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I follow special situations in my Rising Star Portfolio. And here's one that could make you free money. It's an arbitrage of the two share classes of Grupo PRISA (NYSE: PRIS ) (NYSE: PRIS-B ) , a Spanish media company based in Madrid.
Late last year, the company underwent a special transaction that provided a $870 million cash infusion. As part of the deal, two classes of PRISA shares were listed on the New York Stock Exchange. Class A is your garden-variety stock; Class B is more interesting. Those B shares are like the A shares, except that they have no voting rights and offer a 70 cent annual dividend for the next 3.5 years, or $2.45 per share total. That's a 6% annual yield on an $11 stock. Even better, the dividends are cumulative, so the company will pay out unless it goes bankrupt. At the end of the 3.5 years, the B shares become plain old A shares.
Despite this nice dividend, the two share classes have traded at approximately equal values over the past couple weeks. So it appears there's an opportunity to short the Class A and go long the Class B, locking in that dividend with little to no risk. B has even been cheaper than A recently. That's essentially free money.
Arbitrage worked well for investors in Chipotle's (NYSE: CMG ) B shares a couple years ago. The company was organized with two share classes after it was spun off from McDonald's in 2006. Inexplicably, the A shares traded at a premium, until the company announced that the classes would merge. The valuation gap quickly closed, and arbitragers took their profit.
A similar situation happened with Mueller Water (NYSE: MWA ) a few years ago. Walter Industries spun off its ownership interest in Mueller Water and issued B shares, which were similar to the already-existing A shares but had superior voting rights -- 8 times as many votes per share. You might expect that B shares would trade higher, but in fact at one point A shares were traded 22% higher than the better B shares. So there was clear value in the B shares.
A PRISA arbitrage could be played best by professionals who can put a ton of money to work, but like the Chipotle and Mueller Water s ituations, PRISA's B class may be worth buying in its own right and not just as part of a hedged position.
A quick rundown
As I mentioned earlier, PRISA is a Spanish media conglomerate in the fields of education, entertainment, and information. The company owns the leading Spanish newspaper and broadcast TV channel, produces and distributes radio programming, and is a major publisher, too. The company is also the majority owner of Spain's top pay-TV operator and controls nearly one-third of VME, one of the largest networks in the U.S. Hispanic TV market. In short, it has a wealth of media assets.
Those assets attracted T2 Partners, a hedge fund run by Whitney Tilson and Glenn Tongue, but the real deal clincher was the value in the stock. Said their most recent shareholder letter: "We continue to hold because we think the underlying business, with a new, stronger balance sheet, will do well." In fact, PRISA comprised the largest share of their portfolio, as of year-end.
You can see some of the relative valuations in the table below:
|Sirius XM (Nasdaq: SIRI )||11.7||32.9|
|Washington Post (NYSE: WPO )||3.5||7.6|
|Time Warner (NYSE: TWX )||8.4||15.4|
Source: Capital IQ, a division of Standard & Poor's.
Each of these media companies operates in similar spaces to those occupied by PRISA, and you can see the relative disparity of valuation in the price-to-free-cash-flow ratio. The valuation is much narrower by EV/EBITDA multiple, showing that the company is heavily leveraged.
The company got in trouble by acquiring too much in the go-go years, and its leverage ballooned. Net debt reached 8.5 times EBITDA as of September. With the cash infusion above and the company's commitment to use its strong cash generation to reduce debt, one Citigroup analyst predicts that ratio will come down to a much more reasonable 3.5 by the end of the year. The company's deleveraging will act as a great catalyst for the share price.
Better still, the Spanish ad market for TV and newspaper is stabilizing, although it's still in a tough spot. While Spanish ad spending declined 23% in 2009 and was down again in 2010, it's predicted to be roughly level year over year in 2011. Even if this situation does remain soft, PRISA's dominant position means it gains a relative advantage over peers.
Foolish bottom line
While a long-short trade on PRISA's A and B shares looks like a free money situation, it may ultimately be more profitable to go long the B shares. Add in a tasty dividend and this deleveraging story looks quite interesting.
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