Thesis:

Lennar Corp, the 3rd largest US home builder in the US is offering one of the largest arbitrage opportunities seen this year with the discrepancy in pricing between its two equity class shares.

Class A Share: LEN.A – 167,395,196 shares outstanding, voting rights (1 vote per share)

Class B Share: LEN.B – 32,982,817 shares outstanding, voting rights (10 votes per share)

The perplexing question posed from the information above is: Why are LEN.B shares trading at a discount to LEN.A shares if they are entitled to more control of the corporate structure? Presented in their latest 10-k it is clearly outlined that the two classes of shares have only one significant difference: Class A shares are entitled to one vote per share while Class B shares are entitled to ten votes per share.

Historically LEN.B shares have traded in line with LEN.A shares up until the financial crisis of 2008. The 2008 crash caused a divergence between the two classes opening up a 60% discount on LEN.B to LEN.A. A flight to liquidity was a major theme during this period and with LEN.B trading only 50k shares a day and LEN.A trading 5,500k shares a day there is a certain amount of liquidity that is sacrificed with an investment in LEN.B. The main reason for the reduction in liquidity of LEN.B shares stems from CEO Stuart Miller’s control over 68% of the equity class. Additionally, Miller’s majority stake controls over 46% of the overall votes of the combined class A and B shares.

Post 2008 crash the spread averages out around 20% as the market rallies and investors return to equities. Once the S&P downgraded the US from AAA to AA status in early August there was another flight to liquidity and the spread on LEN.A vs. LEN.B once again widened. With the spread residing in the lower to mid 30’s this is a great opportunity to take advantage of the closure of this gap because the majority of investors are turning their cheeks to Europe and parking their money in US equities. This additional liquidity in US equities should be able to close the unwarranted 33% discount on LEN.B shares. Additionally, management could step in to close the gap between the two securities. They realize there is a major discrepancy between the pricing of the two classes. Management could close the gap by switching their individual holdings from Class A shares to Class B shares since they are long term shareholders and liquidity is not an issue.

Trade:

To capitalize on the closure of this gap one must short LEN.A shares and go long LEN.B. Ultimately, if you are on the lookout for a risk free arbitrage that is extremely worthwhile Lennar is a great opportunity.

Disclosure: The author of this article might have a position in the securities mentioned in the article, or may plan on initiating one.

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