Mario Gabelli’s Value Fund portfolio commentary for the third quarter 2014.
To Our Shareholders,
For the quarter ended September 30, 2014, the net asset value (“NAV”) per Class A Share of The Gabelli Value 25 Fund Inc. decreased 4.7% compared with increases of 1.1% and 1.9% for the Standard & Poor’s (“S&P”) 500 Index and the Dow Jones Industrial Average, respectively. See page 2 for additional performance information.
Mario Gabelli’s Value Fund: Market Commentary
The third quarter saw a return of volatility to financial markets, starting with a decline in July, as macroeconomic factors, including conflict in Ukraine and Israel, a slowdown in emerging market growth, and Argentinian debt default on the last day of the month all weighed on the market. Markets rebounded sharply in August, as mostly positive second quarter earnings reports were coupled with dovish comments from Federal Reserve Chair Janet Yellen, who at the annual Federal Reserve meeting in Jackson Hole, reiterated, “that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after our current asset purchase program ends.” In other words, rates are likely to remain low for some time. With the backdrop of a slowly improving economy and continued accommodative Fed policy, the S&P 500 hit an all-time high on September 19.
Towards the end of the month, however, markets began factoring in the possibility of a recession in Europe, a worse than expected emerging markets slowdown, the negative impact of foreign currencies on overseas earnings (especially in the Eurozone), concerns about the impact of communicable diseases on travel and leisure industries, and continued conflict around the globe, whether in Ukraine, Iraq, Syria, or elsewhere. In volatile times, we believe it is important to reiterate that, as value investors, we seek for “Mr. Market” to serve us, rather than inform us about the value of a company. We continue to use stock-specific and market dislocations (as has been with small capitalization stocks this year) in order to buy even more of the companies we own on your behalf. These are high-quality, cash generating franchise businesses, operating in industries in which we have a core competency, which have potential catalysts to surface value: a takeover of the company, financial engineering, new management, regulatory changes, a change in cash flow allocation, or some other dynamic. We note that continued low rates mean that companies will continue to have access to low-cost financing, with which they can pursue mergers & acquisitions (M&A). This underscores our confidence that the “Fifth Wave” of takeover activity is likely to continue.
Mario Gabelli’s Value Fund: Deals, Deals, and More Deals
Dealmaking continued in the third quarter, with worldwide M&A up 59% to $2.7 trillion for the first nine months of 2014, although year over year deal value declined in the third quarter. Fund holding Alere (0.3% of net assets as of September 30, 2014), a leading diagnostics company, received an inquiry from its former CEO, Ron Zwanziger, about taking the company private in September. While the company has so far rebuffed Mr. Zwanziger’s advances, we believe that a transaction is still very possible and note that the company has launched a “strategic review” of its operations. Additionally, Tyson Foods, Inc. (NYSE:TSN) completed its acquisition of Fund holding Hillshire Brands Co (NYSE:HSH), a leading branded meat company, in August.
In addition to M&A activity, financial engineering continued in the third quarter. Fund holding eBay (1.3%) announced plans to spin off its PayPal secure payments business from its core online marketplace operations. We had long anticipated this move and think it could eventually result in the acquisition of one or both units.
Mario Gabelli’s Value 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 September 30, 2014. The Bank of New York Mellon Corporation (NYSE:BK) (1.5% of net assets as of September 30, 2014) ($38.73) is a global leader in providing financial services to institutions and individuals. The company operates in more than one hundred markets worldwide and strives to be the global provider of choice for investment management and investment services. As of June 30, 2014, the firm had $28.5 trillion in assets under custody and $1.6 trillion in assets under management. Going forward, we expect BNY Mellon to benefit from rising global incomes and the cross border movement of financial transactions.
Cablevision Systems Corporation (NYSE:CVC) (1.8%) (($17.51) provides broadband, television, and phone service to over three million subscribers in the New York metropolitan area. An industry pioneer, CVC has developed the most advanced cable plant in the country and converted over 70% of its subscribers into triple play (video, phone, and broadband) customers. In the process, CVC achieved industry leading average monthly subscription revenues and margins. This peak performance led the company to become a victim of its own success; combined with competition from Verizon FiOS in approximately half its footprint, Cablevision saw reduced growth and a sagging share price in 2012/2013. The company’s efforts to address these declines appear to be paying off. Management has also been active on the financial front, spinning off Madison Square Garden (2.4%) in February 2010 and AMC Networks Inc (NASDAQ:AMCX) (1.7%) in June 2011 and repurchasing over 10% of shares outstanding. Cablevision is now a single-market, pure-play cable operator, which could facilitate an eventual consolidation of the company in our view.
CBS Corporation (NYSE:CBS) (3.9%) ($53.62) operates the CBS television network and the premium cable network Showtime and it owns 29 local television stations and 130 radio stations. We believe CBS has a number of opportunities to generate incremental non-advertising revenue from the sale of existing content to online video distributors (OVDs) and the retransmission of content agreements with traditional distributors. In addition, we expect a continued recovery in advertising to contribute to earnings growth. Finally, we believe financial engineering, including the announced $3 billion share buyback, could act as a catalyst for shares.
Energizer Holdings, Inc. (NYSE:ENR) (1.3%) ($123.21) became an independent company after it was spunoff from Ralston Purina in April 2000. Energizer manufactures, markets and sells dry cell batteries and lighting products worldwide. Subsequently, Energizer expanded its product portfolio through acquisitions, including Schick-Wilkinson Sword (2003), Playtex (2007), Edge/Skintimate (2009), American Safety Razor (2010), and most recently, J&J’s feminine hygiene brands (2013). Today, Energizer reports results for two segments: Household ($2.0 billion of revenue), which includes the domestic and international battery businesses, and Personal Care ($2.4 billion), which includes wet shaving, skin, feminine and infant care. In April 2014, ENR announced its intention to split the company into two publicly traded firms through a tax-free spin-off of the Household division. The transaction is expected to be completed by July 2015. This may be the first step in realizing the full value of the two businesses, as both divisions may be more attractive acquisition candidates on a standalone basis.
Flowserve Corp (NYSE:FLS) (1.1%) ($70.52) is one of the largest global pump companies, serving the petroleum, chemical, and power industries. The company’s products