To Our Shareholders,
For the quarter ended June 30, 2016, the net asset value (“NAV”) per Class A Share of The Gabelli Value 25 Fund Inc. increased 4.0% compared with increases of 2.5% and 2.0% for the Standard & Poor’s (“S&P”) 500 Index and the Dow Jones Industrial Average, respectively. See page 2 for additional performance information.
Keep Calm and Carry On
Annualizing the S&P 500’s first half return of 3.8% would suggest 2016 is shaping up to be a solid if not average year. Even casual market observers would note however that it has been anything but boring. We began 2016 with two dates circled: June 23 – the date of the British referendum to leave the European Union (EU) – and November 8 – the date of U.S. elections. To the surprise of many bettors, Britain did in fact vote to leave the EU, the so-called “Brexit,” setting off a 10%+ decline in the British pound versus the dollar and losses in bourses around the world as economists forecast a recession in the UK and possibly elsewhere.
With 2015 GDP of $2.8 trillion, the UK is the fifth largest economy in the world (though roughly only the size of California) and an important trading partner for the U.S. and the EU. We have little doubt that will remain the case outside the EU. Indeed, after a period of adjustment and negotiation with the EU, there is a strong argument that a sovereign UK could be better off not just politically but economically; the rebound in UK stock averages to above pre-Brexit levels would indicate as much. There will be winners (exporters helped by a weaker pound) and losers (the financial sector with the potential loss of frictionless access to the common market) among not just British corporations but countries as well.
Much of the concern surrounding Brexit is for its unintended consequences for the continent and global trade. Already there is a race to determine which country will hold a referendum to leave the EU next (or at least a race to name those campaigns) with “Frexit,” “Quitaly,” “Outstria,” “Departugal,” “Beljump” and “Czech-out” already discussed. In reality very few EU members possess both the constitutional mechanism and motivation to leave. The EU is likely to remain intact but its complexion without the Anglicizing force of the UK will certainly change as Germany will shoulder an ever greater portion of the burden of immigration and the poor financial state of the periphery.
Whether Brexit is representative of a global “anti-global” wave and hurts or helps the populist/outsider campaign of presumptive Republican nominee Donald Trump is another open question. The campaigns in the U.S. are likely to reinforce why summer has long been known as the political “silly season.” We are braced for more surprises. Given Brexit’s come from behind win, the market is unlikely to fully discount any particular outcome in November, ensuring continued market volatility. We may or may not have a better sense of the future political landscape by the next quarterly update.
In the face of global uncertainty, we remain focused on bottom-up fundamental stock picking. That is not to say stock selection takes place in a vacuum. Rather we gather and array macro observations that we use to inform our micro analysis of discrete businesses. We combine these with insights into industry dynamics, including possible policy outcomes (e.g. Obamacare, defense spending, Federal Communications Commission decisions, Dodd-Frank financial regulation) to arrive at ranges of earnings and valuations and possible catalysts for companies within our global coverage. We tend to gravitate toward firms with sustainable competitive moats and predictable and/or recurring cash flows. In each case however, we seek an appropriate discount to Private Market Value and Catalyst before purchase.
Deals, Deals and More Deals
Deal activity rebounded from a slow first quarter as announced U.S. M&A increased 44% year-on-year to $222 billion. Several industries within our core competency saw evidence of ongoing consolidation. One of the most active areas was consumer staples, where Mondelez (1.0% of net assets as of June 30, 2016) disclosed an unsolicited offer for Hershey, and Post was said to be in talks to acquire ConAgra’s Lamb Weston unit. John Malone continued his prolific financial engineering during the quarter as Liberty Media separated into three tracker stocks: Liberty SiriusXM (1.2%), representing a 64% stake in SiriusXM radio; Liberty Braves (0.2%), representing ownership of the Atlanta Braves baseball club and related real estate; and Liberty Media (0.1%), accounting for a variety of public and private assets including a 35% stake in Live Nation Entertainment. Dr. Malone was also involved on both sides of Lionsgate’s long anticipated Q2 agreement to purchase premium cable network Starz, with the combined company likely to serve as a platform for additional consolidation within the content area.
Brexit and other political uncertainties may dampen large cross-border in the near term. However, domestic deals are unlikely to be impacted and certain acquirers may find their currency goes further in certain countries. The underpinnings of what we have termed the Fifth Wave of M&A - cheap financing and scarce organic growth opportunities - remain intact and are unlikely to change.
Investment Scorecard
As might be expected in a tumultuous quarter, consumer staples names performed particularly well with Energizer (0.7% of net assets as of June 30, 2016) (+28%) and Swedish Match (3.7%) (+10%) among the top contributors. Domestic oriented, stable cash generators Republic Services (3.6%) (+8%) and National Fuel Gas (2.7%) (+14) also performed strongly. Diversified industrial Circor International (1.8%) (+23%) rebounded due to firming oil prices. As with last quarter, the Fund’s holding in safe-haven gold miners Newmont Mining (3.5%) (+48%) continued its sharp ascent.
Brexit negatively impacted performance through holdings with large UK exposures such as Liberty Global (1.4%) (-12%), Discovery Communications (0.8%) (-12%) and Twenty-First Century Fox (1.7%) (-3%). While a UK recession could reduce advertising spending for Discovery and Fox, their affiliate fees, and the broadband and pay-TV subscription businesses of Liberty Global should be resilient. Economically, sensitive firms such as Navistar (0.4%) (-17%) were drags on performance. Finally, Legg Mason (0.7%) (-14%) declined as it contends with secular trends and cyclical performance headwinds in the fund management industry.
Let’s Talk Stocks
The following are stock specifics on selected holdings of our 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 share prices are listed first in United States dollars (USD) and second in the local currency, where applicable, and are presented as of June 30, 2016.
CBS Corp. (CBS, Financial) (6.8% of net assets as of June 30, 2016) (CBS – $57.62 – NYSE) operates the CBS television network and the premium cable network Showtime. It also owns 29 local television stations and 130 radio stations. We believe that CBS has a number of opportunities to generate incremental non-advertising revenue from the sale of existing content through its OTT platforms, online video distributors and retransmission agreements with traditional distributors. In addition, we expect a continued recovery in advertising to contribute to earnings growth. Finally, we believe that financial engineering, including the split-off of its radio business, could act as a catalyst for shares.
DISH Network Corp. (DISH, Financial) (1.8%) (DISH – $52.40 – NASDAQ) is the fourth largest pay television provider in the U.S., serving approximately 14 million subscribers through its original satellite business and newer Sling internet delivered over-the-top offering. Founder Charlie Ergen owns approximately 53% of DISH’s shares. DISH has accumulated a significant spectrum position at attractive prices. DISH could monetize its spectrum through a sale of the spectrum or the whole company, or, more likely, a partnership with an existing wireless operator.
Edgewell Personal Care Co. (EPC, Financial) (2.0%) (EPC – $84.41 – NYSE) based in St. Louis, Missouri, is the personal care division of Energizer Holdings, which split its personal care and household products divisions on July 1, 2015. Edgewell generates approximately $2.3 billion of revenue through its principal businesses: wet shaving, including Schick-branded razors and blades, Edge and Skintimate shaving preparation and private label shaving products; sun care, including the Banana Boat and Hawaiian Tropic brands; feminine care, including Playtex and o.b. tampons and Carefree and Stayfree liners and pads; and infant care, utilizing the Playtex and Diaper Genie brands. As a pure-play personal care company, Edgewell competes in high-margin, attractive categories with leading brands. We expect management to focus on improving margins through product mix, restructuring savings and operating leverage, which should afford it flexibility to reinvest in growth opportunities. The company has approximately $1.2 billion of net debt providing management with sufficient flexibility to invest in internal growth, make acquisitions and/or repurchase shares. EPC is a likely acquisition target as a multinational competitor with a strong international infrastructure would benefit from scale, cost synergies, and the opportunity to accelerate international expansion.
Honeywell International Inc. (HON, Financial) (3.1%) (HON – $116.32 – NYSE) operates as a diversified technology company with highly engineered products, including turbine propulsion engines, auxiliary power units, turbochargers, brake pads, environmental and combustion controls, sensors, security and life safety products, resins and chemicals, nuclear services, and process technology for the petrochemical and refining industries. One of the key drivers of HON’s growth are acquisitions that increase the company’s growth profile globally, creating both organic and inorganic opportunities. The company recently acquired Elster Industries, a leading provider of thermal gas solutions, smart meters, software and data analytics for the commercial, industrial and residential heating market. Elster’s gas business offers products in high demand among natural gas customers and brings a strong, global distribution network and numerous cross-selling opportunities for existing HON technologies to new customers. Elster’s gas, electric and water meters are highly valued for their reliability, safety and accuracy. The company maintains an installed base of more than 200 million meter modules deployed over the course of the last 10 years that generate significant recurring revenues. We believe acquisitions such as Elster should drive meaningful and sustained growth for HON spurred by global energy efficiency initiatives and natural resource management.
Newmont Mining Corp. (NEM, Financial) (3.5%) (NEM – $39.12 – NYSE) based in Denver, Colorado, is one of the largest gold mining companies in the world. Founded in 1921 and publicly traded since 1925, NEM is the only gold company included in the S&P 500 Index and Fortune 500. We expect the company to produce approximately 5.1 million ounces of gold and 320 million pounds of copper in 2016, with over 70% of this production coming from Australia and Nevada. Newmont undertook company wide cost cutting measures during the period 2013 – 2015, lowering its average unit costs base by over 20% during this period. The company has sold non-core assets and has deployed the proceeds from these sales into repaying debt and building new projects which it expects will generate superior rates of return for shareholders. Given Newmont’s largely fixed cost base, every increase (or decrease) in the gold price will flow directly to the company’s bottom line.
Ryman Hospitality Properties Inc. (RHP, Financial) (1.6%) (RHP – $50.65 – NYSE) is a Nashville, Tennessee based REIT that owns convention hotels in Nashville, Tennessee; Orlando, Florida; Dallas, Texas; and Washington, D.C. Other assets include the iconic Opryland, the famous Ryman Auditorium, the General Jackson Showboat, and Nashville based radio station WSM-AM. With property manager Marriot’s operational issues resolved, the team is focused on taking advantage of strong convention bookings trends, seeking to drive margin expansion by increasing occupancy and room rates. Finally, as the leading country music entertainment brand, the potential monetization and spin-off of the Entertainment assets, including the Grand Ole Opry, also remains a significant catalyst for RHP shares.
Sony Corp. (SNE, Financial) (3.3%) (SNE – $29.35 – NYSE) is a diversified electronics and entertainment company based in Tokyo, Japan. The company manufactures televisions, PlayStation game consoles, mobile phone handsets, and cameras. It also operates the Columbia film studio and Sony Music entertainment group. We expect the new PlayStation launch and operational improvements in consumer electronics and entertainment to generate EBITDA growth through 2017. We also think the spinoff of the entertainment assets could be a catalyst.
Viacom Inc. (VIA, Financial) (6.7%) (VIA – $46.42 – NASDAQ) is a pure-play content company that owns a global stable of cable networks, including MTV, Nickelodeon, Comedy Central, VH1, BET, and the Paramount movie studio. Viacom’s cable networks generate revenue from advertising sales, fixed monthly subscriber fees, and ancillary revenue from toy licensing, etc. We believe a low valuation and M&A potential outweigh the secular risks of cord-cutting.
Conclusion
Notwithstanding what seems like a steady stream of crises and an inordinate number of unusual events, we have experienced more trying times in even the recent past – hot wars, terror attacks, and the disintegration of the Soviet Union. The departure of the UK, which has always retained its own currency, from what was essentially a trade confederacy is unlikely to alter the course of global history. We remain primed for further change. Eventually the current economic expansion will end, but for the moment the U.S. consumer appears robust and corporate profits solid, albeit not growing. Central banks around the world, including the U.S. Federal Reserve, continue to be accommodative. Against this dichotomous backdrop of volatile markets and placid fundamentals, we continue to find opportunities.
July 13, 2016
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.
