To Our Shareholders,
For the quarter ended March 31, 2014, the net asset value ("NAV") per Class A Share of The Gabelli Value 25 Fund Inc. decreased 1.4% compared with an increase of 1.8% and a decrease of 0.2% for the Standard & Poor's ("S&P") 500 Index and the Dow Jones Industrial Average, respectively. See page 2 for additional performance information.
An Unchanged Process in an Ever-Changing World
Stocks rose modestly in the first quarter of 2014, despite the largely negative geopolitical and macroeconomic events that dominated the headlines.
The long term implications of the Russian Federation's annexation of Crimea are still yet to be determined. Will Russia make a similar move in other provinces in Ukraine or attempt to reclaim other parts of the former Soviet Union that are now independent countries? What will be the economic impact to Russia and its main trading partners? The short term effect has been for the Russian stock market to decline 9%, along with a 6% decline in the Russian ruble.
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- WFT 15-Year Financial Data
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Other emerging market currencies also fell in the first quarter, most notably the Venezuelan bolivar, which underwent a massive "stealth" devaluation when the embattled government introduced a secondary currency exchange market known as SICAD II; the Argentine peso (–18%) and the Brazilian real (–4%) also declined during the quarter. U.S. based multinationals with significant operations in these markets will have a headwind to reported results this year, as profits in these countries must be translated back into U.S. dollars at a lower exchange rate. We also are watching developments in other important markets closely, including China dealing with a slightly slower but perhaps more sustainable growth rate and Japan continuing its attempt to re-inflate under the leadership of Prime Minister Shinzo Abe and Governor of the Bank of Japan Haruhiko Kuroda.
Back in the U.S., the economy continues to expand – albeit slowly. GDP growth was 2.6% in the fourth quarter of 2013, and unemployment held relatively steady at 6.7% at the end of March 2014. Much of the country experienced nearly unprecedented cold temperatures, as well as several severe snowstorms, for much of the first quarter. While the reduced consumer spending and cancelled travel that resulted may have an impact on first quarter earnings, we expect that most expenditures will ultimately be delayed rather than eliminated altogether.
Janet Yellen was sworn in as Chair of the Board of Governors of the Federal Reserve System during the quarter. While we expect Ms. Yellen to continue most of the policies of her predecessor, we note that she also seems committed to continuing the so-called "taper," as the pace of open market asset purchases was reduced to $55 billion per month starting in April, from $85 billion in December 2013. This gradual withdrawal of stimulus has not led to a decline in asset prices – yet.
Deals, Deals, and More Deals
On a positive note, deal-making activity increased substantially during the first quarter, with worldwide mergers and acquisitions (M&A) value growing 36%, net of competing bids, to $756 billion. Within these figures, we note that cross border transactions were up 86% to $245 billion. We believe that we will see more of these kinds of transactions as the "Fifth Wave" of takeover activity since World War II continues to build momentum.
In January, Fund holding Beam, Inc. (2.4% of net assets as of March 31, 2014) agreed to be acquired by Suntory Holdings, a leading Japanese beverage company, for $83.50 per share in cash. The deal price was a 25% premium to BEAM's $67 closing price and represents just over 18x our 2014 EBITDA estimate of approximately $850 million. While the multiple is fairly full, it is consistent with our estimate of Private Market Value, and we believe it is appropriate for a high quality asset such as Beam, with great brands, margins, growth prospects, pricing power, and distribution. The transaction is expected to close in the second quarter. Two media holdings were also the subject of M&A during the first quarter. After being pursued through most of 2013 by Charter Communications, Time Warner Cable (0.3%) agreed to be acquired by Comcast (0.9%) in an all stock transaction. The combined company would serve over 30% of all U.S. pay-television households and thus has drawn close regulatory scrutiny. We believe the odds favor a Comcast closing on current terms early in 2015. Another bidding war took place across the Atlantic, as French media and telecom conglomerate Vivendi (1.2%) auctioned its wireless subsidiary, SFR. Cable entity Numericable and wireless competitor Bouygues submitted competing proposals; in April, Vivendi chose to move forward with Numericable, allowing Vivendi to continue its transition to a pure content company and providing it with significant excess capital, which we expect will be returned to shareholders.
With extremely attractive financing available to acquirers, we expect deal activity to continue to increase over time, albeit not in a linear fashion.
Let's Talk Stocks
The following are stock specifics on selected holdings of the Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the percentage of net assets and their share prices are presented as of March 31, 2014.
American Express Co. (2.5% of net assets as of March 31, 2014) (NYSE:AXP)(AXP - $90.03 - NYSE) is the largest closed loop credit card company in the world. The company operates its eponymous premiere branded payment network and lends to its largely affluent customer base. American Express has 107 million cards in force and over $67 billion in loans, while its customers charged nearly $950 billion of spending on their cards in 2013. The company's strong consumer brand has allowed American Express to enter the deposit gathering market as an alternate source of funding, while the company's affluent customers have picked up spending. Longer term, American Express should capitalize on its higher spending customer base and continue to expand into other payment related businesses like corporate purchasing, while also growing in emerging markets. Similarly, the company is looking at the growing success of social media as an opportunity to expand its product base and payment options.
The Bank of New York Mellon Corp. (1.0%) (NYSE:BK)(BK - $35.29 - NYSE) is a global leader in providing financial services to institutions and individuals. The company operates in over one hundred markets worldwide and strives to be the global provider of choice for investment management and investment services. As of December 31, 2013, the firm had $27.6 trillion in assets under custody and $1.6 trillion in assets under management. Going forward, we expect BNY Mellon to benefit from rising global incomes and the cross border movement of financial transactions.
CBS Corp. (4.4%) (NYSE:CBS)(CBS - $61.89 - NYSE) operates the CBS television network and the premium cable network Showtime, owns 29 local television stations and 130 radio stations, and is the third largest international outdoor advertising network. We believe CBS has a number of opportunities to generate incremental non-advertising revenue from the sale of existing content to online video distributors (OVDs) and the retransmission of content agreements with traditional distributors. In addition, we expect a continued recovery in advertising to contribute to earnings growth. Finally, we believe financial engineering, including the announced $3 billion share buyback and the expected split-off and REIT conversion of CBS Outdoor, could act as a catalyst for shares.
CST Brands Inc. (0.4%) (CST - $31.24 - NYSE), headquartered in San Antonio, Texas, is one of the largest independent convenience store operators in North America, with 1,900 stores located in nine U.S. midwest states and Canada. The company was spun-off by Valero on May 1, 2013. CST's store-base is concentrated in markets with above average population growth; 849 of the 1,034 total U.S. stores are located in three states with projected cumulative population growth of over 15% over the next decade: Texas (628), Colorado (158) and Arizona (63). CST owns the majority of its real estate, which mitigates lease risk and should provide downside protection. We estimate the real estate to be worth in the range of $1.5 billion to $2 billion or ~$20 to $26 per CST share. CST has generated $12.8 billion in revenue and $366 million of EBITDA during 2013.
Diageo plc (2.4%) (NYSE:DEO)(DEO - $124.59 - NYSE) is the leading global producer of alcoholic beverages, with brands including Smirnoff, Johnny Walker, Ketel One, Captain Morgan, Crown Royal, J&B, Baileys, Tanqueray, and Guinness. The company has a balanced geographic presence in both mature and emerging markets, and it benefits from the trend of consumers around the world trading up to premium brand products. In 2011 and 2012, Diageo made several acquisitions that enhanced its presence in emerging markets: Mey Icki, the leading spirits company in Turkey; Shui Jing Fang, a leading Chinese baiju producer; Ypioca, the leading cachaca producer in Brazil; and an increased stake in Halico, the leading domestic spirits producer in Vietnam. Diageo also made an investment in United Spirits, the leading spirits producer in India, which will provide the company with the leading position in another fast-growing emerging market. Longtime executive Ivan Menezes took over as CEO on July 1, 2013, and we expect him to continue to drive the company's growth in both mature and emerging markets.
DISH Network Corp. (1.2%) (NASDAQ:DISH)(DISH - $62.21 - NASDAQ) is the third largest pay television provider in the U.S., with approximately 14 million subscribers. As a satellite operator unburdened by local franchising requirements and wired plants, DISH can market and deliver video extremely efficiently across the entire country. As founder of the company, Charlie Ergen owns approximately 53% of the company's shares and lends his strategic vision to its benefit. DISH has accumulated a significant spectrum position at attractive prices and unsuccessfully attempted to enter the mobility market via the acquisition of Sprint. Among the many options available to DISH from here are: acquisition or partnership with another wireless operator, merger with DIRECTV (2.4%), or sale to a larger entity such as AT&T Inc.
Liberty Media Corp. (1.5%) (NASDAQ:LMCA)(LMCA - $130.73 - NASDAQ) is a diversified investment vehicle guided by cable television pioneer John Malone (Chairman) and former Microsoft Corp. (0.2%) CFO Greg Maffei (CEO). The company owns 52% of satellite radio provider Sirius XM, 27% of cable operator Charter Communications, the Atlanta Braves baseball club, and stakes in several other public and private entities. Malone and Maffei have created significant value for shareholders over the past several years as they tax-efficiently distributed, traded, or sold interests in Discovery Communications (1.2%), News Corp (0.4%), Time Warner Inc. (1.1%), DIRECTV, Starz (0.3%), and QVC, among others. Over the last year, Liberty has been focused on new investments and was a key player in Charter's bid for Time Warner Cable (0.3%). To sharpen the focus on these efforts, Liberty announced it would create a tracking stock for its cable investments to be called Liberty Broadband to be issued later in 2014.
The Madison Square Garden Co. (1.9%) (NYSE:MSG)(MSG - $56.78 - NASDAQ) is an integrated sports and media company that owns the MSG networks (MSG/MSG+ and Fuse), the New York Knicks, the New York Rangers, the Radio City Christmas Spectacular, and the iconic New York venue, Madison Square Garden. These evergreen content assets benefit from sustainable barriers to entry and long term secular growth. We believe the now completed Transformation project and the rising value of sports programming will dramatically increase MSG's earnings power through 2015.
Vivendi SA (1.2%) (NYSE:VIV)(VIV - €20.22 - EPA) is a French media and telecommunications holding company in the late stages of a decade long transition. In April 2014, the company announced it had reached an agreement to sell its French wireless operation, SFR, to French cable operator Numericable. Over the last year the company also sold most of its 62% stake in ActivisionBlizzard and reached an agreement to sell its entire 53% stake in Maroc Telecom SA. After closing the SFR sale in early 2015, Vivendi will be a more focused media firm consisting of Canal+ (a Francophone focused pay television network owner and distributor), Universal Music Group (UMG) (the number one recording music company and number two music publishing entity in the world) and GVT (a fast growing Brazilian broadband and pay television provider). We expect GVT to eventually be sold and would not dismiss the possibility of a breakup of Canal+ and UMG. While operating conditions have been challenging in most of Vivendi's businesses, it appears their trajectory is finally turning more positive and should be supported by a healthier balance sheet after the SFR, Activision, and Maroc disposals.
Weatherford International Ltd. (0.4%) (NYSE:WFT)(WFT - $17.36 - NYSE), based in Houston, Texas, finally resolved its tax accounting problems and various government investigations, which had been on-going for several years. It is now focused on growing its core businesses, enhancing profitability, reducing leverage and improving capital efficiency. The company is targeting total segment operating profit margin to reach 20% by 2016 from 11.3% in 2013 and reducing debt to capitalization from 52% to 25%. It aims to realize $500 million in annualized cost savings and sell four non-core businesses. Also, Weatherford plans to spin-off a portion of its international drilling rig business by the end of 2014 or early 2015. All available free cash flow generated and proceeds from asset sales will be used to reduce debt.
Top contributors to performance included Beam, Inc. (+23%), due to the deal previously mentioned; DIRECTV (+11%) and Dish Network (+7%), which were speculated to be in merger discussions; and Hillshire Brands (0.7%) (+12%), the branded meats producer that spun-off from Sara Lee in June 2012. Content owners AMC Networks (2.0%) (+7%) and World Wrestling Entertainment (0.2%) (+75%) (WWE) also benefited from strong ratings and, in the case of WWE, the launch of its internet delivered over-the-top subscription service.
Detractors to performance included Rolls-Royce (2.2%) (–15%), which is suffering from cuts in defense spending; ADT Corp. (0.6%) (–25%), which reported disappointing quarterly results after repurchasing a large amount of stock from an activist shareholder in November 2013; Media General (0.6%) (–19%), which declined along with other pure-play television broadcasters due to potential new FCC regulations that may negatively impact earnings; and Navistar (0.9%) (–11%), which experienced a slower than anticipated recovery in U.S. Medium and Heavy Duty Truck market share.
As we hope you expect, in the face of these external developments and uncertainties, our process remains unchanged. We conduct bottoms-up research on companies and industries in order to uncover undervalued businesses we would be happy to own for many years. Our Private Market Value (PMV) with a Catalyst™ stock selection process identifies potential acquisition targets and likely candidates for financial engineering. Should volatility return and "Mr. Market" provide us with an opportunity, we remain prepared to increase our ownership of businesses that fit these characteristics, as well as invest in new opportunities as they come available.
April 8, 2014
Note: The views expressed in this Shareholder Commentary reflect those of the Portfolio Managers only through the end of the period stated in this Shareholder Commentary. The Portfolio Managers' views are subject to change at any time based on market and other conditions. The information in this Portfolio Managers' Shareholder Commentary represents the opinions of the individual Portfolio Managers and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. Views expressed are those of the Portfolio Managers and may differ from those of other portfolio managers or of the Firm as a whole. This Shareholder Commentary does not constitute an offer of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this Shareholder Commentary has been obtained from sources we believe to be reliable, but cannot be guaranteed.
Minimum Initial Investment – $1,000
The Fund's minimum initial investment for regular accounts is $1,000. There are no subsequent investment minimums. No initial minimum is required for those establishing an Automatic Investment Plan. Additionally, the Fund and other Gabelli/GAMCO Funds are available through the no-transaction fee programs at many major brokerage firms. The Fund imposes a 2% redemption fee on shares sold or exchanged within seven days after the date of purchase. See the prospectus for more details.
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The Gabelli Value 25 Fund began offering additional classes of Fund shares on March 15, 2000. Class AAA are no-load shares available directly through selected broker/dealers. Class A and C Shares are offered to investors who seek advice through financial consultants. Class I Shares are available directly through the Fund's distributor or brokers that have entered into selling agreements specifically with respect to Class I Shares. The Board of Directors determined that expanding the types of Fund shares available through various distribution options will enhance the ability of the Fund to attract additional investors.