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March 18, 2015 Dear GO Investor, Performance and Top Holdings
Set forth below is the Glenview Opportunity Funds performance
through December 31, 2014.
Performance attribution for Q4 is set forth below:
Our portfolio returns were positive for the quarter driven by
the following1:
i) Our equity long portfolio contributed +17.91% to gross
returns. By name, the top five winners for the quarter were VCA,
Monsanto, Thermo Fisher, Fidelity National Financial and Dollar
General. By sector, the best performing sectors during the quarter
were Consumer Cyclical, which contributed +4.83% to gross returns,
Healthcare, which contributed +3.28%, and Technology, which
contributed +2.35%.
ii) Offsetting these gains were losses of (12.86%) in our equity
short positions, both from individual names as well as from equity
index hedge positions.
* * *
Flatland Sometime in elementary or junior high school, I was
assigned to read the book Flatland, or some childrens derivation of
the 1884 classic. I use the word assigned because I was not a
pleasure reader (oxymoron for kids), and Im not sure if it was
assigned for an English, Math or Science class. Oddly enough, I
still remember the basic tenets of the book, which were to try to
explain things like the fourth and fifth dimension, concepts that
are difficult to grasp. The logic trail went something like
this:
i) If you grab the inside of a point and pull, you get a line.
ii) If you grab the inside of a line and pull, you get a plane or
triangle. iii) If you grab the inside of a plane and pull, you get
a cube or pyramid. iv) If you grab the inside of a cube and pull,
you have now entered the fourth dimension.
1 The performance attribution figures refer specifically to the
offshore trading fund within the Opportunity product, i.e.
Glenview Offshore Opportunity Master Fund, Ltd. Past performance
is not indicative nor a guarantee of future results. Please refer
to Exhibit A attached hereto for important disclosures relating to
performance data, highlighted securities, benchmark comparisons and
forward looking statements, opinions and projections contained in
this letter.
Gross Net Gross Net Gross Net Gross Net Gross NetGLENVIEW
OPPORTUNITY FUNDSGlenview Offshore Opportunity Fund, Ltd. 8.92%
7.14% 12.43% 10.11% 1.59% 1.32% 5.29% 4.41% 31.00% 24.80%Glenview
Capital Opportunity Fund, L.P. 8.99% 7.19% 12.48% 10.15% 1.39%
1.16% 5.84% 4.87% 31.57% 25.25%
Q1 Performance Q2 Performance Calendar Year 2014Q3 Performance
Q4 Performance
Equity Equity Credit CreditLong Short Long Short Total
GLENVIEW OPPORTUNITY FUNDSGlenview Offshore Opportunity Fund,
Ltd. 17.91% -12.86% 0.17% 0.08% 5.29%Glenview Capital Opportunity
Fund, L.P. 18.37% -12.82% 0.20% 0.09% 5.84%
Q4 Performance Attribution (Gross Returns)
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3
As you can see in the above table2, despite the relatively
paltry buy and hold returns offered by long-term fixed income
securities around the globe, investors have been exceedingly well
compensated over the past one, three and five years with returns
many multiples above the annual coupon of the bonds. Said
differently, to a bond investor it has not felt like they were
investing for 1-3% returns when they have achieved greater than 10%
returns over the medium term. Ironically, the equity markets are
wrestling with the concept that strong recent performance may be
borrowing from future returns as multiples have increased, and yet
nobody is talking about the fact that the 31% one year gain in the
30-year bond has reduced the total profit potential for the
remaining 29 years by 40% (the 30-year compound total return was
146% one year ago and the 29 year forward compound total return is
now 88%). Thats paying it forward. Lets consider what it would take
to perpetuate double digit returns in the 30-year bond from here.
In order to earn 10% in the subsequent 12 months from a 2.2%
starting point, investors would need to make 7.8% from capital
appreciation on top of the yield. With an approximate duration of
20 years in the 30-year bond, this implies 39bps of tightening
would be necessary, placing the 30-year at approximately 1.8%.
Extending this track record three years forward would imply a
landing spot for the 30-year at 1% and, in the middle of 2020, the
yield would be 0%, with 24 years remaining on the bond. As an
absolute return manager, its hard for us to get excited about
making absolutely nothing for 24 years. That is Flatland, a line
across the page. While in the last 30 days U.S. Treasuries have
backed up to 2.75%, essentially flat on the year after a 12% 32-day
gain and an approximate (12%) 30-day decline, this phenomenon is
even more pronounced in Germany, where 30-year government bonds
yield 0.76% (the 10-year is 26bps). A buy and hold investor will
make 25.5%, total, cumulatively, chain-weighted, over a 30 year
period, and if they make 10% a year for two years, they will make
0% for the remaining 28 years. Of course, we could have made these
arguments one, three, and five years ago, and on average bond bulls
have been right to the tune of 10% per annum. We have maintained a
short position in government bonds for the past several years as a
hedge against equity multiple compression, and while the bond hedge
has been cheaper than an equity hedge, it has been premature and
therefore wrong. However, what we do know for certain is that at
maturity, holders will only get their money back, and the
extraordinary returns enjoyed by bond investors will absolutely end
with certainty over the coming decade/decades. The Fixed Income
Trader Did It! Because of the dynamics we described above, we
logically conclude that holders of sovereign fixed income around
the world fall into one of three camps:
a) Central Banks, who will get a return on their investment in
other ways by promoting economic growth and investment;
b) Forced holders, who by charter, regulation or simply inertia
hold these securities because they dont have an absolute return
mandate but rather have forced conditions upon them (dedicated
sovereign debt products, financial institutions with inflexible,
inertial or backward looking investment policies or those with
regulatory constraints that incent holding sovereign debt due to
the perception of safety); and
c) Fixed income traders, who simply believe that yields are
going lower before higher, and that they will be in and out before
long-term rates rise and bond prices fall. Alternatively, these
traders could be momentum traders who will use price action to
determine when the run is over. In either case, they are short-term
players in a long-term instrument.
We left out the fourth category an absolute return manager who
seeks 76bps of annual income in Germany or 2.2% annual income in
the U.S. Perhaps our ambitions are greater than the average
investor, but we know of no pension fund, health care trust or
college savings account that can defease its liabilities and
satisfy its obligations making 1-2% per annum in perpetuity.
2 The bond returns in the above table are sourced from Barclays
Aggregate 7-10yr and 20yr+ Bond Indices.
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4
Consider one additional measure an absolute return investor may
consider the risk/reward of holding a Treasury security. While we
believe market volatility is an imprecise and at times misleading
indicator of the true risk of a security, why would someone want to
invest in a highly volatile asset for paltry returns? Bond
volatility has approximately matched equity market volatility over
the past five quarters, yet we believe it is reasonable to assume
that equities in aggregate will produce a return greater than 2.2%
per annum for the next three decades. A detective is investigating
a crime and the suspects are a Fixed Income Investor, a Fixed
Income Trader, Santa Claus and the Tooth Fairy. He immediately
arrests the Fixed Income Trader, because all the others are
fantasy. Ironically, regulatory authorities have heavily incented
banks to own highly volatile low-return securities and restricted
them from investing in absolute return managers. Well defer to
others to fight that battle we are simply focused on our risk
management and absolute return mandate. Saved By Zero? Aaaaahh!
Earlier we established that the massive drop in Treasury yields has
front-end loaded investment returns in long-term securities and
thereby materially diminished future investment returns. In
addition, we established that this could go on for two to five
years of additional 10% returns, after which German and U.S. bonds
would be yielding zero. In the Flatland we are comfortable living
in, zero is a lower bound, as no absolute return manager we know
would invest their money to get most but not all back. However,
that zero lower interest rate bound is being challenged
anecdotally, if not analytically:
i) Presently, Danish, Swiss and German government obligations
all trade with negative yield through 5+ years (Swiss all the way
to 10 years).
ii) Mario Draghi, ECB President, indicated that the QE program
could buy sovereign debt securities all the way down to Deposit
Rate yields in the EMU, which presently are -20bps. They could also
lower the Deposit Rate Denmark and Switzerland are currently at
-75bps.
iii) Nestle recently placed 500mm of bonds that traded at
negative yields it is unclear if you get a Crunch Bar to compensate
you for your loss of principal on the investment.
iv) A total of $3 trillion of debt in Europe and Japan trades at
a negative interest rate. The analytical argument for negative
interest rates is as follows:
a) While it is true that one could earn 0% by holding paper
currency, the costs to store, transport and secure such currency
are significant on a large scale.
b) The largest bill in circulation is the $100 bill, meaning it
would take 10,000 pieces of paper to store $1 million dollars. For
institutions transacting millions at a time, the space and
logistical constraints are enormous.
c) Individuals have become accustomed to holding cash in zero
interest checking accounts or low return savings accounts that
return less than inflation and thus earn negative real returns. As
such, consumers are already accustomed to negative real rates for
payment convenience, and therefore negative nominal rates are just
one more step on a continuum rather than a phase shift.
There is, of course, some lower bound, which would appear to be
zero minus inconvenience costs. Beyond that, we enter the fourth
dimension esoteric concepts that we can write about but are very
difficult to actually comprehend:
1) Despite all the work on working capital efficiency, suppliers
would now push for later collection terms while purchasers would be
incented to pre-pay for goods from creditworthy counterparties.
Working capital management would be turned upside-down.
2) All the formulas we learned in business school blow-up. Good
luck computing a dividend discount model dividing cash flows by
(r-g) when r is negative. (I know r isnt a risk-free rate but you
get the point.) Obviously, growth could be pressured in a
deflationary environment, but many businesses would retain absolute
pricing power and have infinite value.
3) Banks would become large scale currency storage facilities:
perhaps banks could buy public storage and security companies and
see their multiple explode to REIT valuations for storing cash.
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5
Of course, former Fed Chairman Bernanke in 2004 wrote that
nominal rates cannot go meaningfully below zero despite the
inconveniences of cash storage: Because currency (which pays a
nominal interest rate of zero) can be used as a store of value, the
short-term nominal interest rate cannot be pushed below zero. 3
Further, the NY Fed posted two successive articles in 2011 and 2012
that made the arguments for a near zero lower bound (by researchers
Keister 11/16/11 and Garbade/McAndrews 8/29/12). As absolute return
managers, we believe that we are best served by staying focused on
this math problem in advanced algebra terms:
i) Long-term rates are the chain-weighted summation of a string
of short-term rate expectations; ii) Currencies are the
chain-weighted reflection of a string of short-term relative
interest rates, in perpetuity; iii) Risk assets price back of
risk-free assets, and thus movement of risk-free assets competes
with or incents
capital flows into corporate bonds and equities; and iv) Risk
adjusted, investors will always want more money in the future than
they have today.
As such, while we are aware that debt markets can persist at
zero or even modestly negative rates for a period of time, we
believe it is best to make capital allocation decisions on the
basis that fixed income securities will eventually trade where a
fixed income investor would own them rather than where governments
and fixed income traders will push them. On this basis, we maintain
modest net short positions in sovereign and corporate fixed income,
and we remain focused on our secular growth investments that trade
at approximately 15x 2015 and 12x 2016 earnings per share,
multiples that we find attractive even in interest rate
environments that are 100-200bps higher than we are today.
3 Source: Monetary Policy Alternatives at the Zero Bound: An
Empirical Assessment; from the Finance and Economics
Discussion Series, Division of Research & Statistics and
Monetary Affairs, Federal Reserve Board.
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6
Shuffling the Decks A year ago, we shared with you our Big
Picture where we made the argument that calendar turns, more often
than not, extend rather than shift the investment environment. As
we reached the sixth anniversary of the advance of the U.S. equity
markets off their March 2009 lows, we felt it was appropriate to
look at conditions on a historical basis to determine if the equity
markets have similarly borrowed nearly all the risk adjusted
returns from future periods. Rather than focus chronologically, we
shuffled the years and sorted them by returns (from negative to
then positive groups of 0-10%, 10-20%, 20-30% and >30%) to see
if there are leading indicators that correlate to periods of high
or low risk. Set forth (in small numbers, sorry) is the summary of
what we believe are the key indicators:
First, the above snapshot is a summary of a spreadsheet that
goes far off to the right, where we looked at relative earnings
revisions, valuation multiples, operating margins and other factors
that may influence future investment returns. From there, we
summarize that the only clear determinative factors, using the past
20 or 30 years as a guidepost (we show 20 years, but our
conclusions hold at 30 as well), are liquidity and borrowing costs.
As shown in the chart above, in the past few decades, there has
never been a down year in the market when any one of the following
conditions have been met:
a) U.S. 30-year begins the year below 4% b) Investment Grade
bonds below 4% c) High Yield bonds below 8% d) Cash as a % of
assets for non-financials is above 10% e) Fed tightens 0-75bps
(which is present expectation) f) Oil falls >20%
Every time one of these conditions has existed, the market has
produced positive returns. To be clear, we are not making a market
call, nor are we advising you to go levered long the stock market
at these levels. Rather, we would simply observe that the current
conditions appear to be, at a minimum, no more risky than normal as
measured by liquidity and falling commodity costs, and it would
have to be different this time, in fact different all six times,
for the market to decline in 2015. There are of course new
variables: mid-teens dollar strength vs. other currencies, global
weakness and the aforementioned negative interest rates in parts of
the world, and each of these could introduce new risks to capital
preservation in the equity markets. However, as a whole, we
continue to find comfort
BrentCrudeYear US Global (Y/Yavgprice)2008 (37.0%) (0.3%) 3.0%
14.3x 3.1% 4.5% 5.8% 9.6% (425) 8.6% 34% 1.8% (4.2%)2002 (22.1%)
1.8% 3.0% 21.6x 1.8% 5.5% 6.4% 12.5% (50) 8.0% 2% 2.2% 0.1%2001
(11.9%) 1.0% 2.5% 21.3x 1.4% 5.5% 7.4% 14.5% (475) 6.7% (14%) 2.2%
5.8%2000 (9.1%) 4.1% 4.8% 24.8x 1.2% 6.5% 7.7% 11.5% 100 5.7% 60%
2.7% 3.8%
2011 2.1% 1.6% 4.1% 13.2x 2.1% 4.3% 4.0% 7.5% 11.0% 40% 2.0%
(5.2%)2005 4.9% 3.3% 4.9% 16.4x 1.8% 4.9% 4.7% 6.8% 200 9.3% 43%
2.4% (1.7%)2007 5.5% 1.8% 5.7% 15.0x 1.9% 4.8% 5.7% 7.7% (100) 8.3%
11% 2.4% (4.8%)
2004 10.9% 3.8% 5.4% 18.1x 1.6% 5.2% 4.5% 7.4% 125 7.9% 33% 2.3%
(4.5%)2014 13.7% 2.4% 2.4% 15.4x 1.9% 4.0% 3.3% 5.6% 11.3% (9%)
1.9% 2.2%2010 15.1% 2.5% 5.4% 14.5x 1.8% 4.6% 4.7% 9.1% 11.0% 29%
1.6% (4.7%)2006 15.8% 2.7% 5.6% 14.6x 1.8% 4.5% 5.4% 8.2% 100 8.8%
19% 2.6% (1.1%)2012 16.0% 2.3% 3.4% 11.8x 2.2% 2.9% 3.7% 8.4% 10.8%
0% 2.2% 2.1%
1999 21.0% 4.7% 3.6% 23.2x 1.1% 5.1% 6.2% 10.5% 75 5.8% 39% 2.5%
(0.9%)1996 23.0% 3.8% 3.9% 14.2x 2.0% 6.0% 6.3% 9.8% (25) 3.5% 21%
3.0% 2.3%2009 26.5% (2.8%) 0.0% 11.5x 2.0% 2.7% 7.5% 19.4% 10.9%
(37%) 1.6% 4.1%1998 28.6% 4.5% 2.5% 18.8x 1.3% 5.9% 6.6% 8.9% (75)
5.4% (33%) 2.3% 8.6%2003 28.7% 2.8% 4.0% 16.0x 1.6% 5.0% 5.1% 12.1%
(25) 8.9% 16% 2.1% (6.0%)
2013 32.4% 2.2% 3.3% 12.7x 1.9% 3.0% 2.7% 6.1% 11.9% (3%) 2.0%
0.1%1997 33.4% 4.5% 4.2% 15.9x 1.6% 6.7% 7.0% 9.5% 25 5.2% (7%)
2.6% 5.3%1995 37.6% 2.7% 3.4% 12.2x 2.2% 6.0% 8.7% 11.3% 2.9% 8%
3.0% (2.7%)
2015 ? 3.0% 3.8% 16.4x 1.9% 2.8% 3.1% 6.6% +25to50 11.3% (47%)
0.9% 14.0%
30yr IG HY Fedhike Cash Oil4%orlower 4%orlower 8%orlower
0to+75bps 10%orgreater Down20%ormore
22.1% 16.0% 11.6% 22.0% 17.6% 27.5%
GDPActual
ValuationGrowth Inflation/CurrencyInterestRates/Liquidity
S&P500TotalReturn
AVERAGES&P500TSR N/A
ForwardP/E(BegofYr)
DivYield(BegofYr)
30yrYield(BegofYr)
USInvGradeYields(BoY)
USHYYields(BoY)
ChangeinFedFunds
Cash/AssetsExFins(BegofYr)
InflationExpectations
DollarWgtIndexY/Y%
NocloseprecedentKEYMACROCONDITION
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7
in the Fab 5: reasonable valuation (though less cheap than a
year ago), positive economy, deep and cheap credit markets, average
or lower systemic risk and highly engaged shareholders as a
community of owners. While we believe debt markets are largely
unattractive and inappropriate for investment, leading to our net
short credit position, we remain constructive on the domestic
equity markets as a whole and our portfolio companies in
particular. We remain focused on finding convertible equities with
positive value creation optionality, and we continue to encourage
our companies to capitalize on this historically low rate
environment to access long-term, semi-permanent debt capital to
reinvest in capex, M&A and share repurchase. Our net equity
exposure remains slightly elevated versus our long-term history
reflective of the constructive environment, and we retain hedges in
both rates as well as the euro to protect against the negative
translation effect of a stronger dollar on our U.S. based
multinationals. We enter 2015 with a positive outlook for our
portfolio holdings and a strong belief that we will continue to
find fresh investments that meet or exceed our return on capital
requirements. Set forth below is a selection of both some newer
holdings as well as updated thoughts regarding longer-term
positions that we have not written about in some time. Auto
Dealers: Driving Value Through Service and Capital Allocation
During 2014, we initiated investments in five of the six public
auto dealers. The algebra of automotive dealers is reasonably
straight forward:
i) 38% of gross profit comes from the sale of new and used
vehicles: $2,200 average gross profit from new vehicles $1,800
average gross profit from used vehicles
ii) 22% of gross profit comes from F&I, commissions
associated with the finance and insurance of cars: $1,200 average
gross profit from all vehicles
iii) 40% of gross profit comes from service, which is
principally focused on cars sold within the past five years: This
equates to $2,200 per annually sold vehicle If one assumes a 5-year
service life, this means that they make $440 per vehicle in
force
When you add it all up, there is a lifetime dealer gross profit
of approximately $5,400 per vehicle sold. If one assumes 16M to 17M
units is normal in the U.S., then the U.S. auto dealer business
generates $89 billion in gross profits per year, making it a
sizable opportunity. The industry is highly fragmented, and in
fact, the top ten dealerships in the country represent less than
10% of the overall industry. While the industry is clearly
cyclical, with 60% of gross profit coming from vehicle turnover
both new and used, the secular growth opportunity for attractive
capital allocation and future consolidation to drive scale
efficiencies makes this a defensive growth cyclical (another
oxymoron). In any one year, there will be economic sensitivity.
Over time, the industry should grow modestly but the scale players
should grow significantly faster driven by scale efficiencies and
the productive use of free cash flow. The severe recession in
2008/09, and the extremely slow recovery in auto sales that ensued,
caused a double whammy of headwinds for the industry:
a) Constrained financing not only impacted new car purchases but
used car transaction volume as well, thereby impacting the entire
60% pie that is transactional.
b) Because new car sales were weak for a prolonged period, the
installed fleet aged and the stock of 0-5 year old cars shrank
materially, causing a reduction in the opportunity set within the
40% of the portfolio that is service oriented.
As such, not only has the recent recovery led to stronger
transactions and new car sales, but the corresponding fleet refresh
is also causing double digit gains in service revenues and gross
profits as the pendulum swings back to normal. This growth on
growth impact is what caught our attention and made us more excited
about the industry over the medium term.
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8
There are other structural tailwinds that we find attractive to
the industry:
1) Increasing complexity drives service back to dealerships from
small independent service shops; 2) A coming wave of off-lease
vehicles should drive enhanced affordability and therefore volume
of
transactions in the used car space in the coming years; 3) There
is an exceedingly long pipeline of bolt-on M&A opportunities
75% of U.S. new car dealerships are
owned by single families with proprietors in their 60s and 70s;
and 4) Many of the publicly held companies in the space have also
used opportunistic share repurchase as an
additional accretive capital deployment technique, and dry
powder in the space remains quite strong. Despite the success of
many of these investments in the past year, we continue to find the
group compelling at 12x our 2016 earnings estimates on average. We
Bought the Group, But If You Prefer One: Group 1 Automotive (GPI:
$78) GPI owns auto dealerships in the U.S., UK and Brazil, and 94%
of their profits come from the U.S. Our interests in GPI are
consistent with our overall industry theme, and the company has
shown recently accelerating growth trends:
i) The companys U.S. parts and services same store sales growth
steadily accelerated through the year ending at 7% in 4Q, which we
expect to further accelerate going forward.
ii) Used car sales ended the year with a particularly strong
fourth quarter, growing units 9% and gross profit per unit 8%
leading to 17% gross profit growth. While we expect growth rates to
cool from these levels, we believe growth will remain at highly
attractive levels over the medium term.
iii) GPI allocates capital well through both acquisitions and
repurchases: a) The company acquired 27% of revenues in the past
two years at highly accretive multiples of
recurring cash flow b) GPI reduced share count by 9% in 2014
with attractively valued share repurchases.
iv) The companys recent entry into Brazil is currently
loss-generating (modest losses of $0.03 per share) and therefore
not valued in the current P/E. We believe Brazil could generate up
to $0.50 per share of value, which at 12-15x earnings creates about
10% additional value on the stock today that is currently
hidden.
With $8 of EPS power within reach for GPI in 2016, a 15x
multiple would generate a $120 stock price target and more than 50%
upside from todays levels. Continuing to Flex its Muscles:
Flextronics (FLEX: $11.41) Weve written about Flextronics in prior
quarterly letters (2011 and 2013) where weve described how
Flextronics, as an Electronics Manufacturing Services (EMS)
provider responsible for the assembly and production of equipment
and devices, has a more attractive businesses than their branded
customers, particularly those on the technology side, as theyre
able to choose among winners and losers which allows their
business, over time, to prove more stable. Despite the stocks 44%
rise in 2014, we continue to be the companys largest holder and
believe Flextronics is set to outperform again in 2015, driven by
the following factors:
1) Improved execution and credibility. As we noted in our 2Q
2013 letter, Flextronics promoted Chris Collier, its longtime VP of
Finance and Chief Accounting Officer, to Chief Financial Officer in
May 2013. This was followed by a marked improvement in operating
results: prior to Chris promotion, the company had been amidst a
period of uneven operating results, which had materially impaired
investor confidence; since then, the company has met or exceeded
its revenue and earnings guidance in every one of the seven
successive quarters. We expect continued attainment of its earnings
commitments to be an important future driver of Flextronicss stock
performance.
2) More attractive business mix. Five years ago, we estimate
almost 80% of the companys revenue and 70% of operating profits
came from its two shorter cycle businesses manufacturing telecom
equipment and consumer electronics including about 15% from the
combination of producing cell phones for Research in Motion (known
as Blackberry today) and PCs for various global OEMs; both of those
revenue streams have since gone to zero. Today, about 30% of its
revenues and a full 50% of profits come from the long-cycle High
Reliability Solutions (HRS) and IEI (Industrial and Emerging
Industries) groups. These
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9
segments manufacture products for customers in the medical,
automotive, aerospace, general industrial and energy industries,
among others, all newer and later adopters of outsourced
production. On the back of continued healthy double digit revenue
growth rates, these businesses should, by our estimates, account
for 36% of revenue and 55% of operating profits in two years.
Further, were Lenovo to insource the production related to its
recently acquired Motorola Mobility operation, an immaterial impact
to Flextronics earnings that is well understood by investors, HRS
and IEI would be over 40% and almost 60% of Flextronics revenue and
operating profits, respectively, in two years.
3) Coming cyclical lift from telecom capex trends. Flextronics
should also benefit from a modest cyclical rebound in its INS
segment, which accounts for 30% of profits. While this segment is
fairly diversified, its still somewhat sensitive to cyclical
telecom capital expenditure trends, which remain relatively
depressed and should improve towards the back half of calendar
2015. As a proxy, capex for AT&T fell 15% on a year over year
basis in the second half of 2014 after growing 20% in the first
half on the back of that companys heavily front loaded spending
pattern. While AT&Ts full year 2015 capex guidance calls for
full year capex to fall 16%, its guided intra-year trajectory
suggests spending growth by 4Q15. While our long-term expectations
for the INS business remain relatively sober, we do expect its
revenue trajectory to improve from the -7% trend of recent quarters
(notably half of this decline is driven by FLEXs decision to
de-emphasize set-top box production) which will have acted as an
approximate 2% earnings headwind to total company results this year
to closer to flat over the next year.
4) Still sharp capital deployment. Flextronics remains a
reliable repurchaser of its own shares. By the time this fiscal
year draws to a close in two weeks, over the preceding five years
the company will have repurchased about 36% of its shares driving
25% net share count reduction at a total cost of over $2 billion.
Flextronics domiciliation in Singapore would normally limit it to
repurchase 10% of its shares annually. But the company has specific
approval from the Singapore Ministry of Finance to allow it to
repurchase a full 20% of its shares in any given year. We continue
to have a healthy, constructive dialogue with management on this
topic. With net debt to LTM EBITDA of just 0.3x, no debt maturities
until 2018, and expected next-two-year free cash flow generation of
$1.5B, or 22% of its current market capitalization, we expect
Flextronics to use both its free cash flow and potentially its
balance sheet to create meaningful shareholder value via repurchase
and strategic acquisitions.
5) Still latent margin opportunity. Flextronics new CFO has been
less rigidly focused than his predecessor on expanding operating
profit rates, instead centralizing the organization on consistently
delivering healthy operating profit dollar growth. In that vein,
weve seen operating profit dollars grow by a full 14% in this most
recent fiscal year and at a compound annual growth rate of 11% over
the last two years. Despite that pivoted focus, the new CFO still
does plan on delivering operating margin rate accretion over time,
even publicly communicating segment level margin targets for each
business. Were Flextronics to achieve just the low-end of each of
those segment targets, the companys earnings per share would be 12%
higher than our model for the next fiscal year; and at the
midpoint, our earnings would be 38% higher.
6) Consensus expectations that can be met or exceeded. Analysts
model Flextronics earning $1.20 per share for its fiscal year
ending March 2017, or a 6% compound annual growth from the $1.06 it
will earn in fiscal 2015. With revenues accounting for 50% of its
profits growing double digits, a coming modest recovery in its
cyclical INS segment, some independent margin lift expecting from
efficiency improvements and a likely repurchase of almost 20% of
its shares over that two year period, that 6% annual growth rate
should be readily achievable.
7) Exceedingly cheap valuation. Despite its healthy appreciation
over the last two years, Flextronics stock still trades at just 10x
2015 EPS expectations and 9x 2016, egregiously cheap by any
measure, especially when viewed in the context of its sharp
discount to the market. Even a 13x multiple on our calendar 2016
estimates still a 15% discount to the market would make Flextronics
worth $17 per share or still about 50% upside from here; and a
sharply discounted 11x multiple would yield a still healthy 25%
one-year return.
Shares Now Offered on the Value Menu: McDonalds (MCD: $96)
McDonalds is the market share leading quick service restaurant with
over 36,000 restaurants and is the dominant player in the largest
sub-category focused on hamburgers. The company is well diversified
geographically generating approximately 44% of profits in the U.S.,
41% in Europe and 15% primarily in Asia. The majority of McDonalds
restaurants are operated by franchisees that pay approximately 4%
of sales as a brand royalty and, in the cases where McDonalds also
owns the real estate, also pay approximately 9% of sales as rent.
Disappointing
-
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11
can serve as a distraction or even stunt consolidated profit
growth during tough times. Currently, McDonalds mix is below almost
all major peers despite some having demonstrated the viability of a
nearly 100% franchise model. Refranchising has a minimal impact on
EPS when consummated in a rent-adjusted leverage neutral basis, but
the improved quality of the less capital intensive and more stable
earnings stream has been consistently and appropriately rewarded in
the market via improved valuation. Multiple case studies point to
both an immediate recognition upon announcement as well as over
time as the plan is executed, and McDonalds stagnant franchise mix
over the past five years has contributed to a valuation that was at
the high end of its peers five years ago but now ranks as the
cheapest in the group as others have capitalized on the opportunity
while McDonalds has not.
4) Balance sheet optimization. At 2.6x rent adjusted leverage,
the companys current capital structure is inefficiently
conservative when considering the high quality, stable and
defensive nature of the business and a material real estate
portfolio that is still presently owned. With accommodating credit
markets providing access to generationally low interest rates, as
evidenced by McDonalds 30 year debt yielding slightly below 4%
pre-tax or 2.6% after tax, we believe McDonalds could return
approximately 25% of the market cap to shareholders through the end
of 2016 while still maintaining an investment grade rating and as
much as 50% of the market cap if they choose to match the leverage
levels of burger peers, QSR and WEN.
5) Real estate monetization. Unique to the industry, McDonalds
owns 45% of the land and 70% of the buildings for its restaurants.
Using the current rental rates McDonalds charges its franchisees,
we believe the earnings power of these real estate assets as a
standalone entity would be equivalent to approximately 50% of
current consolidated EBITDA. Given that REITs are trading at almost
20x EBITDA, we do not believe this is reflected in McDonalds
current 12x EBITDA valuation, and we believe management efforts to
monetize or illuminate this could unlock at least $20 billion of
value.
While operational changes may not result in an instantaneous
inflection as it may take time to get credit from consumers and the
CEO, who just officially assumed his post less than two weeks ago,
may want a short learning period before taking action, we think the
shape of events will continue to strengthen over the course of the
year. Operationally, comparisons will ease and headwinds from
supply chain issues should fade followed by fundamental traction
from new initiatives. Increased investor interaction with the CEO
should help build confidence in the present and will hopefully be
soon followed by a public articulation of managements vision for
the company. Given the exceedingly large potential for value
creation from a playbook that has been successfully implemented at
peer companies, a CEO who did a good job running the U.K. business
and appears to embrace change and a Board that has recently moved
to an annually elected schedule, we would be surprised to not see
material progress made on the initiatives we outline above, which
we believe could support a $169 price target, making shares of the
purveyor of the dollar menu even cheaper as we see them as 57c
dollar bills. Separating From the Fleet: PHH Corporation (PHH: $23)
PHH, an outsource provider of mortgage services, represents an
extension of our constructive view on housing and offers
significant operational improvement and capital allocation
opportunities. Background In past years, PHH had operated two sets
of businesses its current mortgage services operations and
commercial vehicle fleet management operations. There was seemingly
little strategic rationale for these businesses to remain together,
and in March of 2007, GE and Blackstone teamed up to buy the
company for $1.8 billion ($31.50/share), with GE planning to retain
the fleet management operations and Blackstone planning to retain
the mortgage services operations. While the transaction ultimately
fell through with the onset of the credit crisis, it demonstrated
the logic in separating the businesses. Later, after credit markets
recovered and PHH repaired its balance sheet, the company revisited
the separation. Ultimately, in July 2014, the fleet management
business was sold to a strategic buyer, Element Financial (EFN CN),
for $1.4 billion, transforming PHH into a stand-alone mortgage
services provider.
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12
PHHs Go-forward Operations Today, PHH operates its legacy
mortgage operations through two segments Mortgage Production and
Mortgage Servicing. Mortgage Production originates prime mortgages
through wealth management, regional/community bank, affinity and
real estate broker channels on both a private-label and branded
basis. It generates revenue by collecting a fee-for-service on
loans retained by its PLS (private-label services) partners and
selling all other newly originated mortgages for a gain in the
secondary agency market. Mortgage Servicing services loans
originated by PHH or third parties and earns contractual revenue,
which recurs for the life of the loans, either through outright
ownership of the MSRs (mortgage servicing rights) or sub-servicing
arrangements. PHH has faced several headwinds in its mortgage
businesses in recent years, which have resulted in operating losses
in its PLS channel within Mortgage Production, as origination costs
have expanded in the post-financial crisis regulatory environment
and as production volumes declined given the slowdown in
refinancing activity that began in late 2013. These headwinds have
necessitated leaner operations, better terms for PLS contracts and
greater scale, all of which management has sought to address
through a series of initiatives categorized either as
re-engineering or growth initiatives. Re-engineering & Growth
Initiatives PHH management expects its re-engineering initiatives,
which are comprised of (i) expense reduction actions (organization
redesign, process improvements, vendor management, and facilities
consolidation) and (ii) PLS contract renegotiations, to generate
$225M of pre-tax operating benefit, or $2.06 per share, on an
investment of $200M. 50% of the PLS contracts have been
successfully renegotiated, with another 30% expected to be
completed by mid-year 2015. PHHs growth initiatives, which are
aimed at increasing its scale through both organic and inorganic
means, are expected to generate $175M of pre-tax operating benefit,
or $1.60 per share, on an investment of $150M and are targeted to
be completed by 2017. Growth opportunities include incremental
originations sourced through greater penetration of existing PLS
partners mass affluent customer bases, new regional/community bank
relationships, real estate services channel expansion and retail
branch development. In addition, for Mortgage Servicing, the
company is targeting subservicing acquisitions. Outside of
managements growth initiatives, PHH will benefit from cyclical and
secular tailwinds off of the industrys reset base. Increasing home
sales volumes, home price appreciation, loan-to-value increases and
a declining share of cash purchases should drive growth in purchase
mortgage originations. Additionally, PHH should benefit from
declining foreclosure expenses as we move further away from the
financial crisis. Further, PHH would benefit from interest rate
increases, as it earns interest income on the approximately $3B it
holds in escrow accounts as part of the servicing business. Lastly,
the current regulatory environment should cause more small banks to
outsource mortgage production functions as they can no longer
maintain them in-house cost efficiently due to rising compliance
costs. Excess Cash Following the sale of its Fleet business, PHH
had a significant excess cash position. After deploying $435
million to retire debt and setting aside cash for working capital
and ongoing liquidity preferences, PHH had excess cash of $1-$1.1
billion. Of this amount, $350 million was set aside for its
re-engineering and growth initiatives, collectively, leaving
$650-750 million available for deployment to shareholders, or
37-43% of its pro forma market capitalization. The company has
announced plans to repurchase up to $450 million, with an
accelerated share repurchase program for $200 million of the total
expected to be completed this quarter. As the company advances
further through the $450 million allocated to share repurchases, we
expect management to address plans for the remaining $200-300
million of excess cash.
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13
Earnings Power & Price Target Building off of a base of
negative earnings in 2014, we see earnings power at PHH in excess
of $4 per share in 2017.
Bridge to 2017 Earnings Power ($1.28) Adjusted 2014 Operating
EPS4 +0.23 Reduction in foreclosure expense +0.34 Interest savings
on debt retirement +0.44 Interest on $3B escrow holdings (based on
forward curve) +0.68 Re-engineering expense reductions organization
redesign and facilities +0.52 Re-engineering expense reductions
process improvement +0.40 Re-engineering expense reductions vendor
management and consolidation +0.37 PLS contract renegotiations (80%
of target) +0.80 Growth initiatives (50% of target) +0.58 Mortgage
market growth at ~10% CAGR +1.02 Share repurchases $4.10 2017
Operating EPS
PHH offers upside of over 100% within two years to $50 per
share, or 12x 2017 operating earnings. As we get into the back half
of 2015, with further capital allocation, much of the
re-engineering expenses harvested, earnings turning positive and
growing quickly, and potentially some of the growth initiatives
realized, investors should better appreciate the value in PHH.
Combination Therapy: Specialty Pharma Consolidators We initiated
positions in Endo and Actavis in 2014 in part as a thematic
investment in specialty pharma consolidation. We invested in Endo a
little over a year ago, and Actavis a few quarters ago, and remain
excited about the outlook for both names. Beyond the shared theme
of sector consolidation, both companies have specific
characteristics that make them attractive investments.
Pharmaceutical companies invest a great deal of money in
early-stage development of new drug candidates. The vast majority
of these companies have no secret sauce or advantage in basic
research, and unsurprisingly, the vast majority of these research
efforts fail, destroying shareholder value. Further, this legacy
pharma model relies on significant selling and marketing costs,
which translate mid-80% gross margins into 23-30% profit margins.
In contrast, the consolidators companies such as Actavis and Endo
can cut negative/low ROIC research and acknowledge that this basic
early-stage research is best left to academic labs and startups.
Further, they focus on lucrative specialty niches that require
limited sales and marketing spend and acquire drugs that can be
layered onto the existing selling and marking chassis, such that
they can eliminate significant SG&A spend from assets acquired.
These spec pharma consolidators operate at 50%+ EBIT margins and
create additional value through their tax-advantaged acquisition
platforms as both companies are foreign and thus have significantly
lower taxes. In the end, Actavis and Endo are platforms that can
drive significant shareholder value through consolidation of
inefficient operators. Further, we see excellent risk/reward just
on the standalone organic growth profile (and if no strategic
acquisitions present), as each company is driving durable organic
revenue and earnings growth.
4 Adjusts for $67 million of one-time expenses identified in
PHHs 4Q 2014 results supplement; diluted shares are based on a
stock price of $50.
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14
Financials Legacy Pharma Specialty Pharma
Revenues Organic growth driven by pipeline; "Feed the beast"
mentality Growth driven by acquired marketed
or late-stage products Gross Margins Mid-80% of sales Mid-80% of
sales
R&D ~20% of sales; negative ROIC ~5-7% of sales;
low-risk, late-stage R&D only
SG&A ~35-40% of sales; large primary care sales forces
~20-25% of sales;
lean structure and focus on specialty products EBIT ~25-30%
margins ~50-55% margins
Tax Rate ~25%; frequently large offshore cash balances that are
unusable ~15%: frequently inverted
into a tax-efficient structure Net Income ~20-25% margins
~40-45% margins Capital Structure Underlevered/overcapitalized
Deploys balance sheet for value-creating M&A
Management is the Active Ingredient: Actavis (ACT: $288) We
invested in Actavis in mid-2014, shortly after it completed the
acquisition of Forest Labs. Between 2011 and 2014, ACT transformed
from a mid-size generics company with $1B in EBITDA to a majority
branded (70% of EBIT) company with approximately $4B in EBITDA.
Actavis management had set an EPS goal of $20 in 2017 that we felt
they could reach a year earlier with modest capital allocation,
implying 30-40% upside in the name. We also felt that in addition
to being significantly undervalued on its base business, ACT had
three unique call options:
1. An acquisition by Pfizer that could enable Pfizer to
redomicile to Ireland for tax purposes; 2. A white knight
acquisition of Allergan, which was facing a hostile takeover
attempt from Valeant; and 3. The continued consolidation of smaller
specialty pharma companies through tuck-in acquisitions.
Of these three, we felt the second one was the most likely, and
in November, Actavis did in fact announce the acquisition of
Allergan. Once the acquisition closes, we expect Actavis (a $120B
market cap company post deal with >$11B in 2015E EBITDA) to have
the best organic revenue and EPS growth in large-cap pharma, with a
branded business that is approximately 85% of profits and limited
product concentration or patent expiration risk. As a result, we
continue to regard the stock as significantly undervalued despite
having increased more than 30% since we initially established a
position. Given the highly accretive Allergan acquisition,
management has increased their 2017 EPS goal to $25 per share, and
we see a number of upside levers that could drive EPS as high as
$27. Given that the combined company has a faster-growing,
higher-margin, and more durable business, we think it merits a
higher P/E multiple of 15-17x, implying nearly 50% upside over the
next 18 months. And lastly, while we clearly like the organic
growth story, we do think a potential acquisition by Pfizer remains
a possibility over the medium-term, and regard it as a call option
on our investment. The Little Ones Grow Up So Fast: Endo (ENDP:
$89) While Endo and Actavis do share a common theme, we would
regard Endo as being in an earlier stage of transformation than
Actavis or Valeant (VRX). As mentioned above, ACT has grown from
$1B in EBITDA in 2011 to >$11B in 2015E EBITDA and generated a
>60% annualized shareholder return. Similarly, VRX has grown
EBITDA from $1B in 2011 to approximately $6B in 2015, generating a
58% annualized return for shareholders. In contrast, Endo is still
in the early stages of this transformation. The CEO who has
executed on this model before as COO of Valeant has completed two
major deals (including a redomicile to Ireland), four to five
smaller deals, a major restructuring, and the divestiture of two
non-core businesses since he joined the company only 18 months ago.
In that time, he has already turned Endo from a declining business
to a high single digit organic growth company post-2015.
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15
If Endo were to continue to execute on its model and using up to
4x for tuck-in acquisitions (we estimate at 10x reported EBITDA /
7x synergized EBITDA multiples), it could drive EPS in the
$8.30-8.60 range by 2016, implying that shares are trading at a
10.5x PE multiple on 2016 earnings power. A 14-15x PE, which we
think is conservative for a high single digit organic revenue
grower, would suggest upside of +30-45%. We also think there is a
further blue sky case for Endo worth considering. The bulk of the
value creation at ACT and VRX came from transformational deals such
as Warner-Chilcott and Forest for Actavis, or Bausch & Lomb for
Valeant. Large transformational deals like these are unpredictable
and are not captured in our estimate of earnings power above as
they would likely require stock issuance, but over the next three
years, we think it is much more likely that Endo executes on a
transformational deal than Actavis or Valeant. If Endo is able to
match the pace of shareholder return set by those two companies, a
blue sky scenario would imply a share price greater than $200 by
2017. Concurrent with the writing of our letter, Endo submitted a
topping bid for Salix Pharmaceuticals, which had previously agreed
to be acquired by Valiant. In response, Valiant increased their bid
by nearly 10% and Endo walked away on price. While we understood
the attraction of Salix to multiple acquirers, we do not believe
the property is so unique that it should be pursued at all cost. We
applaud Endos price discipline and believe there will be ample
growth opportunities ahead. Running at a Healthy Pace Before the
Final Sprint: T-Mobile USA (TMUS: $32) Weve owned a position in
T-Mobile USA since June 2013 and increased our stake last December.
T-Mobile, which is majority-owned by Deutsche Telekom, is one of
the Big 4 U.S. wireless carriers with a postpaid sub and service
revenue market share of only 12%. We believe T-Mobile offers both
an underappreciated runway for robust multi-year growth leading to
an inflection in FCF and also significant strategic optionality
that, notwithstanding the recent move in the stock, doesnt appear
to be captured in the current valuation. Until early 2013, T-Mobile
had long been a wholly-owned, orphaned subsidiary of a corporate
parent with competitive disadvantages that led to ongoing share
donorship in the U.S. wireless market and significant erosion in
brand. In May 2013, however, T-Mobile emerged as a publicly-traded
company through the reverse merger with MetroPCS and installed new
management under the leadership of CEO John Legere. New management
attacked the sources of T-Mobiles structural share loss:
i) Aggressively deployed LTE, bringing T-Mobile to network
technology parity vs. peers for first time in a decade;
ii) Secured the iPhone in April 2013 after T-Mobile had been the
only carrier without the device; iii) Acquired low-band spectrum
last year designed to expand and improve T-Mobiles coverage; and
iv) Moved to simplified, more competitive price plans.
Importantly, theyve augmented these fundamental improvements in
their network and product offering with a tremendous job of
rejuvenating the brand aided by a creative series of initiatives
known as the Uncarrier strategy designed to (a) attack consumer
pain points, (b) address pockets of the market theyd previously
underindexed to by tactically discounting to the asymmetric
detriment of AT&T and Verizon, and (c) create a differentiated
voice in the market place. The results to date have been
astounding:
"OldTMUS" "NewTMUS"2015Guidance 2017Outlook
2011 2012 2013 2014 MidPoint HighEnd MidPoint
HighEndPostpaidNetAdds (2,206) (2,074) 2,006 4,886 2,700
3,200SubGrowth* (9.0%) (9.3%) 9.9% 21.9% 9.9% 11.8% ~12%+ ~14%+
PostpaidChurn 2.70% 2.35% 1.69% 1.58%
EBITDA $6,642 $6,398 $5,317 $5,636 $7,000 $7,200 $9,639
$10,304YoYGrowth* (0.2%) (3.7%) (16.9%) 6.0% 24.2% 27.8% 17.3%
19.6%Margin 29.0% 29.4% 25.9% 25.2% 28.3% 29.1% 33.0% 34.0%
EBITDACapex $3,023 $2,651 $1,077 $1,319 $2,450 $2,650 $5,475
$6,065Step#1: Investedin sub growthStep#2:
DrivingrampininEBITDAgrowthStep#3: Wil l trans la te tomeaningful
FCF
*CAGRfrom2015guidanceto2017companyprovidedoutlook;NOTE:2015EBITDAmarginsand201517subscriberCAGRimplied.
$5,000$5,500$6,000$6,500$7,000$7,500$8,000$8,500$9,000
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age expansion wress ~20% of thenetration withhurn levels thath:
As would bse in gross addguidance of 24EBITDA growtne:
in incremental
last several quiber momentumh current 2015gher.
has visibility t
t recent sub monuing, two new
n Competitive . In the midst
with 54% of thowireless marketpete should impls and were se
row EBITDA soing to be smarr revenues. We
recting becauas large as T-Mthat they need
T&T was 94% r that includes tst spent $43B tg for $28B of
thricing umbrelloyment in 2015
ctrum for the fiis low-band freobile to expandse its marketa
will have two ahe population (hin that base anat, though well be
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16
uarters with them, the proof is /16 EBITDA e
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m significant su
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will remain inteeve the level ofly signs of self
s this year comoing to chase cocus on profitab
Verizon have r 2015 EBITDrder to maintainwhile, Sprint
n-cash benefits ctrum in the AW
those carriers f a return on thas now deployinhistory and
wilrum, whereby tfootprint from 2from 230mm t
cts to subscribeOPs) for the firsed network covvels, still
haveusiness with aninflection lagg
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ub growth in b
y and the ultimrs Street EBIT/30% higher th
and an inflecti
h in the pan. Asibility to susta
in the wireless mm postpaid sughly-competitiense in an absof
competitive inf-correcting be
ming off last yecustomer net adbility- AT&
$26B and $35BDA, with wirele
in their dividenended 2014 wand ignores pr
WS spectrum ashould also be
at capital. ng its newly-acll have this spethe signal from265mm
to 300to 290mm POP
er growth: (i) Tst time from a sverage should be room for furthn
upfront SACged subscriber tion of 27% EBEBITDA grow
business with si
ate profitabilityTDA estimates
han where they
ion in FCF:
Aside from theained double-di
market, particubs, an amazinve 2H14. Tho
olute sense andntensity could havior:
ar, which was dds or revenues&T CFO, 3/11/1
B wireless EBIess margins of 4nd payout ratioith 4.7x net
levrospective cashauction with Ae highly-incent
cquired low-baectrum fully-m the tower trav0mm POPs andPs:
T-Mobile will bstarting point obe a needle-moher improveme
C going throughgrowth. Howe
BITDA growthwth moving bey
izeable fixed c
y/unit s have
y were
e igit
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a s just
/15
ITDA 42%
os, verage h burn. T&T
ted to
and
vels d, even
be of oving ent. h a ever,
h yond
costs;
-
17
b) Normalization of SAC-related spend we do model moderate
slowing of sub growth beyond 2015 relative to the above-guidance
4.0mm 2015 net adds in our numbers; and
c) Estimate only ~$500-600mm of the greater than $1B in YE15
run-rate operating cost synergies from shutting down the network of
the now integrated MetroPCS will actually be realized 2015 EBITDA
.
3) FCF Inflection: T-Mobile has guided to positive FCF
generation in 2015 for the first time in its history. We expect
that FCF to rise dramatically over the ensuing years aided by the
growth in EBITDA against a flat-to-modestly declining capex budget.
Using EBITDA less capex levels that are actually below the
mid-point of managements just-issued 2017 outlook although still
above consensus, we believe T-Mobile will generate $3 per share in
2017 FCF on a fully-taxed basis, understanding theyre unlikely not
to be a full-tax payer in 2017 as their NOLs should last into
2017/18.
Aside from the T-Mobile standalone case, we continue to believe
T-Mobile is a key strategic asset in the U.S. wireless market.
Though we dont know the exact path to value realization, we do know
the following to be true:
i) T-Mobile is owned by a corporate parent in Deutsche Telekom
in search of value maximization. ii) DISHs Charlie Ergen has
amassed spectrum that eventually needs to find a home to be
operationalized. iii) Number of players experimenting with mobility
solutions, such as Google and Comcast, will continue to
rise. iv) Foreign interest in the U.S. wireless market has
remained high as evidenced by Softbanks purchase of
Sprint. v) Recent spectrum auction implied T-Mobiles spectrum
alone was worth ~$40/share. vi) Sprints value maximizing outcome
remains a merger with T-Mobile, likely to be revisited in the
next
administration and likely to be anticipated by investors before
then. What should a business trade at with a great management team,
visibility to ongoing operating momentum, significant EBITDA growth
leading to an inflection in FCF, all in the context of being a
strategic asset with at least one known, highly-synergistic bidder
looking out just 18-24 months and with a majority-owner that
appears to be a motivated seller? Even after a recent move higher,
T-Mobile trades at just 6.4x our 2015 EBITDA and 5.3x our 2016
EBITDA whereas AT&T, Verizon and Sprint currently trade at
6.3x, 7.0x and 7.3x 2016 consensus EBITDA, respectively, before
adjusting for the fact that T-Mobile is now the only carrier where
EBITDA isnt currently being artificially inflated by transitory,
non-cash accounting benefits. T-Mobile would still only trade at
6.0x 2016 EBITDA allowing for an illustrative $6B spend by T-Mobile
in the scheduled 2016 broadcast spectrum auction, where T-Mobile
will acquire spectrum on an advantaged basis as the FCC will be
pressured to ensure AT&T and Verizon do not corner the market
in yet another spectrum auction, especially after killing the
Sprint merger. The stock trades at 10x our 2017 fully-taxed FCF
ex-small remaining NOL and, on that basis, we believe T-Mobile is a
stock that can easily offer returns in excess of our opportunity
cost of capital over the next eighteen months, even in the absence
of M&A or other strategic actions that, were they to occur,
carry the potential for an acceleration and an accentuation of
value realization.
* * * Liquidity and Risk The overall liquidity of the portfolio
remains excellent. At the end of Q4, the weighted average median
market capitalization of our equity portfolio was $17.4 billion we
note this is a drop from the prior quarter as we harvested several
larger-cap opportunities that reached price targets. We remain in a
position to liquidate approximately 50% of our consolidated
portfolio in five days (Glenview and GO) while accounting for no
more than 20% of the volume in any one security. Portfolio
volatility in Glenview in Q4 was 24.7%,5 driven by a spike in
volatility in early October. Despite the higher volatility, we
chose to ride it out rather than mitigate risk after the fact in
mid-October, and we were well rewarded for our patience and faith
in the value of volatile long investments such as Avis, Endo,
Actavis and others. For the full year 2014, portfolio volatility
was 19.7%, which is below our inception-to-date average of
28.5%.
5 The volatility figures refers specifically to the offshore
trading fund within the Opportunity product, i.e. Glenview
Offshore
Opportunity Master Fund, Ltd.
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18
Organization As of 12/31/14, total assets under management are
approximately $10.6 billion, comprised of $7.3 billion in Glenview
and $3.3 billion in GO. As you are aware, we closed the GO product
to new inflows early in 2014 because we are sensitive to the
balance between asset size, which funds our significant investment
in team and allows us a greater share of voice as significant
shareholders, and liquidity, which allows for more efficient entry
and exit surrounding individual positions. Additions, Promotions
and Departures We are proud to announce the following additions to
our team during the quarter. Alexandra Busch joined Glenview in
November as a Research Associate reporting to Rami Armon, who runs
our Policy and Economics group. Prior to joining Glenview,
Alexandra worked at Goldman Sachs, where she was most recently a
Fixed Income Investment Guidelines Analyst and, prior to that, an
Investment Banking Compliance Analyst. Alexandra graduated from NYU
with a B.A. in Political Science magna cum laude. Glenview is
thrilled to welcome back John Kim to rejoin our team as an Analyst
in the Healthcare group. As many of you know, John was called to a
higher duty two years ago to serve in the South Korean Army, which
caught both him and us a bit by surprise. As you would expect, John
carried out his service bravely and with distinction, and to our
great benefit, he has agreed to rejoin Glenview and pick-up where
we left off. As you know, we are proud of our culture of training
and development that has produced a very strong pipeline of
leadership and human capital throughout the years at Glenview. We
are proud to announce the following merit-based promotions: Matt
Newman has been promoted to Managing Director on our Healthcare
team. Matt joined Glenview in January of 2010, and he has made
significant contributions to the firm during his tenure. His
research has helped drive some of our largest and most profitable
positions in 2014. Matts coverage within the healthcare space
continues to grow, and now encompasses the pharma supply chain,
managed care, healthcare IT, and pharmaceuticals. We look forward
to Matts continued leadership and success. Rami Armon has been
promoted to Director of Policy and Economics. Rami joined Glenview
in September of 2013 and immediately became a valued member of the
team. He has centralized and enhanced our research efforts on
matters related to policy, regulatory, and legal. His thorough work
has helped add conviction on major themes across the portfolio.
Ramis strong work ethic and depth of knowledge make him an
important resource to all our industry verticals. Cody Zimmer has
been promoted from Research Associate on our Proprietary Research
team to Analyst on the Industrials team working with John
McMonagle. Cody joined Glenview in 2013 and since that time has
made significant contributions to the Industrials team. Most
notably, he has developed and maintained relationships with a deep
network of executives across sectors as diverse as agriculture and
general industrials. With the help of these networks, the
Industrials team has built conviction in several new investments
and improved capital velocity on both the long and short side of
the portfolio. Doug Rogers and Anthony Aiello have been promoted to
Co-Heads of European Proprietary Research based in our London
office. Doug is one of the most tenured members of the prop team,
joining Glenview in 2011. He was the leader of our healthcare prop
effort building out checks around healthcare utilization and the
pharma supply chain. He also helped to train and mentor new hires
over the last few years. Anthony joined Glenview in 2012 and made
an immediate impact through his work on our consumer research.
Similar to Doug, Anthony led by example and helped improve our
overall process across sectors. Anthony managed the development of
a number of new consumer checks, including the expansion of our
work focused on U.S. retail. We look forward to their continued
contributions as they build out our capabilities across Europe.
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19
Daniel Nassar was promoted to Prop Research Associate. Daniel
joined Glenview in 2013 to assist with our healthcare prop research
and quickly established himself as a top performer. Daniel now
leads our efforts across some of our most important healthcare
related projects including managed care, tools and life sciences.
Chris Venezia has been promoted to Co-Head of Investor Relations
and Marketing, working with Elizabeth Perkins, who has been a
Partner since 2011. Chris has been with Glenview since October
2005, initially as a member of our research team before migrating
to an IR role in late 2007. While the timing proved awkward, Chris
performance has been stellar, providing you with strong service and
transparency as well as true insight into our positions, risk and
process. Chris has also been instrumental in our marketing
activities, cultivating numerous new and productive relationships
for the firm that have formed the basis for wonderful long-term
partnerships. We know Elizabeth and Chris work strengthens your
confidence in us, and in turn we have great confidence in and
appreciation of Chris efforts over the past ten years. Jonathan
Danziger has been promoted to Chief Compliance Officer and Deputy
General Counsel, assuming the CCO role from our President and
General Counsel, Mark Horowitz. Jonathan has earned the respect of
the entire organization through his judgment, intellect, integrity
and work ethic and has quickly grown into the senior leadership
position required of a CCO. He leads our efforts in enhancing,
training and documenting our best of breed compliance program in
the U.S and abroad and counsels on a broad range of legal matters.
We believe our strong compliance track record not only reflects our
investment in talent and our good faith efforts, but also reflects
the talents of Jonathan and Mark in guiding us forward. Finally,
during the fourth quarter or shortly thereafter, we parted ways
with a senior analyst, two analysts and a trader: Vik Doshetty
(Industrials), Shannon Knee (TMT/Services), Christian Sisak
(Financials) and Conor Casey (Europe). We wish them all success in
their future endeavors. Partnership It is with great pleasure that
we announce the promotion of Jamie Helwig, Head of our Consumer
Group, to become a Partner of our firm. Jamie joined Glenview in
2007. I remember first seeing Jamies resume when he interviewed
eight years ago and at first blush it looked to be the
stereotypical perfect resume: Jamie graduated with honors from the
Wharton School at the University of Pennsylvania, where he had a
4.0 GPA in his concentrations of Accounting and Finance. He worked
for several years in the M&A department of The Blackstone
Group, where he worked on many deals of consequence. He was captain
of his high schools crew team, and a competitive triathlete
completing a half-ironman at age 15. However, it was one detail
that really caught my attention: he worked five summers before his
internships at a family trucking company, unloading freight and as
a licensed forklift and power hand jack operator. Jamie wasnt just
a bright kid, he was a worker, and he has embodied that each day at
Glenview. He was promoted to senior analyst in 15 months, became
co-head of Consumer in four years and became sole head of Consumer
two years later. Under his leadership, we have developed and
trained significant human capital in the group, broadened our
sector knowledge to include video games and rental cars, auto
dealerships and dollar stores, and our learning process continues.
Jamie is recognized by his team as a strong and well-organized
manager, providing us with a pipeline of investment ideas and
investment talent that will power our future returns. Please join
us in thanking Jamie for his historical contributions and
congratulating him on his well-deserved promotion we look forward
to many years of hard work and mutual success together.
* * *
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20
People, Not Things In our last letter, I wrote a story about my
11 year old son, Ryan, and some of our adventures together. On
December 31st, on vacation in Anguilla, Ryan and I set out on a
34-foot charter boat with two local captains to go bottom fishing
for tropical fish or trolling for tuna or marlin. An hour of bottom
fishing yielded only two tiny fish so we decided to troll north
towards Prickly Pear Islands, along a ridge where seas drop from 60
feet to 700 feet, similar to the canyons we fish offshore of Long
Island. About 15 minutes into our journey, we hook up on a big
fish, as line starts screaming out the reel of the back left
fishing rod. Ryan goes to work on the fish, with the aid of both
captains, and I reel in the other lines to avoid tangles. We had
following seas (waves coming from behind us), and the boat had an
open space to the swim platform and ladder with the captains and
Ryan in the back left corner of the boat and the large fish pulling
down on the rod, we started to take on a bit of water given the
relative elevation of the waves and the opening in the boat. Taking
on water is not a crisis in boating because all boats have a bilge
pump that pumps water back out. However, this boats bilge pump
failed (or never worked in the first place), and we began taking on
more water. Ryan and I took the rod to the front of the boat,
balancing the weight while the crew manually bailed the water from
the back with empty containers. However, the weight of the water we
had already taken on kept the boat slightly tilted backwards, and
it became increasingly apparent that it was only a matter of time
before physics won out. The captains called their boat dispatch for
help, and they were working furiously to save their boat. However,
recognizing the inevitability of the situation, Ryan and I threw
the rod overboard and began the preparations for evacuation. We got
Ryans life vest secured, found all that would float cushions, empty
coolers and floating rings and put them overboard Ryan noticed that
there was a self-inflating life boat in the front hold (good call
Ryan!) and that went over too, and then I had Ryan jump first and I
jumped right after him. Less than a minute later, the boat was
fully vertical, with only five feet of the bow above water where
the air trapped in the forward hold kept it afloat for its last
minutes.
I got Ryan on top of a floating seat cushion, and we then made
our way paddling, while holding all that floats, to the inflatable
lifeboat that had floated 50 feet away. We got there at the same
time as the two captains, and they knew how to trigger the
self-inflation device. Ryan and a captain got in it was the size of
a small bathtub so I thought it best that I stay in the water next
to it rather than crowd in. After ten minutes in the water, we saw
our rescue boat on the horizon and after 15 minutes we were aboard
the second boat. The captains and the second boat wanted to spend
time trying to save the capsized boat whose tip was still visible,
but then it sank completely, and I was anxious just to get Ryan
back to shore. Five miles off the coast of Anguilla, our boat sank
to the bottom of the ocean. We will never know what type of fish
pulled us down. From the location and the fact that it never
surfaced, we think it was most likely a large tuna. Despite marking
the spot where the boat sank, the charter company has yet to
recover the boat or our things on it (or so they say). Once on the
rescue boat and headed back, we reflected on what we did right and
wrong. First, we did joke that in emptying coolers to bail we threw
our bait overboard, and later jumped in overboard quite literally
we chummed for ourselves, causing my wife to conjure up images of
Shark Week. I also realized that I left my phone, wallet, iPad and
even my lucky shoes in a bag on the boat. While the phone and iPad
would have nearly certainly been ruined by the water, my wallet
would have dried and my shoes were sentimental. In truth, I didnt
even think of them. In a crisis, all I could think about was Ryan.
Sometimes a scary experience like that causes a person to look at
life and reevaluate ones priorities. I couldnt be prouder that this
experience simply reinforced the values handed down to me by my
parents and grandparents, and shared throughout Glenview. People,
not things.
* * * Odd coincidence: The Fixxs Saved By Zero song we
referenced in the beginning is a song about meditation and choosing
happiness over material things. The B-side to that 1983 record
Going Overboard. Aaaaahh!
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21
Please save the date of November 12, 2015 for our 15 year
anniversary investor day conference in New York City. We will
provide additional details as we get closer to the event. As
always, should you have any additional questions, please feel free
to call our investor relations professionals, Elizabeth Perkins
(212.812.4723), Chris Venezia (212.812.4722), Bob Burns
(212.323.6544) or Patrik Hansson (212.323.6547) at any time.
Respectfully, Larry Robbins Chief Executive Officer
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22
EXHIBIT A IMPORTANT DISCLOSURES AND DISCLAIMERS This letter does
not constitute an offer to sell nor the solicitation of an offer to
buy any interest in any investment fund (each, a Fund or together
the Funds) managed by Glenview Capital Management, LLC
("Glenview"). Such offer or solicitation may only be made by
delivery of offering documents containing a description of the
material terms of any investment, including risk factors and
conflicts of interest. Any such offering will be made on a private
placement basis to a limited number of eligible investors. You
should conduct your own investigation and analysis of Glenview and
the Funds. Anyone considering an investment in the Funds should
review carefully and completely the applicable Funds Offering
Documents, including the Offering Memorandum of such Fund, the
applicable subscription documents, the applicable Governing
Documents and Glenviews Form ADV Part 2, in their entirety and ask
questions of representatives of the Funds before investing. Gross
and net returns assume that a hypothetical investor (i) has been
invested in Glenview Offshore Opportunity Fund, Ltd. (the "Fund")
since inception of the Fund and has made no additional
subscriptions or withdrawals and (ii) was allocated profits and
losses attributable to "new issues" and any other specially
allocated income on the same basis as all other profits and losses
of the relevant Fund. In addition, gross and net returns (x)
include reinvestment of dividends, interest, income and prior
performance returns, and (y) reflect the deduction for management
fees (based upon a 2% annualized management fee), and all other
Fund expenses. Note, that the return figures for the Fund refer
specifically to the returns for Glenview Offshore Opportunity
Master Fund, Ltd. using the aforementioned methodology. The net
performance figures for any given period take into account an
accrual for the incentive allocation, if any, based upon on a 20%
incentive allocation calculation, as of each month-end in such
period. The performance data reflects the actual allocation of the
incentive allocation in accordance with the terms of the Fund,
which provides that the incentive allocation is made at the end of
a Funds fiscal year (assuming no capital withdrawal prior to such
date). Past performance is not indicative nor a guarantee of future
results. Actual returns for a particular investor will vary
depending upon, among other things, an investors new issue status
and the timing of subscriptions and redemptions. There can be no
assurance that the Fund will achieve comparable results in the
future. An Investor could lose all or a substantial amount of his
investment. In addition, note that net returns for 2014 are
unaudited. HIGHLIGHTED SECURITIES Securities highlighted or
discussed in this letter have been selected to illustrate Glenviews
investment approach and/or market outlook and are not intended to
represent the Funds performance or be an indicator for how the
Funds have performed or may perform in the future. Each security
discussed in this letter has been selected solely for this purpose
and has not been selected on the basis of performance or any
performance-related criteria. The securities discussed herein do
not represent an entire portfolio and in the aggregate may only
represent a small percentage of a Funds holdings. The portfolios of
the Funds are actively managed and securities discussed in this
letter may or may not be held in such portfolios at any given time.
Nothing in this letter shall constitute a recommendation or
endorsement to buy or sell any security or other financial
instrument referenced in this letter. FORWARD LOOKING STATEMENTS,
OPINIONS AND PROJECTIONS This letter contains certain forward
looking statements, opinions and projections that are based on the
assumptions and judgments of Glenview and the Funds with respect
to, among other things, future economic, competitive and market
conditions and future business decisions, all of which are
difficult or impossible to predict accurately and many of which are
beyond the control of Glenview or the Funds. Other events which
were not taken into account in formulating such projections,
targets or estimates may occur and may significantly affect the
returns or performance of any Fund managed by Glenview. Because of
the significant uncertainties inherent in these assumptions and
judgments, you should not place undue reliance on these forward
looking statements, nor should you regard the inclusion of these
statements as a representation by Glenview that the Funds will
achieve any strategy, objectives or
-
23
other plans. For the avoidance of doubt, any such forward
looking statements, opinions, assumptions and/or judgments made by
Glenview and the Funds may not prove to be accurate or correct. All
forward looking statements, opinions and projections are made as of
the date of this letter. The forward looking statements, opinions
and projections expressed herein are current as of the date
appearing in this letter only. Neither Glenview nor the Funds have
any obligation, and expressly disclaim any obligation, to update or
alter the statement, opinions, projections and/or other information
contained herein, whether as a result of new information, future
events or otherwise. In addition, neither Glenview nor the Funds
provide any assurance that the policies, strategies or approaches
discussed herein will not change. ADDITIONAL DISCLOSURES Certain
economic and market information contained herein has been obtained
from published sources prepared by other parties, which in certain
cases has not been updated through the date of the distribution of
this letter. While such sources are believed to be reliable for the
purposes used herein, Glenview does not assume any responsibility
for the accuracy or completeness of such information. Further, no
third party has assumed responsibility for independently verifying
the information contained herein and accordingly no such persons
make any representations with respect to the accuracy, completeness
or reasonableness of the information provided herein. Unless
otherwise indicated, market analysis and conclusions are based upon
opinions or assumptions that Glenview considers to be reasonable.
This letter is being furnished on a confidential basis and is for
the use of its intended recipient only. No portion of this letter
may be copied, reproduced, republished or distributed in any way
without the express written consent of Glenview. ADDITIONAL
INFORMATION FOR SWISS BASED INVESTORS The representative of the
Fund in Switzerland is Hugo Fund Services SA, 6 Cours de Rive, 1204
Geneva (the Swiss Representative). The distribution of Shares in
Switzerland must exclusively be made to