Of all the data contained in hedge fund 13F filings published over the past few weeks for trading activity conducted during the last quarter of 2016, there is one trend that really stands out.
In the value-oriented hedge funds sector, there seems to be one stock all value investors love, and they are all in the position in a big way. Such a large number of value hedge fund managers chasing the same company in a concentrated way leads me to believe it actually is undervalued.
Undervalued play
The company I am talking about is Allergan (AGN, Financial). Based on 13F SEC filings published for the end of last year, David Tepper (Trades, Portfolio), Seth Klarman (Trades, Portfolio), Wallace Weitz (Trades, Portfolio), Leon Cooperman (Trades, Portfolio), John Griffin (Trades, Portfolio) and Carl Icahn (Trades, Portfolio) all had positions in the stock, among others. Tepper’s Allergan holding is by far the highest conviction with 16.7% of his equity portfolio now devoted to the stock, a total of 4.3 million shares.
During the fourth quarter, Tepper upped his position by 250%. Klarman also has a large stake in Allergan. At the end of the fourth quarter, shares in the company amounted to 9.5% of his equity portfolio. Like Tepper, Klarman increased his position in the company by 71.5% during the last quarter of 2016. Weitz’s stake in Allergan amounts to 7.4% of his portfolio.
So, these value hedge fund managers that have made billions of dollars for their investors over the years like the look of Allergan, but what is so attractive about the company and should you buy in?
Time to buy?
In a recent interview with CNBC, Tepper revealed the reason why he liked Allergan was the stock’s attractive valuation. As 13F filings are a historic snapshot of a fund’s equity positions, it is impossible to achieve the same valuation as Tepper did when he first bought. During the fourth quarter, shares in Allergan traded down as low as $185, compared to $235 at time of writing, a gain of 27%. Even after these gains, the company's shares still look cheap.
Allergan’s value is not in its current valuation. The stock does not look particularly cheap trading at a forward price-earnings (P/E) ratio of 14.2, compared to the pharmaceutical industry average of 15. The EV/EBITDA and price to free cash flow ratios are similarly unattractive at 21.5 and 71.8.
Where the value is to be found is in Allergan’s growth. Over the past six years, revenue has grown from $4.6 billion to $14.6 billion and is expected to increase to $16.5 billion for full-year 2018. Over the same period, net profit is projected to hit $6.3 billion by 2018, up from $261 million in 2011.
These figures are relatively irrelevant compared to how much value Allergan’s management has created on the balance sheet over the same period. Specifically, between 2011 and year-end 2016, the company’s book value per share has exploded from $28 to $213, a compound annual growth rate of 50%. This book value includes intangible assets.
Now, there is no guarantee this growth of 50% per annum will continue going forward, but Allergan has a low level of net gearing of 26.3%, giving the business room to expand through bolt-on acquisitions and reinvestment of cash flows into stock buybacks. This is where I believe Tepper and Klarman see value.
Rather than investing in the company as it is today, these two billionaire hedge fund managers are investing in Allergan’s future, betting that management’s wealth creation over the past five years will continue going forward. There are very few other businesses that have been able to compound wealth as efficiently as Allergan. There is no guarantee it will continue, but the company has all the tools at its disposal required to keep growing at a rapid rate.
Disclosure: The author owns no stock mentioned.
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