The Partners Value Fund’s Institutional Class returned +3.82% in the third calendar quarter, compared to +3.85% for the S&P 500 and +4.40% for the Russell 3000. For the calendar year to date, the Partners Value Fund’s Institutional Class returned +4.62%, compared to +7.84% for the S&P 500 and +8.18% for the Russell 3000.
Calendar Year-to-Date Contributors
Range Resources is an independent producer of natural gas and natural gas liquids (NGLs) based in Fort Worth, Texas, with operations in the Marcellus shale and emerging Terryville field. Range’s stock cooled some during the third quarter following a strong rebound during the first half of the year. As expected, Range completed its purchase of Memorial Resource Development during mid-September, adding another sizeable low- cost, high-return natural gas asset in northern Louisiana to its prolific Marcellus acreage position. An improved balance sheet and the opportunity to produce significant quantities of natural gas near growing demand centers at rates of return similar to the Marcellus are clear positives from the Memorial transaction. Overall, we believe the backdrop for the most efficient natural gas producers remains favorable in the intermediate term; though weather continues to pose near-term risks, given elevated gas storage levels. We believe Range shares are worth between $48-50 share.
Liberty Broadband (LBRDA, Financial) holds a 20% ownership interest (25% aggregate voting power) in Charter Communications. Charter Communications reported quarterly results for the first time since closing on its mergers with Time Warner Cable and Bright House Networks. As such, investors had their first look at the combined entity, even if Charter had only operated these assets for 43 days. Results from the legacy Charter footprint remained strong, and management provided a helpful overview of the combined company as well as their integration and synergy plans. We, and other investors, are excited by the opportunity to run the “Charter playbook” with the newly combined company. Charter shares were also aided by the company’s September inclusion into the S&P 500 Index.
Colfax (CFX, Financial) is a leading manufacturer of pumps, gas handling products and welding equipment. Shares have risen through the year at the prospect of a bottoming in many of Colfax’s end markets, which include oil & gas, power generation and mining. This potential bottoming provides confidence that sales growth may return in the near future. In addition, the use of the Colfax Business System, a management philosophy and a set of tools based on the concept of continuous improvement to drive new product development and cut costs, has improved the margin outlook for the business.
Calendar Year-to-Date Detractors
Endo (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 both 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. Considering 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 in the second calendar quarter and refocus our capital in more attractive opportunities.
Express Scripts (ESRX, Financial) is the largest independent pharmacy benefits manager (PBM) in the United States, helping health benefit providers improve access to (and the affordability of) prescription drugs. As the U.S. election enters its final stages, pharmaceutical manufacturers have shouldered a significant portion of the public’s frustration with the growing lack of affordability in healthcare. In recent weeks, several drug companies have attempted to shift the conversation by pointing fingers at PBMs and other “middlemen” as contributing to (as opposed to minimizing) rising prescription drug costs. Express Scripts and its peers provide a necessary and valuable service to plan sponsors, constructing custom plan designs that balance customer desires for access, cost and flexibility. Providing the absolute lowest cost for each drug utilized is not often the sponsor’s only (or even primary) goal. Additionally, competitive intensity across the industry is high, with no less than two (and in most cases three) potential PBM models to choose from for managing drug costs. We believe Express Scripts keeps a reasonable amount of the savings it generates for clients (we estimate between 10-15%) and that demand for its services will remain high as cost challenges persist. Express Scripts’ shares currently trade at a meaningful discount to our estimate of intrinsic value.
Calendar Year-to-Date Detractors (Continued)
QVC Group (QVCA, Financial) is owned by Liberty Interactive. QVC is an American television network and multinational corporation specializing in televised and online shopping experiences. Shares of QVC Group fell after management indicated that its U.S. business had experienced significant sales headwinds, which are likely to continue into the next quarter. QVC’s U.S. business, which has not seen a sales decline since the Great Recession, appears to be tracking down in the mid to high single- digits, as its fashion business has slowed and a large beauty vendor is dealing with customer complaints on its hair care products. Importantly, we don’t view these issues as a sign of the QVC model suddenly being broken. QVC’s customer retention and loyalty remain strong, as does viewership of their network. Additionally, the international businesses appear unaffected by the current U.S.-centric slowdown. Although the decline in QVC shares is disappointing, we believe management will take advantage, growing their per share business value by continuing to execute their share repurchase strategy.
Quarterly Detractors
Range Resources - Please refer to the Calendar Year-to-Date synopsis.
QVC Group - Please refer to the Calendar Year-to-Date synopsis.
Twenty-First Century Fox (FOXA, Financial) is a diversified media and entertainment company. Shares of Fox declined in the wake of the company’s fiscal fourth quarter earnings report. The good news was continued strength in distribution revenues earned by its suite of Pay-TV networks around the world as well as a resilient ad market in the U.S. Unfortunately, Fox’s international ad revenues slowed considerably due to weakness in Northern Europe and India, rising only 1% in local currency after seven straight quarters of very strong, double-digit growth. Additionally, Fox’s three major summer film releases, X-Men: Apocalypse, Ice Age: Collision Course, and Independence Day: Resurgence, all underperformed expectations. Moreover, management de-emphasized share repurchase within their capital allocation plans, preferring to preserve flexibility to either invest in the business organically (e.g., increasing investment in original content at the National Geographic channel) or to make acquisitions. Despite a more challenging international ad market and disappointing box office results, we continue to believe the underlying business is sound.
Quarterly Contributors
Liberty Broadband - Please refer to the Calendar Year-to-Date synopsis.
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. As the worst of the Brexit fears began to abate (the United Kingdom represents roughly 38% of Liberty Global’s cash flow generation), shares of Liberty Global recovered some of their losses of the prior quarter. Shares also likely benefited from the EU’s approval of the previously announced formation of a 50/50 joint venture with Vodafone combining Liberty’s strong cable and broadband businesses with Vodafone’s mobile offering to create a more competitive “converged” bundle. We remain confident of continued growth for Liberty Global’s cable offerings and management’s ability to deliver operationally.
Avon Products (AVP, Financial) is a manufacturer and marketer of beauty and related products. Avon shares responded positively to developments during the quarter, including continued improvement in local currency sales and the identification of $70 million of cost savings in 2016. In addition, the outlook for the Brazilian economy, Avon’s single largest market, is slowly improving. Although the stock responded well this quarter to positive developments, the allocation is sized in accordance with the economic headwinds that still persist and the variance of possible outcomes among our estimates of intrinsic value.
New Holdings
No new equity holdings were added in the third quarter 2016.
Eliminated Holdings
Motorola Solutions - We sold Motorola Solutions at a gain as the stock approached our business value estimate after the company reported solid quarterly earnings.
Liberty Media Group - We sold our small position in Liberty Media at a significant gain after a rally in Live Nation, one of the company’s core investments.
The trick is to boldly take advantage of the rare, great buying opportunities and to not “give back” the profits by taking unnecessary risks when the odds are unfavorable
