Geoff Gannon April 6, 2007

On the Mueller Mispricing: “A” Shares vs. “B” Shares

Some smart investors see value in Mueller Water Products (MWA). They’re probably right; but, Mueller isn’t the kind of situation that jumps out at me as a clear bargain I can understand. However, there is something peculiar about this situation that makes it worth writing about.

A or B?

There are two shares of Mueller Water Products common stock – Series A common stock and Series B common stock. There are roughly three times as many B shares as A shares. The A shares and B shares have identical economic rights. So, ownership of all of the B shares would provide a roughly 75% economic interest while ownership of all of the A shares would provide a roughly 25% economic interest.

Here’s where things get interesting. “Shares of Series A common stock and Series B common stock generally have identical rights in all material respects except Series B shares have eight votes and each Series A share has one vote per share.”

So, what’s the premium on the B shares? There is none. The last trade on Mueller A shares (MWA) was at $13.98; the last trade on Mueller B shares (MWA.B) was at $13.64. Buyers of the A shares are currently paying $0.34 a share more to reduce their voting power by 87.5%.

You can’t convert A shares into B shares or B shares into A shares. If you could, there would be a profit in simply buying, converting, and selling. Unfortunately, you can’t do that. So, there’s no “manual” arbitrage opportunity here. Obviously, you can bet that the discount on the B shares will be eliminated – but, the market has to close the gap for you.

Regardless, there is a nonsensical discrepancy in price between the A shares and the B shares.

Anyone looking to make a new investment in Mueller should buy the B shares. There’s no reason to even think about touching the A shares until they are trading at a discount to the B shares.

Owners of Mueller A shares who currently hold those shares in a manner that would cost them less than $0.34 a share to sell should immediately begin selling their A shares and putting the proceeds into the B shares. Doing so would slightly increase their economic interest in Mueller’s business (because they would end up with more shares), greatly increase their voting power – and, over the long-term, possibly provide additional appreciation in the share price, if and when the B shares consistently trade at a premium to the A shares.

Do the B shares have to trade at a premium to the A shares? Technically – no. But, in the future, it’s possible that circumstances may make the B shares far more attractive to certain investors. The A shares are extremely unattractive to any large shareholder who isn’t committed to complete passivity as nearly 96% of the votes are tied to the B shares – the A shares are essentially non-voting shares.

Furthermore, there are fewer A shares, so it would be more difficult for a large investor to acquire a meaningful economic interest via the A shares without moving the price of those shares.

While some investors might have very good reasons for buying the B shares when they trade at a higher price than the A shares – no one has a good reason for buying the A shares when they trade at a higher price than the B shares.

Right now, the choice seems simple – dump the A shares; buy the B shares.