Over the past several decades, Seth Klarman (Trades, Portfolio) has built himself a reputation as one of the world's best value investors. So today, when he buys a position for his portfolio, it usually pays to take a look and see if it is worth following him into the stock.
According to Baupost's fourth-quarter 13F filing with the SEC, Klarman made a number of key changes to his equity portfolio during the period. I should clarify these filings only include equity holdings and do not include any cash or debt instruments Baupost may hold in the rest of its portfolio. They are also backward-looking reports, so they may not be an accurate reflection of the current portfolio.
No positions were divested from the portfolio during the quarter, although a few holdings were reduced substantially, including a stake in PBF Energy Inc. (PBF, Financial), which was reduced by about a third. The largest increase in an existing position was a 6,821% increase in Klarman's ownership of shale oil producer Pioneer Natural Resources (PXD, Financial). It seems he believes, with oil prices rising, this company is set to benefit significantly in the years ahead as it doubles down on its goal of becoming one of the best oil producers in North America.
”‹
Two stocks were added to the portfolio during the quarter. The first was Sentinel Energy Services Inc. (STNLU, Financial), which is a relatively insignificant position, accounting for just 0.16% of the overall equity portfolio worth just under $16 million compared to the overall equity portfolio value of $10 billion. The second buy was Time Warner (TWX, Financial). Even though it is a new position to the portfolio, Time Warner is among the firm's top five holdings, accounting for 7.4% of the overall equity portfolio with 8 million shares worth just under $750 million.
So why has Klarman decided to make such an enormous bet on this media group?
Time Warner play
Time Warner owns the largest film and television production studio in the world (Warner Brothers) as well as premium networks HBO/Cinemax and ad-supported television networks, including CNN, TNT, TBS and Cartoon Network. In a world where content is increasingly becoming the primary driver of growth for media groups, HBO has proven itself to be extremely attractive to customers, with over 2 million HBO Now subscriptions.
Access to high-quality content and a strong competitive advantage are the reasons why AT&T (T, Financial) decided it wanted to acquire Time Warner in late 2016 in an attempt to improve its position in the increasingly competitive U.S. media landscape.
This takeover is not going smoothly, however. In November of last year, the Department of Justice announced it is litigating to block AT&T’s pending acquisition. After the announcement, the stock dropped from $103 to $89. I am guessing this is when Klarman initiated his position.
Risk-reward
Looking at the company today, the risk-reward profile is highly attractive. For a start, the stock is trading at a forward price-earnings ratio of only 12.4, compared to the media sector average of 16.8. What's more, the company has a history of creating value for shareholders. It has not utilized stock buybacks since the merger announcement, but over the five years to year-end 2016, the company bought back 25% of its outstanding shares. Further, the new tax law is set to add an estimated 10% to earnings going forward.
”‹”‹
AT&T is offering $107.50 per share for Time Warner. At the current price of $95, this implies a return of 13.1%, which could be an attractive rate of return depending on when the deal closes. If the stock was acquired at $90, a return of 19% would be on the table. And if the deal doesn't close? Well then you get a cheap media giant that has a record of creating value for shareholders. If Time Warner's management decides to unlock even more than you, it could spin off its HBO division (the company has a history of spinning off divisions to create value) and recommence stock buybacks.
Put simply, this looks to be an arbitrage play with a double-digit return available in the short term, or a steady single-digit return possible over the long term if the deal does not go through -- a classic “heads I win, tails I don’t lose much” arbitrage play.
Disclosure: The author owns no stocks mentioned.
