Part 2
Zoetis’ animal healthcare portfolio is highly durable. In 2014, ~80% of Zoetis’ revenue was derived from products that are not patent protected. Rather than rely on patents, which have a finite life, Zoetis’ business is driven by brand, market position, customer relationships and service and other durable factors which have led to long product lifecycles.
One of the most important factors which contribute to the durability of Zoetis’ products is the small size of animal health products. Only about 20 products in the industry have sales exceeding $100 million, with the majority of products having sales significantly below this level. Gross margins of branded animal health products are lower than branded human health products. This combination of smaller products and lower gross margins has made it difficult for generic manufacturers to compete in the animal health market.
We have had a very positive dialogue with the board and management of the company. In February of 2015, Bill Doyle from our investment team joined the Zoetis Board of Directors. We expect the company to add an additional director shortly. We look forward to working with the board and management as along-term shareholder of Zoetis.
The Howard Hughes Corp (HHC, Financial)
A little more than four years ago on November 10, 2010, HHC became a public company in a spinoff from General Growth Properties Inc (GGP, Financial). At the time, there was considerable skepticism about the orphaned development assets that comprised HHC’s asset base. This was reflected in the company’s share price which closed at $36.90 that day. Since its launch as a public company, shareholders have been rewarded with a fourfold increase in the company’s stock price.
In a short period of time, management designed and launched development or monetization plans for each of the company’s assets. HHC continues to create value converting its development-stage assets and vacant land into income-producing real estate and high-rise residential condominiums held for sale. We have not before seen a real estate company accomplish so much in so little time while maintaining superbly high quality execution along the way. Credit for this progress belongs to the extraordinary management team at HHC that is led by CEO David Weinreb and President Grant Herlitz, and a highly shareholder-oriented, real-estate-savvy board of directors.
While the stock declined at the end of 2014 due to concerns about the decline in energy prices and its impact on the Houston assets held by the company, we viewed the market reaction as overdone and temporary. Since the beginning of 2015, the stock price has returned to near its all-time high.
We believe that HHC is well positioned to benefit from the housing recovery, and that over time, the intrinsic value of HHC will be easier for investors to assess as the company’s cash generation from stabilized income-producing assets increases.
Fannie Mae / Federal National Mortgage Assctn Fanni Me (FNMA, Financial) / Freddie Mac / Federal Home Loan Mortgage Corp (FMCC, Financial)
Fannie Mae and Freddie Mac remain a critical piece of the U.S. mortgage market, and we expect will serve as a core driver of the continuing housing recovery. In spite of much rhetoric about the desirability of replacing and shutting down Fannie and Freddie, we believe that there is no credible alternative to replace them. Consumers in the U.S. benefit enormously from the existence of the 30-year, prepayable, fixed-rate mortgage. As a result, we believe that Fannie and Freddie’s role is fundamental to the economy, and that ultimately, a renewed and recapitalized Fannie and Freddie is a far better alternative to any other.
Beginning in 2013, the U.S. Government began stripping all profits from Fannie and Freddie and sending them to the Treasury every quarter, in perpetuity. The Treasury unilaterally amended the 10% dividend rate on its senior preferred stock to a variable dividend equal to 100% of Fannie and Freddie’s future earnings and existing net worth. We view this net worth sweep as an unlawful taking of shareholders’ private property, and brought suit in District Court and in the U.S. Court of Federal Claims on behalf of common and preferred shareholders.
In September 2014, the U.S. District Court for the District of Columbia dismissed shareholder lawsuits seeking to enjoin the net worth sweep undertaking by the government. We believe that much of the U.S. District Court ruling may ultimately be overturned on appeal.
The adverse court ruling resulted in a large decline in Fannie and Freddie’s respective share prices, which we used as an opportunity to purchase additional shares in both companies. We voluntarily withdrew our case in the U.S. District Court and are devoting our legal resources to reversing the federal government’s improper seizure of common shareholders’ property by prosecuting our constitutional takings claims in the U.S. Court of Federal Claims.
In addition to our belief that the net worth sweep constitutes an unlawful taking under the U.S. Constitution, we believe that it is an untenable economic arrangement. By stripping Fannie and Freddie of the earnings that they could otherwise use to build capital, the Treasury is subjecting the U.S. taxpayer to grave risk during the next economic downturn.
We remain convinced that a reformed Fannie and Freddie is the only credible path to preserving widespread access to the 30-year, prepayable, fixed-rate mortgage at a reasonable cost. It is therefore essential that Fannie and Freddie build a sufficient level of capital through the retention of their earnings so they can continue to perform their vital function in the mortgage markets while limiting risk to the U.S. taxpayer. A reformed and well-capitalized Fannie and Freddie will accomplish the important policy objective of providing widespread and affordable access to mortgage credit for millions of Americans while, at the same time, delivering tremendous economic value to the U.S. taxpayer through Treasury’s ownership of warrants on 79.9% of Fannie and Freddie’s common stock.
While we remain confident in the prospects for Fannie and Freddie and believe our investment in their common shares will ultimately be worth a large multiple of current prices, the litigation is likely to continue for a protracted period before being resolved, unless the administration, Treasury, Congress and other interested parties forge a consensual resolution. In light of the inherent uncertainty of the situation, our combined investment in the two companies represents about 3% of our capital at current market values.
Exited positions
During 2014, we exited our positions in Beam Inc. through a sale to Suntory Holdings, General Growth Properties, Inc. in a share sale to the company, and Procter & Gamble (PG, Financial) through open market sales.
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