Third Point Takes Stake in Dutch Life and Material Sciences Corporation (NASDAQ:MASC), Koninklijke DSM N.V. (AMS:DSM) (OTCMKTS:RDSMY)
Below is the full quarterly letter, a copy of which was obtained by ValueWalk
Second Quarter 2014 Investor Letter
Markets Review and moved Outlook higher in the first half of 2014, despite an early sell-off in heavily-owned hedge fund names and popular technology stocks. While investors perceived the market as volatile, the +7% return for the first half largely exceeded expectations.
In the U.S., the Second Quarter’s strength was magnified by the rebound from poor weather that depressed Q1 results. Despite strong recent data on jobs and manufacturing, it remains unclear whether growth will be robust enough to merit tightening action by the Fed this year. We believe we are entering a decisive period and normalized Third Quarter economic growth will mark a key inflection point.
Until then, anticipating a rate hike has been like waiting for Godot. If growth is approximately 3% during the second half of this year, we expect the market will look to the Fed to take action in early 2015. If growth moves closer to 2%, the Fed is likely to remain on hold for longer. While typically markets have applauded that course of action, at current S&P multiples, lower growth could instead cause a modest de-rating as corporate earnings growth will likely disappoint.
Our profits this year have been led by corporate and structured credit investments which have generated two to three times the returns of their indices and peers. Our U.S. equity portfolio’s return has been slightly ahead of the S&P 500 index’s performance. Relatively small investments in Latin America have been exceptional performers.
Exposure to Japan has been our biggest source of losses in 2014. A strong year-end rally and frustration over the pace of reforms caused the Japanese markets to correct by more than 10% in the First Quarter. Our team’s trip to the region in May and meetings with senior officials confirmed that the desire for reform is acute and widespread. Though Prime Minister Abe and other leaders appear committed to changing Japan, shifts of this magnitude do not happen overnight. Moving a country from a culture of persistent deflation to an inflationary environment will only happen slowly. We are seeing early signs that the government’s growing support for improved corporate governance and increased focus on shareholder returns is impacting Japanese companies, a few of which have adopted measures addressing these areas recently. We continue to find compelling individual situations in Japan and, while each has an event-driven component, we recognize that the macroeconomic backdrop will factor significantly in the outcomes of these investments. We think recent macro headwinds will become tailwinds again towards year-end but remain vigilant about inaction. A failure of Abenomics would likely mean that it is time to move on.
Looking ahead, we expect market volatility to continue. After increasing exposure in May, we recently sold down some positions and are focused on several larger new ideas. We are agnostic about geography and sector. Credit exposures should remain steady and we will continue to be highly selective when initiating new opportunities. We believe that having dry powder on hand will be increasingly useful towards year-end.
Set Quarterly forth below Results are our results through June 30th and for the year 2014
While there were lots of fits and starts – which has been our experience in every Brazilian arbitrage situation we have been involved in – the deal ultimately did close and the value of our position has nearly doubled. We still see growth ahead for Kroton and believe CEO Galindo will deliver significant value through post -merger synergies and organic growth in an expanding industry in Brazil.
In Fibra Mexico, Uno we recently participated in the $2.2 billion capital raise for Fibra Uno Administracion SA de CV (BMV:FUNO11), the country’s largest REIT. Fibra’s CEO, Andre El-Mann, and his team have an impressive history of creating substantial value via development and M&A which we believe is not fully reflected in Fibra Uno’s current price. Additionally, macroeconomic conditions in Mexico are very attractive following the recent passage of several critical, long-awaited government reforms.
Higher economic growth should prompt increasing rent levels for Mexican retail, office, and warehouse properties, which surprisingly are the lowest in developed Latin America. Over time, we expect to see demand for new space drive up land values which, in turn, should increase replacement cost and necessitate higher rents to compensate new developers. We believe we are in the early innings of this real estate cycle in Mexico and Fibra Uno offers attractive exposure to a fundamentally sound business with excellent leadership.
Finally, Argentina after the January sell-off in Argentine equities and bonds driven by much-needed currency devaluation, we re-entered our long position in select government credit securities and initiated a stake in Argentina’s main oil company, YPF SA (ADR) (NYSE:YPF) (BCBA:YPFD). We are in the midst of a critical inflection period for the country: if the government settles with its hold-out creditors, Argentina will regain access to global capital markets and solve its liquidity (reserve) problem since its “balance sheet” (debt/GDP) is healthy. Following the resolution last month of the decade-long legal process in the U.S. courts, we believe the hold-out creditors and the government are finally likely to arrive at an agreement by year-end. Doing so would undoubtedly benefit the Argentinian economy.
Beyond this, after a decade of virtually no foreign investment, an impending change in political leadership at the end of 2015 should lead to more market-friendly policies. This should increase foreign direct investment and boost the economy. We hope to uncover additional investment opportunities in Argentina as it emerges from its long malaise.
Over Equity the Position: past three Royal years, Koninklijke DSM N.V. (AMS:DSM) (OTCMKTS:RDSMY) has transformed itself into a leading global life sciences company focused on health and nutrition with ~$12 billion of sales and ~$1.7 billion of EBITDA. DSM’s portfolio of businesses also includes legacy activities in materials sciences. While the Materials segments account for ~55% of sales, their profit contribution to the DSM group (~30% of EBITDA) has been greatly surpassed by that of the Nutrition segment (~70% of EBITDA). Earlier this year, DSM shares sold-off following: i) a profit warning in the Nutrition segment, and ii) growing skepticism about DSM’s ability to execute on its plan to divest its commodity caprolactam business. The weakness in DSM’s share price served as an opportunity to build our position. We believe that the profit warning in Nutrition was driven by cyclical factors and abnormally adverse weather rather than any structural changes in the underlying fundamentals. We are also optimistic that management can successfully separate its commodity caprolactam exposure through either a sale or joint venture. Finally, near-term trends are positive in both of DSM’s businesses, with Nutrition starting to show signs of reverting to a more normalized growth rate and Performance Materials starting to inflect from depressed levels given its exposure to rebounding European automotive and construction markets.
DSM group currently trades at 7.5x forward EV/EBITDA. Based on our analysis, we believe that both the Nutrition and Performance Materials segments should command higher multiples than DSM’s current group multiple. The low group valuation