Investment Style: Multi-Cap Value
Co-Portfolio Managers: Wally Weitz, CFA & Brad Hinton, CFA
The Partners Value Fund’s Institutional Class returned -0.97% in the second calendar quarter, compared to +2.46% for the S&P 500 and +2.63% for the Russell 3000. For the calendar year to date, the Partners Value Fund’s Institutional Class returned +0.77%, compared to +3.84% for the S&P 500 and +3.62% for the Russell 3000.
Calendar Year Contributors
Range Resources (RRC, Financial) is an independent producer of natural gas and natural gas liquids based in Fort Worth, Texas. Following a difficult 2015, Range shares rallied from depressed levels, thanks to the successful completion of non- core asset sales, long-term debt reduction and an improving natural gas outlook. In a surprise move, Range announced its intention to acquire natural gas producer Memorial Resources (MRD) in mid-May in an all-stock transaction valued at approximately $4.4 billion. Unlike many exploration & production (E&P) companies, Range has been extremely protective of its equity over the years and has generally not been acquisitive in the recent past. The Memorial purchase accomplishes a number of important objectives for Range, including further de-leveraging the company’s balance sheet as well as geographic diversity via an asset with an attractive return profile. While we remain favorably inclined toward the transaction, we took the opportunity to lighten our position in the low-$40s during the quarter as Range’s discount to our estimate of value narrowed.
Liberty Broadband holds a 17% ownership interest (25% aggregate voting power) in Charter Communications in addition to a minority equity interest in Time Warner Cable. Charter Communications is the fourth-largest cable operator in the U.S. and provides advanced video, high-speed internet, and telephone service to residential and business customers. In the second calendar quarter, “New Charter” was formed with a merger between Charter, Time Warner Cable and Bright House Networks. Furthermore, at the time of the merger announcement (a year and one-half ago), Liberty Broadband agreed to invest $5 billion into “New Charter” at a fixed price ($195 per share) that proved to be a material discount to Charter’s market price at the time of closing ($225 per share), thus giving Liberty Broadband shareholders an immediate unrealized gain. Our investment in Liberty Broadband represents additional upside to our business value estimate for Charter on a stand-alone basis.
Berkshire Hathaway is a conglomerate holding company owning subsidiaries engaged in a number of business activities. Berkshire shares were helped by the closing of the Precision Castparts acquisition (in the first calendar quarter), improved operating performance at its Burlington Northern railroad subsidiary and the potential of further capital allocation opportunities. Additionally, Berkshire shares were helped by the diversification represented by the underlying businesses and continued momentum resulting from management’s general optimism about the company’s long-term prospects.
Calendar Year Detractors
Liberty Global (LBTYA, Financial) is the largest international cable company, with operations in 14 countries providing video, broadband Internet, fixed-line telephone and mobile services to its customers. Shares fell in the first calendar quarter after an influential Wall Street analyst downgraded his outlook for the stock, principally due to concerns over continued competitive struggles in Holland. Since that time, Liberty announced it would move its Dutch operations into a 50/50 joint venture with Vodafone, allowing Liberty Global to combine its strong cable and broadband businesses with Vodafone’s mobile offering to create a more competitive, “converged” offering. Share prices declined in the second calendar quarter due to Brexit. The pound fell roughly 10% versus the U.S. dollar on the news. Without any rebound this will depress Liberty Global’s future earnings, regardless of underlying fundamentals, as its largest operation is in the United Kingdom and represents roughly 38% of its cash flow generation. Management has already turned its attention to reducing indirect costs, better integrating its various operations, leveraging its scale and operating more efficiently. We remain confident of continued growth for Liberty Global’s cable offerings and management’s abilities to deliver operationally.
Endo International (ENDP, Financial) is a specialty healthcare company engaged in developing, manufacturing, marketing and distributing branded pharmaceutical and generic products and medical devices. Endo experienced significantly worse than anticipated erosion at Qualitest, its legacy generic drug platform. Simply put, our analysis of the company’s competitive positioning in controlled substance generics was wrong. The competitive environment changed quickly and we were slow to recognize it. After conversations with management and a couple of the larger drug buying consortiums, we could not gain comfort in the durability of Endo’s now lower earnings base. The company’s balance sheet and potential legal obligations (liabilities relating to the company’s legacy vaginal mesh products) leave less room for error given growth challenges on the branded side of Endo’s business. Given the erosion in our investment thesis, questions about management’s ability to identify and navigate risk, and a growing list of unknowns surrounding the business, we elected to close our position and refocus our capital in more attractive opportunities.
Calendar Year Detractors (Continued)
Allergan (AGN, Financial) is a global specialty pharmaceutical company focusing on the development, manufacturing, marketing and distribution of generic, brand name, biosimilar and over-the-counter (OTC) pharmaceutical products. The dissolution of Allergan’s merger with Pfizer in April, delays in gaining Federal Trade Commission approval for the sale of its global generics business to TEVA and broader industry concern around prescription drug prices combined to push Allergan’s stock down by 26% during the first half of the calendar year. As we wrote in January, we like the stand- alone Allergan business without the generics business and believe the $ 40 billion sale to TEVA should soon close. There are a number of signs that growth in Allergan’s aesthetics franchise is accelerating, and the company’s key product launches – VIBERZI, VRAYLAR and KYBELLA – appear to be off to healthy starts. The combination of healthy organic growth, debt reduction and meaningful share repurchases should drive per share value creation over our investment horizon. We substantially increased the Fund’s Allergan position during the second quarter at attractive discounts to our business value estimate.
Quarterly Detractors
Endo International - Please see the Calendar Year synopsis for quarterly contribution details.
Liberty Global - Please see the Calendar Year synopsis for quarterly contribution details.
Fossil Group (FOSL, Financial) is the fourth-largest producer of watches and the largest licenser of watches and jewelry globally. Following a strong first quarter earnings report, Fossil reported disappointing results in the second quarter due to a tough consumer environment and weakness in the wholesale channel in North America and Europe. The main drivers of the wholesale channel weakness were weak foot traffic, inventory destocking and continued moderation at their largest licensed brand, Michael Kors. This difficult environment led management to cut guidance for the full year. The retail channel and Fossil’s owned brands continued to outperform, with Skagen growing double-digits and the Fossil brand posting growth in a difficult environment. Despite low visibility over the next several quarters, we expect a rebound in 2017 led by a large pipeline of product introductions, including wearables launches across 10 brands. Furthermore, investments in brand building and omni-channel initiatives should also benefit 2017 results.
Quarterly Contributors
Range Resources - Please see the Calendar Year synopsis for quarterly contribution details.
Laboratory Corp. of America (LH, Financial) is a healthcare diagnostics company providing comprehensive clinical laboratory services to medical professionals and end-to-end drug development support to pharmaceutical manufacturers. LabCorp reported stronger than expected organic growth during the first quarter in both its diagnostics and drug development segments and raised its financial forecast for the full year. Covance, its drug development segment, has demonstrated improving operating momentum the past three quarters, with strength across each of its primary end markets (pre-clinical, central lab, late stage). Finally, the Center for Medicare and Medicaid Services’ (CMS’) highly anticipated Final Rule on changes to the Medicare Clinical Lab Fee Schedule in mid-June included two positives for the lab industry – a delay in implementation until 2018 and the inclusion of higher cost outpatient hospital labs, which is a piece that will determine future reimbursement levels. While final details won’t be known for some time, we anticipate these reimbursement changes will have a very modest impact on LabCorp’s future earnings power.
TransDigm Group is a designer, producer and supplier of engineered aircraft components for use on commercial and military aircraft. TransDigm’s shares moved higher during the second calendar quarter on better than expected results in the company’s commercial aftermarket business, the acquisition of Data Device Corporation and the raising of additional debt capital, which may signal the possibility of future mergers & acquisitions or a special dividend. Moreover, TransDigm’s investor meeting in late-June provided additional information regarding the strength and durability of the company’s business model and strategy for the foreseeable future.
New Holdings
No new equity holdings were added in the second quarter of 2016.
Eliminated Holdings
Liberty Braves - During the second quarter, Liberty Media recapitalized into three tracking stocks. As a modest piece of the overall value of Liberty Media, the tracker associated with the Atlanta Braves and the related real estate development represented a very small position in the portfolio after the recapitalization, and we elected to exit our holdings.
Endo International plc - Please see Calendar Year synopsis for details of the Fund’s sale rationale.
Brown & Brown - We sold Brown & Brown at a gain as the stock approached our revised estimate of business value.
Past performance does not guarantee future results. The investment return and the principal value of an investment in any of the Funds will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than the original cost. Average annual total returns for the Fund’s Institutional and Investor Class for the one, five and ten year periods ended June 30, 2016 were -7.94%, 7.83%, 5.54% and -8.11%, 7.75%, 5.50%; respectively. The returns above assume reinvestment of dividends and redemption at the end of each period, and reflect the deduction of annual operating expenses, which as stated in the most recent Prospectus are 1.05% (gross) and 1.18% of the Fund’s Institutional Class and Investor net assets, respectively. The returns above also include fee waivers and/or expense reimbursements, if any; total returns would have been lower had there been no waivers or reimbursements. The investment adviser has agreed in writing to waive its fees and reimburse certain expenses (excluding taxes, interest, brokerage costs, acquired fund fees and expenses and extraordinary expenses) to limit the total annual fund operating expenses for Institutional Class shares and Investor Class shares to 0.99% and 1.18%, respectively, of each Class’s average daily net assets through July 31, 2016. Current performance may be higher or lower than the performance data quoted. Performance data current to the most recent month end may be obtained at www.weitzinvestments.com/funds_and_performance/fund_performance.fs.
Investors should consider carefully the investment objectives, risks and charges and expenses of the Funds before investing. The Fund’s Prospectus contains this and other information about the Funds and should be read carefully before investing. The Prospectus is available from Weitz Investment Management, weitzinvestments.com.
