To Our Shareholders,
For the quarter ended December 31, 2014, the net asset value (“NAV”) per Class A Share of The Gabelli Value 25 Fund Inc. increased 4.0% compared with increases of 4.9% and 5.2% for the Standard & Poor’s (“S&P”) 500 Index and the Dow Jones Industrial Average, respectively. See page 2 for additional performance information.
Annual (P)review
More than in previous years, 2014 offered many surprises, both positive and negative. We suspect few prognosticators correctly predicted more than a handful of the headline economic indicators below:
As bottom up stock pickers, we didn’t hazard guesses at these numbers last year and we won’t again this year. However, we were admittedly surprised at just what a constructive environment for U.S. stocks it turned out to be. With no other context, a year end perusal of the first six statistics would indicate that the U.S. economy should be on increasingly firmer footing. The market, it seems, got it right in 2014.
Unfortunately, that conclusion is made in a vacuum with the benefit of hindsight. Reality has been more eventful — skirmishes in the Ukraine, ISIS’ reign of terror in the Middle East and the spread of the Ebola virus added plenty of what, for now, appears to have been noise to the investment mosaic. More recently, the 40%+ crash in oil prices has been a focus. This development has spurred important questions about what triggered the decline and how it might affect the global economy. Have prices collapsed because of increased supply, in part from growth of U.S. shale production, and strategic inaction by the Saudis, or has demand abated due to a slowdown in global growth? Will lower prices lead to greater political instability in places like Russia, the Middle East and Venezuela? Can savings by the consumer at the pump offset the negative impact of oil industry job losses and investment cuts? The answers to these questions are as yet unclear.
Notwithstanding the uncertainty around the culprits and implications for falling commodity prices, today’s leading indicators would lead one to believe that the odds of continuing improvement in the U.S. economy have increased. But world events could be more than just distractions for the market in 2015. Sometimes noise is meaningful and sometimes…it’s just noise. Our job as analysts is not to make idle predictions, but to construct an adaptable world view that is informed by new and changing data and to make stock selections based on that view.
All this reinforces our belief in two differentiating aspects of our process and philosophy. First, we are fundamentally bottom up stock pickers. We have chosen to focus on the companies in a subset of industries in which sustainable competitive advantages can be cultivated. Volatile and unpredictable crude prices, for example, are reasons we tend to avoid the energy sector and gravitate to less commoditized industries. Second, we are value investors. Our contribution to the body of work begun by Benjamin Graham and David Dodd has been the concept of Private Market Value (PMV) with a CatalystTM – we seek businesses selling in the public markets at a substantial discount to their PMVs and for which we can identify one or more events that will narrow that discount. We tend to gravitate toward hard assets and cash flow and away from visions of grandeur that may or may not occur in the future.
What Worked in 2014
Our focus on financial engineering and dealmaking bore fruit last year. In January, our ownership of Beam Inc. was rewarded when Suntory of Japan offered to purchase Beam at $83.50 per share, a transaction which closed on the last day of April. In May, the remaining piece of Sara Lee, known as Hillshire Brands, made an ill-advised bid for Pinnacle Foods. Hillshire’s management path to remain independent, as the company approached its two year anniversary as a public company, backfired. It led (much to our delight) to a bidding war between JBS’ Pilgrim’s Pride and Tyson Foods, with Tyson Foods the victor. Tyson’s purchase of Hillshire at $63 per share closed in July. In media, DIRECTV (2.8% of net assets as of December 31, 2014), once a tracker stock of General Motors, then a holding of Dr. John Malone’s Liberty Entertainment, agreed to a sale to AT&T for $95 per share in cash and stock. Dr. Malone continued to be the most prolific financial engineer, giving birth to two new companies, Liberty TripAdvisor and Liberty Broadband (0.6%), while repositioning other assets.
Other Fund holdings announced restructurings including The Madison Square Garden Co. (2.8%), itself a February 2010 spin-off of Cablevision (2.2%), which is evaluating the separation of its entertainment segment from its Sports and its Entertainment segments. Graham Holdings Company (0.8%), formerly the Washington Post Company, announced it would spin-off its cable unit in a year in which it was rewarded for concluding a cash-rich split-off transaction with Berkshire Hathaway. Energizer (1.5%) announced it would split its Household Products and Personal Care businesses, with each company possibly following the path of Sara Lee into the arms of acquirers. Finally, in the fourth quarter, Chemtura (0.7%) completed the sale of its AgroSolutions business and launched a Dutch auction to re-deploy cash via a capitalization shrink. Many other holdings have catalysts in place, with Sony Corp. (1.4%), CBS (4.3%) and Viacom (7.1%), among others, prime candidates for change.
The Fund’s returns, relative to its benchmark, were negatively impacted by our investment in small capitalization stocks and our underweighting of certain strongly performing sectors including utilities and biotechnology. In keeping with the philosophy outlined above, we do not allocate assets to market sectors on a top-down basis. Unfortunately, at times areas where we possess accumulated compounded knowledge fall out of favor — 2014 was one of those periods. While small caps and media, for example, might not immediately revert to market leadership, over an investment cycle we are confident our stock selection in those areas will be rewarded.
Let’s Talk Stocks
The following are stock specifics on selected holdings of the Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the percentage of net assets and their share prices are presented as of December 31, 2014.
AMC Networks Inc. (1.9% of net assets as of December 31, 2014) (AMCX, Financial)(AMCX – $63.77 – NASDAQ) owns and operates cable networks AMC, WE tv, IFC, and The Sundance Channel. In addition, the company owns IFC Entertainment, an independent film distribution company, and AMC Networks Broadcasting & Technology, a network programming feed origination and distribution company. The AMC channel is highly rated, and has benefited from growing popularity in an attractive and affluent demographic, which should aid advertising sales. AMC offers the potential for levered equity returns, and could be an attractive acquisition candidate to a number of large cable network operators.
CBS Corp. (4.3%) (CBS, Financial)(CBS – $56.36 – NYSE) operates the CBS television network and the premium cable network Showtime and it owns 29 local television stations and 130 radio stations. We believe CBS has a number of opportunities to generate incremental non-advertising revenue from the sale of existing content to online video distributors (OVDs) and the retransmission of content agreements with traditional distributors. In addition, we expect a continued recovery in advertising to contribute to earnings growth. Finally, we believe financial engineering, including the announced $3 billion share buyback, could act as a catalyst for shares.
Energizer Holdings Inc. (1.5%) (ENR, Financial)(ENR – $128.56 – NYSE) became an independent company after it was spunoff from Ralston Purina in April 2000. Energizer manufactures, markets and sells dry cell batteries and lighting products worldwide. Subsequently, Energizer expanded its product portfolio through acquisitions, including Schick-Wilkinson Sword (2003), Playtex (2007), Edge/Skintimate (2009), American Safety Razor (2010), and most recently, Johnson & Johnson’s feminine hygiene brands (2013). Today, Energizer reports results for two segments: Household ($1.8 billion of revenue), which includes the domestic and international battery businesses and Personal Care ($2.6 billion), which includes wet shaving, skin, feminine and infant care. In April 2014, ENR announced its intention to split the company into two publicly traded firms through a tax-free spinoff of the Household division. The transaction is expected to be completed by July 2015. This may be the first step in realizing the full value of the two businesses, as both divisions may be more attractive acquisition candidates on a standalone basis.
Genuine Parts Co. (2.2%) (GPC, Financial)(GPC – $106.57 – NYSE) is an Atlanta based distributor of automotive and industrial replacement parts, office products, and electrical and electronic components. We expect GPC’s well known NAPA Auto Parts group to benefit as an aged vehicle population, which includes the highest percentage of off warranty vehicles in history, helps drive sales of automotive aftermarket products over the next several years. Additionally, economic indicators remain supportive of the company’s industrial and electrical parts distribution businesses amid steady economic expansion. Finally, GPC’s management has shown consistent dedication to shareholder value via share repurchases and dividend increases.
Liberty Global plc (1.0%, 1.4%) (LBTYK, Financial)(LBTYK – $48.31 – NASDAQ, LBTYA – $50.21 – NASDAQ) is the leading international cable operator, offering advanced video, telephone, and broadband internet services. The company operates broadband communications networks in 14 countries, principally located in Europe under the brands UPC, Unitymedia (Germany), Virgin (UK), Telenet (Belgium), and VTR (Chile). As part of its June 2013 acquisition of Virgin Media, Liberty Global redomiciled in the UK, increasing its strategic flexibility in the future. The company is internationally focused and well positioned to capitalize on the growing demand for digital television, broadband internet, and digital telephony services in markets across its diverse geographic footprint. The company closed its acquisition of Netherlands cable operator Ziggo, among its largest to date, in November 2014. In an effort to surface additional value, in early 2015 Liberty Global is expected to issue a stock tracking its Latin American operations.
Madison Square Garden Co. (2.8%) (MSG, Financial)(MSG – $75.26 – NASDAQ) is an integrated sports and media company that owns the MSG networks (MSG/MSG+ and Fuse), the New York Knicks, the New York Rangers, the Radio City Christmas Spectacular, and the iconic New York venue, Madison Square Garden. These evergreen content assets benefit from sustainable barriers to entry and long term secular growth. We believe the now completed Transformation project and the rising value of sports programming, as demonstrated by the NBA’s recently contract renewal with TWX & DIS, will dramatically increase MSG’s earnings power through 2018.
Rolls-Royce Holdings plc (1.8%) (RR, Financial)(RR – $13.56 – London Stock Exchange) provides jet engines, power and propulsion systems, and services to commercial aviation, defense, marine, oil, and gas, and other industries. RR has leading engine positions as the sole supplier on the Airbus A350 and one of two suppliers on the Boeing 787 Dreamliner, two new wide body programs with healthy backlogs, to be delivered over the next decade. A recently announced re-engineering of the A330 will extend one of RR’s most profitable engine programs, with RR as the exclusive engine supplier. Engine deliveries lead to recurring, higher margin parts and service revenues, which benefit the company more than twenty years after new engines are delivered. RR’s stock continues to struggle given recent mid-term guidance that calls for no pick up in earnings and cash flow until at least 2016, given aerospace investments and weak demand in power and marine. Notwithstanding near term headwinds, we believe that over the next decade, RR will see substantial growth in its civil aerospace operations, accompanied by improved margins approaching the levels of its peers. Recent portfolio changes have been positive, including the two billion GBP acquisition of Daimler’s 50% interest in Rolls-Royce Power Systems and the one billion GBP sale of the energy aero-derivative gas turbine business to Siemens. RR recently started a one billion GBP repurchase program with the proceeds from the energy sale.
Ryman Hospitality Properties Inc. (RHP, Financial)(1.1%) (RHP – $52.74 – NYSE) is a Nashville, Tennessee based REIT that owns convention hotels in Nashville, Tennessee; Orlando, Florida; Dallas, Texas; and Washington, D.C. Other assets include the iconic Opryland, the famous Ryman Auditorium, the General Jackson Showboat, Gaylord Springs Golf Links, and Nashville based radio station WSM-AM. With property manager Marriot’s operational issues resolved, the team is now focused on driving margin expansion by increasing occupancy and room rates. Finally, as the leading country music entertainment brand, a potential spin-off of the Opry segment, including the Grand Ole Opry, also remains a significant possible catalyst for RHP shares.
Swedish Match AB (2.5%) (SWMA, Financial)(SWMA – $31.40 – Stockholm Stock Exchange) produces tobacco products that include snus and snuff, chewing tobacco, cigars, and lights. The company has been benefiting from the growth of the smokeless tobacco market in both Scandinavia and the U.S., as public smoking bans and health concerns are driving consumers to seek alternative tobacco products to cigarettes. In February 2009, Swedish Match created a joint venture with Philip Morris International to sell Swedish snus in markets around the world, taking advantage of Swedish Match’s brands and production capabilities and Philip Morris International’s distribution network. In September 2009, the company sold its South African pipe tobacco business to Philip Morris International for about 1.9 billion SEK, and it is using most of the proceeds to repurchase shares. In October 2010, Swedish Match combined its European and premium cigar portfolios with Scandinavian cigar and pipe tobacco company STG, creating a new company that will benefit from enhanced scale and synergies. The company’s standstill with STG expired in October 2014, so Swedish Match now has the flexibility to opportunistically monetize this asset. As a more focused company, we expect Swedish Match to grow sales and earnings over time as the smokeless tobacco category continues to develop.
Vivendi SA (1.4%) (VIV, Financial)(VIV – $25.04 – NYSE) is a French media and telecommunications holding company in the late stages of a decade long transition. In December 2014, the company sold its French wireless operation, SFR, to French cable operator Numericable. Vivendi also reached an agreement to sell its Brazilian telecom operator, GVT, to Telefonica. After closing the GVT sale, Vivendi will be a more focused media firm, consisting of Canal+ (a Francophone focused pay television network owner and distributor), Universal Music Group (UMG), the number one recording music company and number two music publishing entity in the world. While operating conditions have been challenging in most of Vivendi’s businesses, it appears their trajectory is finally turning more positive and should be supported by a healthier balance sheet.
Investment Scorecard
The top contributor to performance for 2014 was The Madison Square Garden Co. (2.8% of net assets as of December 31, 2014) (+31) which posted strong results, named a new CEO and initiated a potential splitup of the company. As referenced above, takeover targets DIRECTV (2.8%) (+25%), Hillshire Brands (+90%), and Beam Inc. (+23%) also contributed. Other strong performers included automotive parts distributor Genuine Parts (2.2%) (+31%) which did well in a benign consumer environment, Republic Services (2.3%) (+25%) which benefitted from an increase in economic activity and steady share repurchase program, Time Warner (1.7%) (+30%) which spurned a takeover offer from Twenty-First Century Fox (2.5%) and DISH Network (1.3%) (+26%) whose spectrum values began to be appreciated by the market. Media holdings Viacom (7.1%) (-13%), CBS (4.3%) (-11%) and Discovery Communications (1.0%) (-20%) detracted from performance as they reported soft advertising trends and are plagued by concerns over a potential shift in consumer viewing behavior. Other detractors from performance included Rolls-Royce (1.8%) (-34%) which committed execution missteps against a background of weak defense and marine markets, Flowserve (1.0%) (-23%) and Circor (1.1%) (-25%) which were impacted late in the year by the fall in oil prices, and Diageo (2.7%) (-11%) which faced slowing emerging markets growth.
Conclusion
While most signs point towards an improving U.S. economy, certain geopolitical dynamics are concerning. The market’s response to the potential for increased interest rates is also in question. As a result, 2015 is likely to be a volatile year in which we will seek opportunity. Our focus remains on generating superior tax efficient, inflation adjusted returns by relying upon our time tested people, process and Private Market Value (PMV) with a CatalystTM philosophy. Our embrace of this philosophy and process has demonstrated superior returns over the history of our firm, and we have confidence this should remain the case in the future.
January 8, 2015
Note: The views expressed in this Shareholder Commentary reflect those of the Portfolio Managers only through the end of the period stated in this Shareholder Commentary. The Portfolio Managers’ views are subject to change at any time based on market and other conditions. The information in this Portfolio Managers’ Shareholder Commentary represents the opinions of the individual Portfolio Managers and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. Views expressed are those of the Portfolio Managers and may differ from those of other portfolio managers or of the Firm as a whole. This Shareholder Commentary does not constitute an offer of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this Shareholder Commentary has been obtained from sources we believe to be reliable, but cannot be guaranteed. Minimum Initial Investment – $1,000 The Fund’s minimum initial investment for regular accounts is $1,000. There are no subsequent investment minimums. No initial minimum is required for those establishing an Automatic Investment Plan. Additionally, the Fund and other Gabelli/GAMCO Funds are available through the no-transaction fee programs at many major brokerage firms. The Fund imposes a 2% redemption fee on shares sold or exchanged within seven days after the date of purchase. See the prospectuses for more details.
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The Fund’s Nasdaq symbol is GABVX for Class A Shares. Please call us during the business day, between 8:00 AM – 7:00 PM (Eastern Time), for further information. e-delivery We are pleased to offer electronic delivery of Gabelli fund documents. Direct shareholders of our mutual funds can elect to receive their Annual and Semiannual Reports, Manager Commentaries, and Prospectus via e-delivery. For more information or to sign up for e-delivery, please visit our website at www.gabelli.com.
Multi-Class Shares The Gabelli Value 25 Fund began offering additional classes of Fund shares on March 15, 2000. Class AAA are no-load shares available directly through selected broker/dealers. Class A and C Shares are offered to investors who seek advice through financial consultants. Class I Shares are available directly through the Fund’s distributor or brokers that have entered into selling agreements specifically with respect to Class I Shares. The Board of Directors determined that expanding the types of Fund shares available through various distribution options will enhance the ability of the Fund to attract additional investors.
