A and Class C shares. Alphabet put a clause in its non-voting shares that if the spread widened beyond 3% for a protracted period of time, the holders of the non-voting shares would get a special share dividend to make them whole. Under Armour could consider a similar structure. With Plank hell bent on retaining control but wanting to sell down his stake, he’s highly motivated to come up with creative ways to tighten the spread and keep the spread reasonably tight.

If Under Armour is ever sold, the Class A and Class C shares would receive the same value and the spread would collapse to 0.

Borrow continues to free up in the Class A shares. In late 2016, borrow rates for the Class A shares were in the high teens. However, since the company’s share price collapsed in response to its Q4 2016 earnings report, the borrow in the A shares has freed up and borrow rates around currently around 3%. If borrow rates go towards 0% the spread should converge toward 0.

Catalyst

Management continues to highlight the wide spread between the Class A and Class C shares. Alphabet put a clause in its non-voting shares that if the spread widened beyond 3% for a protracted period of time, the holders of the non-voting shares would get a special share dividend to make them whole. Under Armour could consider a similar structure. With Plank hell bent on retaining control but wanting to sell down his stake, he’s highly motivated to come up with creative ways to tighten the spread and keep the spread reasonably tight.

If Under Armour is ever sold, the Class A and Class C shares would receive the same value and the spread would collapse to 0.

Borrow continues to free up in the Class A shares. In late 2016, borrow rates for the Class A shares were in the high teens. However, since the company’s share price collapsed in response to its Q4 2016 earnings report, the borrow in the A shares has freed up and borrow rates around currently around 3%. If borrow rates go towards 0% the spread should converge toward 0.