Oak Value Top Purchases: ACTIVISION BLIZZARD INC, Intuit Inc., XTO Energy Inc., ITT Educational Services Inc. (ESI), and Monsanto Company
Oak Value Fund invests in businesses that are of high quality, growing, and predictable. The fund returned 33.41, 0.87, 2.86, and 8.84% for the past 1, 5, 10 years and since inception on 1/18/1993, beating the S&P 500’s 26.46, 0.42, -0.95, and 7.76% in the respective periods.
The Fund is managed by a team that consists of David Carr, Larry Coats, and Christy Phillips. The managers commented in the quarterly review their recent purchases:
ACTIVISION BLIZZARD, INC (ATVI)
Activision Blizzard - Activision is a leading publisher of interactive products that belong to the genre that was once called “video games,” although that term seems increasingly quaint. Activision Blizzard publishes online games, games for PCs, console games, and games for handheld devices.
The company has two distinct segments—Activision and Blizzard. Activision is in the business of developing, marketing and selling interactive games in numerous mainstream categories such as action/adventure, action sports, racing and music, often through third-party publishers. The Activision brand is associated with some extremely well known franchises, such as “Guitar Hero” and “Call of Duty.” The Blizzard business is geared more toward developing, marketing and selling role-playing action and strategy games. The most well-known franchise in this category is Blizzard’s “World of Warcraft,” the massively multiplayer online role-playing game, or “MMORPG” in industry parlance.
With World of Warcraft, Activision Blizzard is the industry leader in subscriber-based game entertainment. This large and growing subscriber base of recurring revenues is an important component of our investment thesis in the company. We believe that the success of the World of Warcraft subscriber-based revenue model suggests that the historically hit-driven model that has been the core of the interactive gaming industry since its genesis will evolve toward a much more stable and more profitable economic model over time. In our opinion, Activision Blizzard, as the industry leader in the category, is very well positioned to take advantage of this gradual evolution.
More broadly, the company has attractive product offerings across price points, demographic segments and delivery channels. Activision Blizzard management has demonstrated great prowess in opportunistically acquiring companies and products that provide strategic or complimentary intellectual property and market opportunities. Additionally, we are encouraged by the growth of online content delivery, as this channel strengthens the direct ties with the consumer and reduces the risk of piracy and the dilutive effects of used game sales through retailers.
We have followed the interactive entertainment software industry for several years as it has consolidated and its customer base has expanded. In the case of Activision Blizzard, the financial results of the company have continually improved, reflecting its competitive advantages and improving business model. Amid the economic downturn, near-term industry growth has slowed and the historically lofty valuations of many of the companies in the segment have contracted. Looking forward, we expect Activision Blizzard to retain its position as an industry leader both in the U.S. and abroad. With more than half of its revenues being generated outside the U.S., the company should continue to demonstrate the benefits of scale and reach. In our opinion, the inevitable evolution in the technology used to develop, deliver and play these games will likely inure to the benefit of Activision Blizzard’s customers and shareholders. As opportunistic buyers of advantaged businesses, we view the recent share price weakness that has resulted from near-term economic headwinds and tough year-over-year comparisons as an attractive window of opportunity.
Intuit Inc. (INTU)
Intuit - Intuit is a leading provider of business and financial management solutions for a broad array of end users, including small and medium-sized businesses, consumers, accounting professionals, and financial institutions. The company is best known for its widely used flagship products QuickBooks, Quicken, and TurboTax, which help customers manage processes and tasks such as payroll, payments, personal finance, tax preparation and tax filing.
Intuit is focused on delivering technology and functionality to provide users with easy-to-use products at relatively low costs. In our opinion, this is a very attractive value proposition. Building on the foundation of its flagship products, the company has listened to its customers and responded with additional products and services that increase the value of each customer relationship. With a very large installed customer base, Intuit benefits from significant economies of scale in the development and distribution of these offerings. Furthermore, the stickiness of the company’s products has served to create a significant barrier to entry in the high switching costs that customers face when considering alternatives. As is the case with any company that provides technology solutions, changes in the technology landscape represent both threats and opportunities. Intuit has embraced the migration of its product offerings to the online platform and has effectively demonstrated the ability to use this platform to broaden its customer base.
One of the benefits of a large installed customer base is the opportunity to listen to what the customers want and need. In doing so, Intuit has expanded its product offering into payroll processing and payment processing for small businesses. In partnership with commercial banks, the company has rapidly expanded the functionality of its personal finance products to allow users to seamlessly integrate their personal financial management with their online banking relationships. In healthcare, the company has recently introduced products to assist insurance companies and their customers in understanding, tracking, and processing health insurance-related transactions.
Intuit is a highly profitable company that produces high operating profit margins, high returns on capital and significant free cash flow. Though the company has gone through a period of transition and currently faces the prospect of continued headwinds in a sluggish domestic environment, we believe its long-term growth prospects remain favorable. Small business creation in the U.S., a significant long-term growth opportunity for the company, will likely remain under pressure for some time. Meanwhile, we believe the company’s ability to leverage new product offerings to greater penetration across its existing customer base and the opportunity to expand its market share in general will provide shareholders with attractive growth potential.
In our opinion, the prospects for renewed small business creation in the U.S. and the potential for the company to expand its small presence outside the U.S. are “icing on the cake.”
As long-time admirers of the company and users of its products, we welcome the opportunity for the Fund to invest in this advantaged business at a price that we believe is a significant discount to the company’s longterm intrinsic value. There will be bumps along the way, and the company’s results and shares are susceptible to volatility around the tax season. Our investment thesis acknowledges the potential for these near-term fluctuations but is focused squarely on the long-term value of the company and its potential to provide increased value for its shareholders.
XTO Energy Inc. (XTO)
XTO Energy - Nearly a year after our initial investment in the natural gas industry through Chesapeake Energy, we added shares of XTO Energy to the Fund portfolio during the quarter. Though the specifics of the company and its positioning are somewhat distinct from that of Chesapeake, our investment thesis for XTO is very similar. We believe that natural gas provides a viable and abundantly available alternative as our country continues to grapple with the realities of energy dependency. It is cleaner than coal and less expensive than oil. The combination of advanced drilling technologies and significant discoveries of reserves in the shale fields in recent years have resulted in a significant increase in the amount of natural gas available within the U.S. Simply, the natural gas from shale fields is less expensive to access and deliver as a result of the technology used and the proximity of the fields to major centers of population. XTO has a very attractive portfolio in its legacy assets but perhaps more importantly are the company’s unproved reserves located in the major shale areas. We have learned more and more about the advantages of horizontal drilling from companies like XTO and Chesapeake Energy, as they have been able to demonstrate the ability to be a low-cost provider by driving their finding costs down year over year with the advances in technology. This low-cost provider status combined with the right portfolio of opportunity is a key component to the Fund’s second investment in an onshore natural gas provider.
Not only did we take an initial interest and position in XTO shares, but so did Exxon Mobile (XOM). Shortly after our initial investment in XTO, Exxon made an all stock offer to acquire the company. In announcing its largest acquisition since the Mobil transaction ten years ago, Exxon stated that its interest is motivated by scale and resource growth upside. It claims that XTO has a total resource potential of 45.1 tcfe (“Trillion Cubic Feet Equivalents”) compared to XTO’s proved reserves of 13.9 tcfe at the end of 2008. In addition to the growth opportunity, we also think Exxon is acknowledging XTO’s strong position in both technical capabilities and operating an organization.
While we believe the price that Exxon is paying for XTO falls short of the true value of the business, it does underscore the acceptance of the shale plays. It goes a long way toward recognizing value for shale owners as ongoing fields convert from unproved to proved reserves. This transaction by Exxon truncated our ability to view this investment as anything larger than an initial position. Meanwhile, we believe the Fund’s recently increased position in Chesapeake Energy continues to provide shareholders with the opportunity to benefit from the advantages of the shale portfolios and advances in technology.
Other Top Purchases
Besides the stocks discussed thus far, Oak Value Fund also purchased ITT Educational Services Inc. (ESI) (add 1.5% of the portfolio to a total of 62,225 Shares) and Monsanto Company (MON) (add 1.41% of the portfolio to a total: 89,725 Shares).
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