The biggest negative contributor for the Fund was Houghton Mifflin (NASDAQ:HMHC), which detracted 47 basis points from the Fund’s performance in the quarter. HMHC has not performed well for the Fund since we first purchased its shares. The company has missed quarterly earnings expectations, and the Board of Directors recently chose to terminate the CEO.
We like HMHC’s core business of publishing K-12 textbooks in the U.S., but the former CEO, who previously worked at Microsoft, chose to expand the business into the Educational Technology industry by purchasing a division from Scholastic Corp. In our opinion, this acquisition has taken management’s eye off the core business, and the former CEO paid a substantial premium to acquire the business. Nonetheless, we believe the board now understands it needs to find an operator who can manage the core business and generate the kind of free cash flow we believe is reasonably possible for HMHC, given the concentrated competitive landscape and barriers to entry. We have materially increased the Fund’s position in HMHC since our initial purchase and as the stock declined closer to our downside-case scenario level.
From FPA Capital's fourth quarter 2016 commentary.
