WILL BERKSHIRE POP FRIDAY UPON JOINING S&P500 ? / BARRON´S ( RECOMMENDED READING )

MONDAY, FEBRUARY 8, 2010

Will Berkshire Pop Friday Upon Joining Standard and Poor 500?

By ANDREW BARY

The addition of Warren Buffett's company to the index is prompting a big Wall Street guessing game.

ONE OF THE BIGGEST GUESSING GAMES on Wall Street is whether Berkshire Hathaway (ticker: BRKA) shares will rise sharply at the close of trading on Friday, the final trading session before the company is added to the Standard & Poor's 500 index. Berkshire (BRKB) joins the index on Tuesday, Feb. 16 (the markets are closed for a holiday on Monday, Feb. 15).

Berkshire's class B shares already have moved up nicely, rising to over $74 from $68 on Jan. 26, the date that S&P surprised the Street by announcing that Berkshire at long last would join the S&P 500. Berkshire shares rose 66 cents to $74.23 Monday, while the company's class A stock was up $1,100 to $111,111.

The potential driver for Berkshire stock is that index funds which track the S&P 500 need to buy an estimated 150 million to 175 million shares of Berkshire's class B shares, or about $12 billion of stock. That's a lot relative to the recently elevated volume in Berkshire's B shares, which are the ones that will be added to the S&P. Daily trading volume lately has been running at about 10 million shares after peaking at almost 20 million shares on Jan. 27.

Traders are wondering whether index buying, which often is concentrated at the close of trading prior to a stock's addition to the S&P 500, will prompt a large upward move at the close of trading on Friday.

The betting now is that Berkshire is apt to rise late Friday, but not dramatically so. There could be an upward move of 3% to 5%, or 2 to 4 points. Again, this is a guess.

Berkshire is going into the S&P 500 to replace Burlington Northern (BNI), the railroad that is due to be purchased by Berkshire on Friday for $100 a share, or $34 billion, in a 60/40 mix of cash and stock.

Berkshire is the largest addition to the S&P in some time. The company now has a market value of about $170 billion, although its weight in the index will be about two thirds of that because of a sizable chunk of the stock is still held by CEO Warren Buffett. Berkshire will have a roughly 1% weight in the index. S&P weights companies by their public float.

Trading volume in Berkshire is up sharply since the company split its B shares 50 for one last month ahead of the Burlington deal. Prior to that, the Berkshire B daily volume was the equivalent of just 2 million shares a day.

There are complicated set of forces that will come to a head late Friday.

Traders are wondering how much of the recent buying of Berkshire's class B shares has been done by hedge funds and others that aim to sell on Friday in an effort to capitalize on the index buying. There's also uncertainty about whether some institutional holders of Berkshire would be willing to part with stock if the shares pop.

Then there is the possibility that the Gates Foundation, which at last reading held 78 million class B shares, will part with a sizable chunk of stock if the price is right. The Gates foundation has been a steady seller of Berkshire stock, stemming from ongoing gifts of Berkshire stock by Buffett.

Then there is uncertainty about how index funds will play the situation. The funds are holders of Burlington shares. Will they tender their shares to Berkshire as part of the takeover offer or wait and unload all their stock late Friday? How much buying of Berkshire stock will they have done prior to Friday?

In a recent note, JP Morgan's risk arbitrage group estimated that S&P index funds may potentially buy 173 million Berkshire B shares. Offsetting this, JP Morgan wrote, is an estimated 15 million to 38 million Berkshire shares that index funds will get for their Burlington stock.

Arbitragers and hedge funds that own Burlington may supply another 10 to 40 million Berkshire B shares. Then there are a potential 85 million Berkshire shares held as an opportunistic investment by those seeking to the profit from Berkshire's inclusion in the S&P 500. JP Morgan wrote. This figure of 85 million is just an estimate.

Some of the recent buying of Berkshire also could have come from institutional investors that now want to hold Berkshire because it will join the S&P. Investors whose performance is measured against the S&P will have incentive to own Berkshire or risk trailing the index if Berkshire outperforms the S&P 500 in the future.

Berkshire said recently that is won't issue stock directly to index funds. Index funds like the SPDR S&P 500 trust (SPY) and the Vanguard 500 index fund control about 10% of the S&P 500 index.

The smart money seems to think that the index buying will overwhelm selling late Friday and drive up Berkshire shares. Anything, of course, could happen, include a surprise drop in the stock. Then there will be second act, which will come Tuesday morning once the index buying dries up. Berkshire could fall back then.

Whatever the outcome, the Berkshire situation will be the most closely watched addition to the S&P 500 in a long time and could produce a dramatic finish to trading activity on Friday.

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