The document summarizes an investment opportunity involving a pair of shares - bearer shares and registered shares - of the Swiss company Swatch Group. Historically, the registered shares had traded at a small premium but now trade at a significant discount to the bearer shares, despite having equal voting rights. The document recommends shorting the bearer shares and going long the registered shares to profit from a reversion of this price difference, arguing the large current spread is unjustified and not explained by liquidity differences. Any decline in the Swatch share price could also catalyze a narrowing of the spread between the two classes. Regression analysis shows the spread is strongly correlated to the share price level.

1. 12/13/2012
Swatch Group has two share classes that trade in Zurich; “Bearer” shares and “Registered” shares. Both
shares have 1 vote each and bearer shares have 5x the economic interest. There are about 4x as many
registered shares outstanding. However, since the controlling family owns 53% of the registered shares
and another large holder owns 9%, the registered shares are significantly less liquid (average daily
volume of the registered shares is about Fr 8M vs. 67M for the bearer shares.). The registered shares
offer greater voting power, but given the Hayek family controls 42% of the votes, its unclear how
valuable voting rights are here.
Otherwise the shares are exactly the same, so any price difference should be determined only by the
differences in voting rights and liquidity.
From 1993 until mid-2009 the registered shares traded at a slight premium to the bearer shares
implying that the market ascribed a small value to the additional voting rights offered by the registered
shares. However, in mid-2009 this began to change and now the registered shares trade at a significant
discount to the bearer shares. Since there were no changes to the share classes or relative liquidity
profiles, the only explanation for this is that the market suddenly placed a much higher value on the
additional liquidity offered by the bearer shares. The company has no additional explanation for this
discount.
Currently, the spread between the price of a bearer share and 5 registered shares is at an all-time high
of Fr 64 - more than 3.5 standard deviations from the 19-year mean of 2.99. Now, if you purchase the
bearer shares you’re paying 16.0x estimated 2012 earnings for Swatch vs. only 13.7x for the registered
shares. This spread is much greater than any reasonable liquidity premium would justify – especially
since the registered shares are hardly illiquid in an absolute sense. As such, I recommend shorting
Swatch bearer shares and going long the registered shares in order to profit when this spread narrows.
Since this trade involves being both long and short fundamentally identical securities there is no
business or market risk.
Difference between the price of a bearer share and 5x an ordinary share
70
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0
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2. Share price difference vs. liquidity difference
65
55 Ratio of 30 average trading volume
Bearer share price - 5x ordinary share price
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Just as there is no economic justification for this disconnect in the two share classes, there is also no
catalyst for it to reverse. However, it appears that the spread between the share classes is strongly
positively correlated with share price (ie. as the share price rises, the discount of the registered shares
also rises). A simple regression shows a positive correlation with a 99% confidence interval and an r-
squared of 0.722. One possible explanation for this robust relationship is that price movements are
driven by large institutions who require the liquidity provided by the bearer shares. As such, a fall in the
share price could be a catalyst for this discount to narrow.
Share price vs. Registered share discount
85 Bearer share price divided by 5
75 Bearer share price - 5x ordinary share price
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Regression output of bearer share price vs. share class spread
X Variable Line Fit Plot
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Bearer share price - 5x registered shares
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Bearer share price
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Predicted Share Price
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0
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Bearer share price

3. I don’t have a directional view on Swatch shares, however there are any number of factors that could
cause shares to fall. Swiss watches are highly discretionary purchases, so Swatch is obviously exposed to
global consumer health. Furthermore, China accounts for about 40% of Swatch’s sales (and likely a
higher % of profits), so anything that impacts the Chinese consumer or discourages “gifts” in China (see
article below) would clearly impact the company.
http://www.nytimes.com/2012/09/25/business/global/as-beijing-clamps-down-on-gift-giving-luxury-
goods-losing-their-appeal.html
Of course, shares could continue to rise. However, since Swatch pays a divided the yield spread between
the two classes should prevent price spread from widening much more. As such, its hard for me to
envision a situation in which this position results in a permanent loss of capital.
Despite minimal risks, the potential upside is significant. For example, if the share class relationship
were to return to its 19-year average, the return would be almost 16%. While if the spread went to 30 –
the level it touched during the last market downturn in late-2011 the return would be about 9%. The
potential returns at various spreads are shown below:
If spread goes to… … Profit as % of Long capital
Fr 0 16.5%
Fr 10 13.9%
Fr 20 11.3%
Fr 30 8.7%
Fr 40 6.1%
Fr 50 3.5%
Fr 2.99 (19-year avg) 15.7%