Mason Hawkins had a very good quarter with Longleaf Funds. All of his three funds outpaced their respective indices, and the Small-Cap Fund and International Fund also significantly outperformed their inflation plus 10% absolute annual return goal. These are his commentaries on Dell, Direct TV and Nikko Cordial.
Mason Hawkins on Dell (DELL, Financial)
The Fund's largest position, Dell, declined during the quarter. Kevin Rollins resigned and Michael Dell has taken the reins as CEO. Dell has brought in several new senior managers, is improving customer support, and is focused on restoring margins and sales growth to previous levels. While the outcome of the SEC's investigation of Dell's accounting is uncertain, we believe that the company's competitive advantages remain in place, i.e. being the low cost provider via the direct sale model and having an entrenched distribution network with unique access to small and mid-sized customers. Even in what was arguably a bleak year, the company earned $3.7 billion in free cash flow and had margins, albeit depressed, that were higher than its competitors (in the case of HP, this excludes the printer cartridge business.) Our appraisal is significantly higher than the current price, and as the business improves and the company repurchases shares, Dell's intrinsic value should grow meaningfully.
Mason Hawkins on DIRECTV (DTV, Financial)
DIRECTV, one of the Fund's best performers in 2006, gave back some gains in the first quarter. DIRECTV continued to add high-quality subscribers and realize excellent pricing. Our appraisal of the company grew, and we watched Chase Carey exhibit his commitment to building value by repurchasing a large number of shares as they became cheaper.
Mason Hawkins on Nikko Cordial
Nikko Cordial, Japan's third largest brokerage firm, contributed most to the quarter's performance. The market's overreaction to penalties imposed by the Japanese regulator, the FSA, upon Nikko Cordial in the fourth quarter of last year allowed us to rapidly accumulate a sizeable position in a company with a tarnished reputation, but with a pristine balance sheet and a valuable franchise. In March Citigroup made a bid for all of Nikko Cordial's outstanding shares, and raised the bid after the announcement that the company's shares would not be delisted. The revised offer of 1,700 yen per share remains below our appraisal, but represents a substantial premium to the Fund's cost. Citigroup's bid was outstanding at the end of the quarter.
The Nikko Cordial experience validates components that underpin all of our Japanese investments. First, the tide of large-scale, cross-border mergers and acquisitions that has swept most of the developed world has touched Japan's shores. The tide may not move as fast as we would like, but we believe it is irreversible. Second, courts and regulators increasingly uphold and protect shareholder rights. Third, despite a multi-year malaise, the Japanese financial markets provide substantial opportunities to managements who provide innovative solutions to Japan's savers, as Nikko Asset Management's success has proven. Fourth, despite recent increased attention from investors, the Japanese market remains surprisingly inefficient given its size and maturity. Finally, executives of undervalued companies increasingly are being held accountable, and in some cases, are being replaced by managers, whether inside or outside of Japan, who think they can do a better job.
Mason Hawkins on Dell (DELL, Financial)
The Fund's largest position, Dell, declined during the quarter. Kevin Rollins resigned and Michael Dell has taken the reins as CEO. Dell has brought in several new senior managers, is improving customer support, and is focused on restoring margins and sales growth to previous levels. While the outcome of the SEC's investigation of Dell's accounting is uncertain, we believe that the company's competitive advantages remain in place, i.e. being the low cost provider via the direct sale model and having an entrenched distribution network with unique access to small and mid-sized customers. Even in what was arguably a bleak year, the company earned $3.7 billion in free cash flow and had margins, albeit depressed, that were higher than its competitors (in the case of HP, this excludes the printer cartridge business.) Our appraisal is significantly higher than the current price, and as the business improves and the company repurchases shares, Dell's intrinsic value should grow meaningfully.
Mason Hawkins on DIRECTV (DTV, Financial)
DIRECTV, one of the Fund's best performers in 2006, gave back some gains in the first quarter. DIRECTV continued to add high-quality subscribers and realize excellent pricing. Our appraisal of the company grew, and we watched Chase Carey exhibit his commitment to building value by repurchasing a large number of shares as they became cheaper.
Mason Hawkins on Nikko Cordial
Nikko Cordial, Japan's third largest brokerage firm, contributed most to the quarter's performance. The market's overreaction to penalties imposed by the Japanese regulator, the FSA, upon Nikko Cordial in the fourth quarter of last year allowed us to rapidly accumulate a sizeable position in a company with a tarnished reputation, but with a pristine balance sheet and a valuable franchise. In March Citigroup made a bid for all of Nikko Cordial's outstanding shares, and raised the bid after the announcement that the company's shares would not be delisted. The revised offer of 1,700 yen per share remains below our appraisal, but represents a substantial premium to the Fund's cost. Citigroup's bid was outstanding at the end of the quarter.
The Nikko Cordial experience validates components that underpin all of our Japanese investments. First, the tide of large-scale, cross-border mergers and acquisitions that has swept most of the developed world has touched Japan's shores. The tide may not move as fast as we would like, but we believe it is irreversible. Second, courts and regulators increasingly uphold and protect shareholder rights. Third, despite a multi-year malaise, the Japanese financial markets provide substantial opportunities to managements who provide innovative solutions to Japan's savers, as Nikko Asset Management's success has proven. Fourth, despite recent increased attention from investors, the Japanese market remains surprisingly inefficient given its size and maturity. Finally, executives of undervalued companies increasingly are being held accountable, and in some cases, are being replaced by managers, whether inside or outside of Japan, who think they can do a better job.
