Ron Baron likes to buy future big companies ... when they are still small. He holds the companies for years and waiting for the companies to grow to their full potential. These are comments from his shareholder letter on some of the buys and sells he has made in his fund. Baron Partners fund averaged 14% a year since 1992.
Wynn Resorts (WYNN, Financial)
Wynn Resorts’ shares fell in the second quarter due to investors’ concerns regarding current earnings at the company’s Las Vegas’ casino/hotel resort. While Wynn’s baccarat business catering to its ultra high end customer is about flat compared to a year ago, the balance of this resorts’ business has been negatively impacted by the current Las Vegas’ recession. Players are visiting less frequently and when they do, spending less on rooms, food and beverages and in the casino. Airlines’ higher fares and capacity reductions have also adversely affected Las Vegas’ and this resort’s visitation.
Since Steve Wynn believes that it is bad business to have staff reductions, i.e. layoffs, we guess profits for this property will fall about 25% this year to $325 million. Investors are also concerned that Wynn will open its $2.3 billion Encore property in December in the midst of this recession and, as a result, will probably take longer than normal to reach maturity. All is not bad, though. Steve likes to say that “you have one chance to make a first impression” and as a result of sluggish business in Las Vegas at present, we expect visitors will have a better first visit to Encore as Wynn lavishes them with attention. We think Wynn Macau is also doing great which investors don’t seem to appreciate.
When Wynn Macau opened in 2006, its share of the market was 12%. Wynn has not raised its commission rates paid to junket operators like its competitors and although there are a lot more competitors now than then, Wynn Macau’s market share is now 18.5%! Further, gaming win in Macau has doubled in the past two years and is now about twice that of Las Vegas! We estimate Wynn Macau will have EBITDA this year of about $500-550 million compared to $375 million last year, more than offsetting the decline in Las Vegas. With, in our view, significant earnings increments likely from its expansions in Macau and Las Vegas and large undervalued land holdings in Las Vegas likely to be developed over the next decade, we think the decline in Wynn stock is temporary. In addition, we think its properties built during the past five years could probably not be replaced for 35-50% more than they cost Wynn. Finally, during the next decade we think casino resort developments will become increasingly common throughout Asia as South Korea, Taiwan, Japan and Singapore seek to copy what has taken place in Macau over the past seven years. We think Wynn will get at least its share of this business. (David Baron)
Arch Capital Group, Ltd. (ACGL - Market Capitalization: $4.3 billion)
The “bear market” of the past nine months also provided us with the opportunity to add to investments we have held for several years at what we also believed to be attractive prices. Among these investments are property and casualty insurer Arch Capital that we first began to purchase in 2002; exchange CME Group that we first acquired in 2003; securities brokerage firm and asset manager/ aggregator Charles Schwab that we first purchased in 1992; and sporting goods retailer Dick’s Sporting Goods, that we first purchased in 2005. We guess it is probably not surprising to you that we regard those businesses and their prospects highly since we have maintained our ownership interests in those businesses for many years. After share prices of those businesses fell sharply in price, as have so many this year, we took the opportunity to buy more.
We began to purchase property and casualty insurer Arch Capital in 2002 at about one third its current price. That was after 9/11, numerous instances of corporate malfeasance, a couple of back to back “once in hundred year” natural disasters and asbestos claims that had devastated insurance industry reserves. This confluence of adverse events required insurers to significantly increase rates to strengthen reserves and enable them to pay their claim obligations. Arch then was a relatively well capitalized startup insurance business formed by Dinos Iordanu, a highly regarded former Berkshire Hathaway senior executive. When we invested initially we believed Arch would benefit from higher rates without having to pay legacy liabilities. We were right and Arch shares appreciated significantly. The property and casualty industry has prospered in recent years and rates and profits in many cases are now falling. Arch has minimized rate pressure by emphasizing new business with smaller customers, a less competitive business. The company now earns about $7 per share from investment income, $3 per share from underwriting. It also has a significant share repurchase program. Arch shares are selling at about our estimate for book value and we think Arch’s underwriting earnings can quickly double following the next natural disaster. Arch is now selling at about 7X estimated earnings per share and we have been adding to our investment.
CME Group, Inc. (CME - Market Capitalization: $20.9 billion)
As the largest U.S. futures exchange, we think CME Group is in an excellent competitive position. In the U.S., futures contracts must be bought and then sold on the same exchange, making it difficult for new entrants to take market share from incumbents. CME also, in our view, has significant volume growth opportunities including increasing trading of CME products in international markets and pursuing opportunities to bring central counterparty clearing to the large over-the-counter marketplace dominated by commercial banks. CME has benefited from the financial crisis that has enveloped markets during the past year. This is because it has made traders and commercial hedgers more acutely aware of the counterparty risk associated with trading with commercial banks rather than holding investments at a triple A rated central clearing house. OTC trading is considerably larger than exchange trading while a relatively modest share of commercial transactions is currently hedged. We increased our CME investment when CME’s share price fell due to concerns: about increased competition from a possible rival exchange; concerns that deleveraging by hedge funds would reduce trading volumes; and, most importantly, we think, concerns about multiple contraction. CME shares now trade for about 16X our estimated 2009 earnings. (Katherine Harman)
Charles Schwab Corp. (SCHW - Market Capitalization: $23.5 billion)
We opportunistically added to our investment in Charles Schwab early in the June quarter. Schwab’s stock was trading lower, in our opinion, in sympathy with falling share prices of financial companies with much riskier profiles as well as concern over the near term earnings impact of a falling equity market. We think Charles Schwab’s trusted brand has benefited from the disarray in financial markets. It is, we think, rightfully considered a “safe haven” by its customers and, as a result, has increased its “wallet share” of those customers’ assets. Schwab’s share price increased later in the quarter, following reported strong growth of net new customer assets. We think Schwab is positioned to double its customer assets to $3 trillion over the next five years, half through flows, the balance through appreciation. We believe its earnings should follow suit as a result of the company’s growth initiatives in its registered investment adviser, banking and retirement services businesses. In contrast to many large financial businesses that have recently incurred substantial losses as a result of their exposure to subprime mortgages, Charles Schwab has navigated the current credit crisis virtually unscathed. (Katherine Harman)
Sold Whole Foods (WFMI, Financial), Las Vegas Sands (LVS, Financial) and Boyd’s (BYD, Financial)
In the midst of a volatile and falling stock market, we sold shares in three businesses, Whole Foods, Las Vegas Sands and Boyd’s, all of which had fallen in price due principally, in our opinion, to management miscues some of which related to financing their businesses’ growth opportunities. These sales were principally to obtain capital so that we could either make new investments or add to our investments in businesses which had also fallen in price but whose prospects seemed to us brighter. We just love the quality of food offered in Whole Foods’ supermarkets, its managements’ exceptional merchandising talent and this business’ physical expansion opportunities. Further, we think Whole Foods’ stores add significant value to nearby real estate due to its supermarkets’ strong consumer patronage. This should permit Whole Foods’ stores to demand offering rents significantly lower than other supermarkets, providing that company with important competitive advantage.
Despite this, we sold Whole Foods’ shares when we lost confidence in that company’s senior management and Board. We did not agree with their rationale for acquiring Wild Oats. Whole Foods’ store rents seemed to be not as cheap as real estate executives with whom we consulted believed they should be. We thought the company’s management compensation structure left much to be desired, i.e. we think it is too low, making the company vulnerable to losing talented executives. Despite the company’s aggressive expansion program which had become more difficult to finance, the company persisted with a significant cash dividend. The company’s expansion in London seemed, to us, struggling and ill timed, i.e. years too early. Finally, the unusual behavior and decisions by the chief executive officer, who, while a brilliant founding entrepreneur seemed to us increasingly unsuitable as the chief executive of a rapidly growing, publicly owned business. We sold our shares in Las Vegas’ casino hotelier Boyd Gaming when that company’s senior management chose to risk the viability of their company by beginning construction of its $4 billion Las Vegas’ Echelon casino before financing had been committed to complete the project. Construction cost increases and project delays, coupled with a slowing of the Las Vegas “locals” casino hotel business and a more competitive environment for its Atlantic City Borgata property from newly legalized slots in Pennsylvania, hurt Boyd’s free cash flow and diminished the appeal of this investment.
We sold our shares in Las Vegas Sands after we were unimpressed by its two newly opened casino hotels, The Palazzo in Las Vegas and The Venetian in Macau. The Palazzo seemed unimaginative when compared to competing properties and The Venetian too large and unwelcoming. Neither property has been able to achieve good operating results since their resort openings although, as they say, “the night is young.” While Las Vegas Sands is clearly asset rich, with profitability in its existing Las Vegas casinos under pressure and capital markets unwelcoming, it has been difficult for this business to finance its ambitious casino expansion projects on Macau’s Cotai Strip. Las Vegas Sands’ Singapore casino hotel opening in late 2009 should provide the company with strong growth opportunities. Regardless, we elected to source additional investments in businesses able, in our view, to take advantage of the financing miseries of so many by selling the remainder of our investment in Las Vegas Sands.
Wynn Resorts (WYNN, Financial)
Wynn Resorts’ shares fell in the second quarter due to investors’ concerns regarding current earnings at the company’s Las Vegas’ casino/hotel resort. While Wynn’s baccarat business catering to its ultra high end customer is about flat compared to a year ago, the balance of this resorts’ business has been negatively impacted by the current Las Vegas’ recession. Players are visiting less frequently and when they do, spending less on rooms, food and beverages and in the casino. Airlines’ higher fares and capacity reductions have also adversely affected Las Vegas’ and this resort’s visitation.
Since Steve Wynn believes that it is bad business to have staff reductions, i.e. layoffs, we guess profits for this property will fall about 25% this year to $325 million. Investors are also concerned that Wynn will open its $2.3 billion Encore property in December in the midst of this recession and, as a result, will probably take longer than normal to reach maturity. All is not bad, though. Steve likes to say that “you have one chance to make a first impression” and as a result of sluggish business in Las Vegas at present, we expect visitors will have a better first visit to Encore as Wynn lavishes them with attention. We think Wynn Macau is also doing great which investors don’t seem to appreciate.
When Wynn Macau opened in 2006, its share of the market was 12%. Wynn has not raised its commission rates paid to junket operators like its competitors and although there are a lot more competitors now than then, Wynn Macau’s market share is now 18.5%! Further, gaming win in Macau has doubled in the past two years and is now about twice that of Las Vegas! We estimate Wynn Macau will have EBITDA this year of about $500-550 million compared to $375 million last year, more than offsetting the decline in Las Vegas. With, in our view, significant earnings increments likely from its expansions in Macau and Las Vegas and large undervalued land holdings in Las Vegas likely to be developed over the next decade, we think the decline in Wynn stock is temporary. In addition, we think its properties built during the past five years could probably not be replaced for 35-50% more than they cost Wynn. Finally, during the next decade we think casino resort developments will become increasingly common throughout Asia as South Korea, Taiwan, Japan and Singapore seek to copy what has taken place in Macau over the past seven years. We think Wynn will get at least its share of this business. (David Baron)
Arch Capital Group, Ltd. (ACGL - Market Capitalization: $4.3 billion)
The “bear market” of the past nine months also provided us with the opportunity to add to investments we have held for several years at what we also believed to be attractive prices. Among these investments are property and casualty insurer Arch Capital that we first began to purchase in 2002; exchange CME Group that we first acquired in 2003; securities brokerage firm and asset manager/ aggregator Charles Schwab that we first purchased in 1992; and sporting goods retailer Dick’s Sporting Goods, that we first purchased in 2005. We guess it is probably not surprising to you that we regard those businesses and their prospects highly since we have maintained our ownership interests in those businesses for many years. After share prices of those businesses fell sharply in price, as have so many this year, we took the opportunity to buy more.
We began to purchase property and casualty insurer Arch Capital in 2002 at about one third its current price. That was after 9/11, numerous instances of corporate malfeasance, a couple of back to back “once in hundred year” natural disasters and asbestos claims that had devastated insurance industry reserves. This confluence of adverse events required insurers to significantly increase rates to strengthen reserves and enable them to pay their claim obligations. Arch then was a relatively well capitalized startup insurance business formed by Dinos Iordanu, a highly regarded former Berkshire Hathaway senior executive. When we invested initially we believed Arch would benefit from higher rates without having to pay legacy liabilities. We were right and Arch shares appreciated significantly. The property and casualty industry has prospered in recent years and rates and profits in many cases are now falling. Arch has minimized rate pressure by emphasizing new business with smaller customers, a less competitive business. The company now earns about $7 per share from investment income, $3 per share from underwriting. It also has a significant share repurchase program. Arch shares are selling at about our estimate for book value and we think Arch’s underwriting earnings can quickly double following the next natural disaster. Arch is now selling at about 7X estimated earnings per share and we have been adding to our investment.
CME Group, Inc. (CME - Market Capitalization: $20.9 billion)
As the largest U.S. futures exchange, we think CME Group is in an excellent competitive position. In the U.S., futures contracts must be bought and then sold on the same exchange, making it difficult for new entrants to take market share from incumbents. CME also, in our view, has significant volume growth opportunities including increasing trading of CME products in international markets and pursuing opportunities to bring central counterparty clearing to the large over-the-counter marketplace dominated by commercial banks. CME has benefited from the financial crisis that has enveloped markets during the past year. This is because it has made traders and commercial hedgers more acutely aware of the counterparty risk associated with trading with commercial banks rather than holding investments at a triple A rated central clearing house. OTC trading is considerably larger than exchange trading while a relatively modest share of commercial transactions is currently hedged. We increased our CME investment when CME’s share price fell due to concerns: about increased competition from a possible rival exchange; concerns that deleveraging by hedge funds would reduce trading volumes; and, most importantly, we think, concerns about multiple contraction. CME shares now trade for about 16X our estimated 2009 earnings. (Katherine Harman)
Charles Schwab Corp. (SCHW - Market Capitalization: $23.5 billion)
We opportunistically added to our investment in Charles Schwab early in the June quarter. Schwab’s stock was trading lower, in our opinion, in sympathy with falling share prices of financial companies with much riskier profiles as well as concern over the near term earnings impact of a falling equity market. We think Charles Schwab’s trusted brand has benefited from the disarray in financial markets. It is, we think, rightfully considered a “safe haven” by its customers and, as a result, has increased its “wallet share” of those customers’ assets. Schwab’s share price increased later in the quarter, following reported strong growth of net new customer assets. We think Schwab is positioned to double its customer assets to $3 trillion over the next five years, half through flows, the balance through appreciation. We believe its earnings should follow suit as a result of the company’s growth initiatives in its registered investment adviser, banking and retirement services businesses. In contrast to many large financial businesses that have recently incurred substantial losses as a result of their exposure to subprime mortgages, Charles Schwab has navigated the current credit crisis virtually unscathed. (Katherine Harman)
Sold Whole Foods (WFMI, Financial), Las Vegas Sands (LVS, Financial) and Boyd’s (BYD, Financial)
In the midst of a volatile and falling stock market, we sold shares in three businesses, Whole Foods, Las Vegas Sands and Boyd’s, all of which had fallen in price due principally, in our opinion, to management miscues some of which related to financing their businesses’ growth opportunities. These sales were principally to obtain capital so that we could either make new investments or add to our investments in businesses which had also fallen in price but whose prospects seemed to us brighter. We just love the quality of food offered in Whole Foods’ supermarkets, its managements’ exceptional merchandising talent and this business’ physical expansion opportunities. Further, we think Whole Foods’ stores add significant value to nearby real estate due to its supermarkets’ strong consumer patronage. This should permit Whole Foods’ stores to demand offering rents significantly lower than other supermarkets, providing that company with important competitive advantage.
Despite this, we sold Whole Foods’ shares when we lost confidence in that company’s senior management and Board. We did not agree with their rationale for acquiring Wild Oats. Whole Foods’ store rents seemed to be not as cheap as real estate executives with whom we consulted believed they should be. We thought the company’s management compensation structure left much to be desired, i.e. we think it is too low, making the company vulnerable to losing talented executives. Despite the company’s aggressive expansion program which had become more difficult to finance, the company persisted with a significant cash dividend. The company’s expansion in London seemed, to us, struggling and ill timed, i.e. years too early. Finally, the unusual behavior and decisions by the chief executive officer, who, while a brilliant founding entrepreneur seemed to us increasingly unsuitable as the chief executive of a rapidly growing, publicly owned business. We sold our shares in Las Vegas’ casino hotelier Boyd Gaming when that company’s senior management chose to risk the viability of their company by beginning construction of its $4 billion Las Vegas’ Echelon casino before financing had been committed to complete the project. Construction cost increases and project delays, coupled with a slowing of the Las Vegas “locals” casino hotel business and a more competitive environment for its Atlantic City Borgata property from newly legalized slots in Pennsylvania, hurt Boyd’s free cash flow and diminished the appeal of this investment.
We sold our shares in Las Vegas Sands after we were unimpressed by its two newly opened casino hotels, The Palazzo in Las Vegas and The Venetian in Macau. The Palazzo seemed unimaginative when compared to competing properties and The Venetian too large and unwelcoming. Neither property has been able to achieve good operating results since their resort openings although, as they say, “the night is young.” While Las Vegas Sands is clearly asset rich, with profitability in its existing Las Vegas casinos under pressure and capital markets unwelcoming, it has been difficult for this business to finance its ambitious casino expansion projects on Macau’s Cotai Strip. Las Vegas Sands’ Singapore casino hotel opening in late 2009 should provide the company with strong growth opportunities. Regardless, we elected to source additional investments in businesses able, in our view, to take advantage of the financing miseries of so many by selling the remainder of our investment in Las Vegas Sands.
