To Our Shareholders,
For the quarter ended March 31, 2015, the net asset value (“NAV”) per Class AAA Share of The Gabelli Asset Fund increased 0.8% compared with an increase of 1.0% for the Standard & Poor’s (“S&P”) 500 Index. See page 2 for additional performance information.
Commentary
In a somewhat volatile quarter, with both macro and company specific headlines affecting stock prices, the market rose marginally. In January, the Swiss National Bank discontinued its minimum exchange rate peg of CHF 1.20 per euro, and later that month the European Central Bank announced that it was expanding its asset purchase program to include bonds issued by euro-area central governments, agencies, and European institutions. The combined effect of these two events led the U.S. dollar to substantially strengthen against the euro, going from $1.21 at the end of 2014 to $1.08 at the end of March. This dynamic will create a meaningful currency headwind for U.S. based multinationals with exposure to the eurozone and with currencies that have fallen against the dollar, such as Great Britain, Russia, and Latin American currencies. At the same time, the U.S. economy continued to strengthen, with GDP growth of 2.4% in 2014 and unemployment declining to 5.5%. Many large U.S. employers, including McDonald’s and Walmart, announced wage increases, boding well for consumer purchasing power but at the same time raising concerns about eventual inflation.
Several holdings in the Fund made progress with financial engineering transactions that we believe will benefit shareholders. Madison Square Garden (1.1% of net assets as of March 31, 2015) provided further details on the planned spin-off of its Sports and Entertainment businesses from Media Networks, which we believe will help to surface value in both entities. Additionally, Energizer Holdings (1.5%) attended the Consumer Analyst Group of New York conference, with management teams presenting from its Energizer battery business as well as its newly named Edgewell Personal Care business, with brands including Schick razors, Edge shaving products, Hawaiian Tropic, Banana Boat sun care products, and Playtex feminine and baby care products.
Deals, Deals and More Deals
Along with financial engineering, the "Fifth Wave" of mergers and acquisitions (M&A) activity continued to build during the quarter. In the first quarter, worldwide M&A increased 25% year over year to $854.2 billion, making it the strongest first quarter for M&A since 2007. In the U.S., deal activity totaled $415.9 billion, an increase of 33% compared to Q1 2014, and the best Q1 for deal making in fifteen years. This M&A wave continues to be global in nature, with cross border M&A totaling $267 billion in the quarter, a 10% increase over Q1 2014 and comprising 31% of total M&A.
In February, Exelis Inc. (0.5%) announced it agreed to be acquired by Harris Corp. for $23.75 per share in cash and stock. Exelis shareholders will receive $16.625 in cash and 0.1025 of a share of Harris common stock. Upon closing, Harris shareholders will own approximately 85 percent of the combined company, and Exelis shareholders will own approximately 15 percent. On a pro forma basis, the combined company will generate more than $8 billion in revenue.
Let’s Talk Stocks
The following are stock specifics on selected holdings of our 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 share prices are listed first in United States dollars (USD) and second in the local currency, where applicable, and are presented as of March 31, 2015.
AMETEK Inc. (1.7% of net assets as of March 31, 2015) (AME – $52.54 – NYSE) is a leading global manufacturer of analytical instruments for the process, aerospace, and industrial markets, and a leading producer of electric motors and blowers for the floor care and outdoor power equipment markets. In the near term, the company continues to experience growth in its longer cycle businesses in the aerospace, power generation, and process industries. Longer term, the company continues to make acquisitions to augment growth. In 2015, AMETEK expects one half to two thirds of its revenue growth to come from acquisitions. The company is focused on acquiring differentiated businesses with revenues of $150-$300 million. The company expects to spend ~$1 billion on acquisitions this year. AMETEK also decided to moderate its investment into the Floorcare and Specialty Motors end market within the Electromechanical Group; we believe the segment may be a prime spin-off candidate.
Berkshire Hathaway Inc. (1.3%) (BRK.A – $217,500.00 – NYSE), based in Omaha, Nebraska, is the holding company for a diverse group of operating subsidiaries, including insurance, freight rail transportation, utilities and energy, financial services, and retailing. The subsidiaries operate in an autonomous fashion, while investment and capital allocation decisions are managed by 84 year-old Warren Buffett (Trades, Portfolio) in consultation with 90 year-old Charlie Munger (Trades, Portfolio). From 1965 through December 31, 2014, the firm had an annual compounded gain on book value of 19.4%.
CVS Health Corp. (0.9%) (CVS – $103.21 – NYSE) is a pharmacy innovation company helping people on their path to better health. Through their 7,800 retail pharmacies, more than 900 walk-in medical clinics, a leading pharmacy benefits manager with nearly 65 million plan members, and expanding specialty pharmacy services, CVS Health enables people, businesses, and communities to manage health in more affordable, effective ways. Their unique integrated model increases access to quality care, delivers better health outcomes, and lowers overall health care costs.
DIRECTV (1.6%) (DTV – $85.10 – NASDAQ) is the largest pay television provider in the world, with over twenty million subscribers in the U.S. and over twelve million throughout Latin America. Originally part of General Motors (0.1%), DTV used its technological advantage, focus on high income customers, recognition of the necessity for superior customer service, and clever (Sunday Ticket) participation in exclusive sports programming to cement its position in the U.S. The company used essentially the same strategy in Latin America, where it is benefiting from the growth of the middle class in countries such as Brazil and Colombia. Atop a superior operating business, DTV has layered a capital structure that maximizes equity returns. The company has used modest leverage to repurchase stock, in the process cutting its shares outstanding by more than half over the last five years. Long of interest to its telecom distribution partners, AT&T (less than 0.1%) agreed to acquire the company in April 2014 for $95 per share in cash and stock. We expect the transaction to be approved and close in the first half of 2015.
Energizer Holdings Inc. (1.5%) (ENR – $138.05 – NYSE) became an independent company after it was spun- off 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 spin-off 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.
Exelis Inc. (0.5%) (XLS – $24.37 – NYSE) is a leader in C4 (command, control, communications, computers) and ISR (intelligence, surveillance and reconnaissance) products and information and technical services. The company provides mission critical systems in integrated electronic warfare, sensing and surveillance, air traffic management, information and cyber security, and networked communications. Products in the Information and Technical Services segment include large scale ground communication networks for NASA and the DOD, national intelligence defense against chemical, biological, and explosive threats, space ground and range systems for U.S. military launch, logistics, and base operations to the armed forces, and air traffic control management. On February 6, 2015, XLS announced a definitive agreement under which Harris Corp. will acquire the company in a cash and stock transaction valued at about $24.70 per share. Under the terms of the deal, XLS shareholders will receive $16.625 in cash and 0.1025 of a share of Harris common stock. Based on the Harris closing price of $78.70 per share and including the $140 million of XLS net debt and underfunded pension liability of $2.1 billion, Harris is paying about $6.8 billion for XLS. The transaction EBITDA multiple of 12.6x (XLS estimated 2015 EBITDA is $540 million) is in line with the industry’s deals. The deal is expected to close in June 2015 and is subject to customary closing conditions, including regulatory and XLS shareholder approval.
Genuine Parts Co. (1.4%) (GPC – $93.19 – 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.
Kraft Foods Group Inc. (0.2%) (KRFT – $87.12 – NASDAQ), based in Northfield, Illinois, is the North American grocery business of Kraft Foods Inc., which was separated through a tax-free spin-off to shareholders on October 1, 2012. As a result, shareholders received one share of Kraft Foods Group Inc. for every three shares of Kraft Foods Inc. common stock, which was subsequently renamed MondelÄ“z International Inc. (0.5%). Kraft Foods Group is comprised of the North American grocery operations, excluding the snack businesses, which generated approximately $18.2 billion of revenue from leading brands such as Maxwell House coffee, Oscar Mayer meats, Jell-O desserts, Cool Whip toppings, and Cracker Barrel, Kraft, Polly-O, and Velveeta cheeses. On March 25, 2015, the H.J. Heinz Company and Kraft signed a definitive agreement to merge and form the Kraft Heinz Company. Accordingly, shareholders of Kraft will receive a $16.50 per share special dividend and 49% ownership of the newly formed company, which will be the third largest food and beverage company in North America and the fifth largest globally. The remaining 51% will be owned by current Heinz shareholders, 3G Capital, and Berkshire Hathaway.
Precision Castparts Corp. (1.2%) (PCP – $210.00 – NYSE) is a manufacturer of investment castings and forgings, primarily for the aerospace and industrial gas turbine markets. The company also makes fasteners and industrial products for the automotive, aerospace, and general industrial markets. PCP is a strong cash flow generator, and we continue to believe the company will use its cash for acquisitions, such as the acquisition of Titanium Metals Corp. in 2013. PCP’s acquisition strategy centers on buying businesses within the company’s core competencies, which include manufacturing component products for complex end users. The strategy also includes finding companies that have procurement or technologies similar to PCP’s and similar customer profiles. These characteristics should provide opportunities for PCP to improve the acquired company’s profitability, enhancing PCP’s earnings.
Twenty-First Century Fox Inc. (2.3%) (FOXA – $33.84 – NASDAQ), (FOX – $32.88 – NASDAQ) is a diversified media company with operations in cable network television, television broadcasting, filmed entertainment, and direct broadcast satellite television. Cable networks account for 66% of the company’s EBITDA and benefit from contractually recurring affiliate fees and exposure to the fast growing global pay television market. We also expect the company to benefit from rising demand for premium content, driven by emerging distribution platforms such as Netflix, retransmission revenue, and aggressive share repurchases.
Investment Scorecard
The top contributors to performance during the quarter included Sony Corp. (SNE) (0.7% of net assets as of March 31, 2015) (+31%) and Yakult Honsha (TSE:2267) (0.6%) (+31%), which are both benefiting from “Abenomics” as well as a reawakening of corporate Japan. Other large contributors included Exelis (XLS) (0.5%) (+40%), which announced an agreement to be acquired by Harris Corp.; Madison Square Garden Group (MSG) (1.1%) (+12%), which provided more details on the spin-off of its Sports and Entertainment businesses; and AMC Networks (AMCX) (0.5%) (+20%), which reported better than expected Q4 results, with strong performance for original programming.
Detractors from performance included National Fuel Gas (NFG) (0.5%) (-13%), whose Energy & Power (E&P) business is being impacted by lower natural gas prices in the Marcellus hubs in which it operates; Procter & Gamble (PG) (0.6%) (-9%), which reduced its outlook in January due to slower organic growth and greater impact from currency; Navistar (NAV) (0.6%) (-12%), which has yet to show market share improvement in the class 8 truck market; and Viacom (VIA) (0.9%) (-9%), which declined due to lower than expected advertising revenue in Q4 and higher than expected restructuring and program write-offs in Q1.
Conclusion
Strong recent M&A activity reinforces our view that we are in a building "Fifth Wave" of takeover activity. In an increasingly volatile market, we continue to stick to our long term investment philosophy and hope to use any opportunity that “Mr. Market” provides to us. We seek high quality companies trading at a discount to Private Market Value—the price an informed industrialist would pay to own an entire business. We also look for catalysts to surface value, such as a takeover of the company, financial engineering, new management, regulatory changes, or a change in cash flow allocation.
April 14, 2015
Top Ten Holdings (Percent of Net Assets)
March 31, 2015
| Twenty-First Century Fox Inc. | 2.3% | IDEX Corp. | 1.5% |
| AMETEK Inc. | 1.7% | Genuine Parts Co. | 1.4% |
| Brown-Forman Corp. | 1.7% | American Express Co. | 1.4% |
| DIRECTV | 1.6% | Deere & Co. | 1.4% |
| Energizer Holdings Inc. | 1.5% | Berkshire Hathaway Inc. | 1.3% |
