Gabelli Value 25 Fund’s letter to shareholders for the quarter ended June 30, 2014.
To Our Shareholders,
For the quarter ended June 30, 2014, the net asset value (“NAV”) per Class A Share of The Gabelli Value 25 Fund Inc. increased 4.1% compared with increases of 5.2% and 2.8% for the Standard & Poor’s (“S&P”) 500 Index and the Dow Jones Industrial Average, respectively. See page 2 for additional performance information.
Gabelli Value 25 Fund: The economy
The second quarter of 2014 offered its share of surprises: first quarter GDP was revised to 2.9%, ten year U.S. Treasury rates declined to 2.5% after ending 2013 at 3.0%, tensions worsened in Ukraine, and the previously little known group ISIS executed a lightning-fast takeover of much of oil-rich northern Iraq. Perhaps the biggest surprise, however, was that in the face of these dynamics, the S&P 500 marched up over 5% for the quarter. Clearly, the market is looking at other variables. Job growth continues to improve and the housing market is showing pockets of strength, but neither to the extent that would cause the Federal Reserve to accelerate the withdrawal of stimulus; interest rates are likely to remain historically low well into 2015. The market has also been heartened by a surge in mergers and acquisitions (M&A), as quarterly global transaction volumes more than doubled year-over-year, exceeding $1 trillion for the first time since 1998. Several years ago, we noted that we expected a “Fifth Wave” of post-World War II M&A, fueled by low interest rates and a dearth of organic growth opportunities. Two additional ingredients – rising corporate confidence and the pursuit of tax domiciles outside of the U.S. – have recently swelled that wave. We believe that a virtuous cycle of more deals and awakening animal spirits has been set into motion, which should extend the M&A trend into the foreseeable future.
As we have written in the past, the level and trajectory of interest rates and inflation are likely to have the biggest impact on future M&A and the stock market. Spurring the economy to outgrow an eventual normalization of rates is the needle that central banks around the world must thread. There are certainly many obstacles to achieving this goal, including geopolitical instability. The price of oil, often a barometer of global tensions, rose substantially in the quarter and is a factor we monitor carefully, as it could snuff the global recovery.
Gabelli Value 25 Fund: Activists all around
While Russian President Vladimir Putin and Federal Reserve Chair Janet Yellen have been active in their respective spheres, we concern ourselves here with the rising ride of so-called shareholder activists. Tracing their history to the conglomerateurs of the 1970s and raiders of the 1980’s, today’s activists tend to be more institutionalized, even partnering with other corporations, as Valeant Pharmaceuticals Intl Inc (NYSE:VRX) did recently with Pershing Square in a bid for Allergan, Inc. (NYSE:AGN). Often seen among the varied goals of activists are changes in capital structure, corporate transactions (e.g. a sale or spinoff) and improved governance or operations. The toolbox used to pursue these measures includes a combination of public relations and proxy contests.
We take a nuanced view as to the long term impact of these campaigns – it depends on the target, the objectives, and the activist. Although we would not consider ourselves activist investors, your Advisor issued a Magna Carta of Shareholder Rights in 1988 which states: “We are neither for nor against management. We are for shareholders.” The document goes on to list a number of governance policies we favor (e.g. cumulative voting, golden parachutes, one share/one vote) and oppose (e.g. poison pills, super dilutive option plans). Unlike many of today’s headline grabbing activists, we do not typically enter a situation seeking change. However, if we believe a company in which we have invested is harming its shareholders, we will be tireless in protecting (y)our interests.
Gabelli Value 25 Fund: Deals, deals, and more deals
The Fund was a significant beneficiary of deal activity in the second quarter. Suntory’s acquisition of Beam Suntory Inc (NYSE:BEAM) for $83.50 per share, announced in January, closed in April. Beam was the global distilled spirits business that resulted from the October 2011 split-up of Fortune Brands and Fortune Brands Home & Security Inc (NYSE:FBHS) (0.2% of net assets as of June 30, 2014). The product of another split-up, Hillshire Brands (1.1%), from the result of Sara Lee’s separation of its meats and coffee units, became the subject of a bidding war in the quarter, with Tyson Foods, Inc. (NYSE:TSN)’s agreeing to pay $63.00 per share. Covidien plc (NYSE:COV) (0.3%), itself a result of Tyco International Ltd. (NYSE:TYC)’s original 2007 breakup, agreed to be acquired by Medtronic, Inc. (NYSE:MDT), which sought, among other things, Covidien’s domicile in Ireland. Finally, on the heels of Comcast Corporation (NASDAQ:CMCSA)’s (1.1%) acquisition of Time Warner Cable Inc (NYSE:TWC) (1.1%), AT&T Inc. (NYSE:T) agreed to acquire DIRECTV (NASDAQ:DTV) (2.5%) for $95 per share in cash and stock. We had long believed a telecom operator would covet DIRECTV’s premium brand and customer base. We believe the continued strong pace of financial engineering will facilitate more deal activity in the future.
Gabelli Value 25 Fund: Let’s talk stocks
The following are stock specifics on selected holdings of the Fund. Favorable earnings prospects do not necessarily translate into higher stock prices, but they do express a positive trend that we believe will develop over time. Individual securities mentioned are not necessarily representative of the entire portfolio. For the following holdings, the percentage of net assets and their share prices are presented as of June 30, 2014.
Covidien plc (NYSE:COV) (0.3% of net assets as of June 30, 2014) ($90.18) is one of the largest and best positioned medical device manufacturers in the industry. On June 15, 2014, Medtronic agreed to acquire Covidien for $93.22 per share, over $43 billion total. The combined company will be able to partner with customers and bundle together the broadest product offering in the industry. This deal is also structured as a tax inversion, giving the combined company a lower tax rate and more flexibility in using its global cash. At 15x EBITDA and 23x earnings, we think Covidien shareholders are getting full value for their company.
Crane Co. (NYSE:CR) (1.1%) ($74.36) is a manufacturer of highly engineered industrial products serving niche markets in aerospace, fluid handling, automatic merchandising and building products. The aerospace and fluid handling businesses make up about 70% of Crane’s sales. In the Aerospace segment, Crane produces aircraft brake controls, anti-skid systems, pressure sensors, radio frequency components, and custom miniature electronic circuits. This group is poised for significant growth, driven by the increased production of Boeing and Airbus aircraft, including new programs such as the Boeing 787 Dreamliner, the stretched version of the 747, Airbus A380 jumbo jet and the F-35 Joint Strike Fighter. In the Fluid Handling segment, the company makes pumps and valves for the chemical, hydrocarbon processing, pharmaceutical, oil and gas, and commercial construction industries. This later cycle business is showing higher sales driven by increased capital spending in the chemical and process markets. We believe that these dynamics, along with