The SunPower Conundrum

CNN has just published this article on the share classes of SunPower, a prominent solar power equipment manufacterer.

I haven't looked at alternative energy shares in a long time, as last time I did, they had valuations that looked like dotcom stocks during the Dotcom Boom. Now, no doubt, they're cheaper now, but in the meantime, other assets have become appallingly cheap, so I still haven't bothered to research them. Granted, I do believe (well, sincerely hope) that this industry will save us from fossil fuels.

However, in this case, it's not a question of investment. It's a question of arbitrage opportunity. (From time to time, I'm apt to digress momentarily from my central concern in this blog, which is IRA performance, in order to highlight an important investment concept. This is one such case.)

As the article states: "Class B shares are identical to class A, except they have eight times the voting power. Both are liquid. Which ought to be worth more?" Clearly, all else being equal, the Class B shares should be worth more.

The bizarrity is that Class B has been trading for a few percent less since last October, as you can see in this chart. In my opinion, this is stark evidence against the Efficient Market Hypothesis. In a fatal bankruptcy situation, in which the only value to the stock is voting power itself, then we would expect SPWRB to trade for 8X SPWRA. Indeed, if a proxy fight ensued tomorrow, we might expect SPWRB to leap relative to SPWRA. Instead, at the moment, it is debased to subparity with SPRWA.

While I have no idea how this occurred to begin with, other than through market inefficiency, the phenomenon now exists. So now the question is, how can we, as responsibly greedy market participants, fix the problem?

The obvious thing to do is to short sell SPWRA and buy SPWRB. That way, regardless of the financial success of the company, we should make money. In fact, we should make money no later than 2010, which is when, according to the CNN article, the company hopes to combine the shares (and presumably pay some sort of dividend to SPWRB owners in order to compensate for the loss of their extra voting rights). Even if the shares are never combined, however, SPWRB should naturally rise above SPWRA.

Ah, but there is no such thing as a free lunch! You see, unfortunately, it costs money to short a stock -- not just the commission. One must pay "short interest", typically equal to margin interest, to the person from whom the shares are borrowed. Worse, there is a risk that at some inconvenient time, the owner will demand the return of the shares. In this event, another willing lender of shares will need to be identified, resulting in a cost in both money and time. Thus there is a risk to the shorting party that the act of maintaining the short for a sufficiently long time will be unprofitable, arbitrage gains notwithstanding.

Of course, one could simply just buy SPWRB and ignore SPWRA. There is little doubt that it will outperform SPWRA in the next few years. However, it may drop in value, nevermind underperform any number of other stocks.

Over time, it would seem that the laws of nature will restore balance to these fraternal assets. In the interim, hold onto your wallet, and perhaps put some solar panels on the roof.