Longleaf Partners Small-Cap Fund gained 3.93% in the first quarter and outperformed the Russell 2000 Index’s 2.47%. Our absolute return surpassed our annual absolute goal of inflation plus 10%, continuing the strong performance from 2016. We exceeded the market’s return thanks to strong performance from key holdings and pullbacks from some of the “Trump rally” highfliers that we did not own.
Companies with substantial non-earning assets (NEAs) were particularly rewarding in the quarter. Wynn Resorts, Graham Holdings, and OCI all have or had a number of assets that were not reflected in a simple earnings per share (EPS) calculation, and they also are run by owners who are willing to think long-term. One of the largest contributors over the last 12 months — Formula One Group (formerly Liberty Media Group) — started off as an NEA-heavy company before its great acquisition of Formula One turned non-earning cash into what will be a strong free cash flow generation business.
We did not buy any new securities and only added to two existing investments in the quarter. We trimmed five positions and exited another three. Our on-deck list is smaller than usual, but we are following closely a few capably led, strong businesses that would be in our buying range with just a little price pull back.
Contributors/Detractors
(1Q portfolio return; 1Q Fund contribution)
Wynn Resorts (WYNN, Financial) (+33%, +1.78%), the luxury gaming and hotel operator with prime properties in Las Vegas, Macau, and Boston, was the largest contributor in the quarter. Macau’s rebound continued, as that market now has grown for several months, some at double-digit rates. Wynn’s Palace property is ramping up from non-earning status more quickly than expected and gaining share as the premium property in Macau. Las Vegas continues to be a steady market, and the company is making progress on developing and monetizing its under earning golf course land. Wynn also is likely to benefit from the NFL coming to Las Vegas. Construction on the Boston resort is moving ahead as planned. Wynn has a large amount of optionality, and we are confident that CEO Steve Wynn and his team can maximize our outcome. Given the price strength and the position size, we trimmed the stock in the quarter.
Graham Holdings (GHC, Financial) (+17%; +0.95%), the media, education, and services company, was another contributor in the quarter. The Kaplan International segment reported relatively good results for the first time since 2015 and showed signs of having bottomed out as cost cuts should kick in this year. Graham’s TV segment continued to deliver industry-leading results, and the market began to anticipate TV consolidation opportunities under a less regulatory administration. We applaud CEO Tim O’Shaughnessy for buying back a meaningful amount of stock at discounted prices last year, and we are excited about his ability to go on offense with Graham’s formidable balance sheet.
Formula One Group (+9%; +0.59%), the media and entertainment company controlled by Liberty Media Corporation and formerly named Liberty Media Group, contributed positively in the company’s first quarter as the owner of the global car racing business, Formula One (F1). While there was only one race late in the quarter, our management partners were hard at work making positive changes from day one of their 100% ownership of F1. F1 CEO Chase Carey significantly upgraded his team, adding racing legend Ross Brawn and former ESPN executive Sean Bratches to work on the sport’s competitiveness and revenue maximization, respectively. The company also refinanced high cost debt to a lower rate and longer term. Formula One still owns a 34% stake in Live Nation, which reported a somewhat disappointing quarter but remains on track to grow nicely going forward.
Although several of our investments slightly declined in the quarter, none significantly detracted from the Fund’s return.
Portfolio Changes
We sold Triangle Petroleum, Tribune Media, and Rayonier in the quarter. We exited Triangle, an oil and gas company, and recognized a loss when we were unwilling to put further capital into the business because of a lack of confidence in several qualitative aspects of the investment case after we had gotten to know the company better. Our second time owning media company Tribune (TRCO, Financial) was not nearly as gratifying as our first successful investment in the company’s bonds as it came out of bankruptcy. This time, our value declined due to disappointing results at the TV division, a weak spectrum auction, and a lack of value growth from other assets. Our small positive return amid these disappointments speaks to the margin of safety in our initial purchase. We also sold timber REIT Rayonier (RYAM, Financial) late in the quarter after the company issued equity at a price that reinforced our assessment that the stock was at or near fair value. Over the three years we held the stock, a challenging timber environment hindered value growth, and while the discount we paid plus the dividend helped preserve our capital, our 12% total return was less than we anticipated.
Outlook
Our P/V ratio is higher than usual in the mid-70s%. We also are holding a 26% cash position. While both of these numbers could seem discouraging at first glance, we feel that the strong businesses we own and the superior management teams running them will be able to grow their values per share at above average rates. If times get tougher, we have stronger-than-usual balance sheets that will allow our investees to go on offense. Our cash will eventually turn into our next great qualifiers. We cannot tell you when that will happen, but we are confident that our patience will be rewarded as it has in the past.
