Weitz Value Fund 2Q16 Commentary: Hurt By Liberty Global, Endo, AllerganVW Staff
Weitz Value Fund commentary for the second quarter ended June 30, 2016.
The Weitz Value Fund’s Institutional Class returned -0.41% in the second calendar quarter, compared to +2.46% for the S&P 500 and +2.54% for the Russell 1000. For the calendar year to date, the Value Fund’s Institutional Class returned -0.65%, compared to +3.84% for the S&P 500 and +3.74% for the Russell 1000.
Calendar Year Contributors
Range Resources is an independent producer of natural gas and natural gas liquids based in Fort Worth, Texas. Following a difficult 2015, Range shares rallied from depressed levels, thanks to the successful completion of non-core asset sales, long-term debt reduction and an improving natural gas outlook. In a surprise move, Range announced its intention to acquire natural gas producer Memorial Resources (MRD) in mid-May in an all-stock transaction valued at approximately $4.4 billion. Unlike many exploration & production (E&P) companies, Range has been extremely protective of its equity over the years and has generally not been acquisitive in the recent past. The Memorial purchase accomplishes a number of important objectives for Range, including further de-leveraging the company’s balance sheet as well as geographic diversity via an asset with an attractive return profile. While we remain favorably inclined toward the transaction, we took the opportunity to lighten our position in the low-$40s during the quarter as Range’s discount to our estimate of value narrowed.
Liberty Broadband holds a 17% ownership interest (25% aggregate voting power) in Charter Communications in addition to a minority equity interest in Time Warner Cable. Charter Communications is the fourth-largest cable operator in the U.S. and provides advanced video, high-speed internet, and telephone service to residential and business customers. In the second calendar quarter, “New Charter” was formed with a merger between Charter, Time Warner Cable and Bright House Networks. Furthermore, at the time of the merger announcement (a year and one-half ago), Liberty Broadband agreed to invest $5 billion into “New Charter” at a fixed price ($195 per share) that proved to be a material discount to Charter’s market price at the time of closing ($225 per share), thus giving Liberty Broadband shareholders an immediate unrealized gain. Our investment in Liberty Broadband represents additional upside to our business value estimate for Charter on a standalone basis.
Berkshire Hathaway is a conglomerate holding company owning subsidiaries engaged in a number of business activities. Berkshire shares were helped by the closing of the Precision Castparts acquisition (in the first calendar quarter), improved operating performance at its Burlington Northern railroad subsidiary and the potential of further capital allocation opportunities. Additionally, Berkshire shares were helped by the diversification represented by the underlying businesses and continued momentum resulting from management’s general optimism about the company’s long-term prospects.
Calendar Year Detractors
Liberty Global is the largest international cable company, with operations in 14 countries providing video, broadband Internet, fixedline telephone and mobile services to its customers. Shares fell in the first calendar quarter after an influential Wall Street analyst downgraded his outlook for the stock, principally due to concerns over continued competitive struggles in Holland. Since that time, Liberty announced it would move its Dutch operations into a 50/50 joint venture with Vodafone, allowing Liberty Global to combine its strong cable and broadband businesses with Vodafone’s mobile offering to create a more competitive, “converged” offering. Share prices declined in the second calendar quarter due to Brexit. The pound fell roughly 10% versus the U.S. dollar on the news. Without any rebound this will depress Liberty Global’s future earnings, regardless of underlying fundamentals, as its largest operation is in the United Kingdom and represents roughly 38% of its cash flow generation. Management has already turned its attention to reducing indirect costs, better integrating its various operations, leveraging its scale and operating more efficiently. We remain confident of continued growth for Liberty Global’s cable offerings and management’s abilities to deliver operationally.
Endo International is a specialty healthcare company engaged in developing, manufacturing, marketing and distributing branded pharmaceutical and generic products and medical devices. Endo experienced significantly worse than anticipated erosion at Qualitest, its legacy generic drug platform. Simply put, our analysis of the company’s competitive positioning in controlled substance generics was wrong. The competitive environment changed quickly and we were slow to recognize it. After conversations with management and a couple of the larger drug buying consortiums, we could not gain comfort in the durability of Endo’s now lower earnings base. The company’s balance sheet and potential legal obligations (liabilities relating to the company’s legacy vaginal mesh products) leave less room for error given growth challenges on the branded side of Endo’s business. Given the erosion in our investment thesis, questions about management’s ability to identify and navigate risk, and a growing list of unknowns surrounding the business, we elected to close our position and refocus our capital in more attractive opportunities.
Allergan is a global specialty pharmaceutical company focusing on the development, manufacturing, marketing and distribution of generic, brand name, biosimilar and over-the-counter (OTC) pharmaceutical products. The dissolution of Allergan’s merger with Pfizer in April, delays in gaining Federal Trade Commission approval for the sale of its global generics business to TEVA and broader industry concern around prescription drug prices combined to push Allergan’s stock down by 26% during the first half of the calendar year. As we wrote in January, we like the stand-alone Allergan business without the generics business and believe the $40 billion sale to TEVA should soon close. There are a number of signs that growth in Allergan’s aesthetics franchise is accelerating, and the company’s key product launches – VIBERZI, VRAYLAR and KYBELLA – appear to be off to healthy starts. The combination of healthy organic growth, debt reduction and meaningful share repurchases should drive per share value creation over our investment horizon. We substantially increased the Fund’s Allergan position during the second quarter at attractive discounts to our business value estimate.
Range Resources – Please see the Calendar Year synopsis for quarterly contribution details.
Monsanto is a provider of seeds and biotech traits for corn, soybeans and cotton. Bayer, a German Life Sciences company, proposed acquiring Monsanto in the second quarter in what is a rapidly consolidating agricultural seeds and chemicals sector. Monsanto ultimately rejected Bayer’s initial offer of $122 per share as financially inadequate, but discussions remain ongoing. We have long viewed Monsanto as the highest quality franchise in agriculture, a view validated by Bayer’s acquisition proposal. The company’s earnings power is currently facing a number of headwinds, including currency effects, low commodity prices, regulatory delays and longer product introduction cycles. Nevertheless, we view its technology and research & development pipeline as second-to-none, which should allow it to create double-digit earnings growth from 2017 through 2019.
TransDigm Group is a designer, producer and supplier of engineered aircraft components for use on commercial and military aircraft. TransDigm’s shares moved higher during the second calendar quarter on better than expected results in the company’s commercial aftermarket business, the acquisition of Data Device Corporation and the raising of additional debt capital, which may signal the possibility of future mergers & acquisitions or a special dividend. Moreover, TransDigm’s investor meeting in late-June provided additional information regarding the strength and durability of the company’s business model and strategy for the foreseeable future.
Endo International – Please see the Calendar Year synopsis for quarterly contribution details.
Allergan – Please see the Calendar Year synopsis for quarterly contribution details.
Liberty Global – Please see the Calendar Year synopsis for quarterly contribution details.
No new equity holdings were added in the second quarter of 2016.
Liberty Braves – The Fund received tracking stock in Liberty Braves during the second quarter as a result of its ownership of Liberty Media Corp. We closed the Fund’s position shortly thereafter, as Liberty Braves’ size was inconsistent with the Fund’s mandate.
Liberty Media Series C – The Fund received tracking stock in Liberty Media Group during the second quarter as a result of its ownership of Liberty Media Corp. We closed the Fund’s position in Liberty Media Group and redeployed the proceeds into higher-conviction Liberty Broadband at what we believe to be a more attractive discount.
Omnicon Group – Omnicom is the second-largest advertising agency holding company in the world, providing marketing, advertising and communication services to clients across the globe. The Fund first purchased shares in Omnicom roughly six years ago, attracted by the industry’s oligopolistic structure; the importance (some would say necessity) of the services its agencies provide to corporate advertisers; the capital efficient nature of its business; and an undemanding price, as investors fretted over advertising budgets that were slow to rebound on the heels of the Great Recession. Omnicom compounded nicely during our period of ownership, generating an annualized total return of approximately 21%. We closed our position in April, with the stock reaching our estimate of business value.
Endo International plc – Please see Calendar Year synopsis for details of the Fund’s sale rationale.
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