Longleaf Partners Fund commentary for the first quarter ended March 31, 2016.

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Longleaf Partners Fund posted a formidable 4.34% return in the first quarter, exceeding the S&P 500 Index’s 1.35%. A number of our stocks had double-digit gains, including several of our most undervalued businesses coming out of 2015. Most of our companies generated solid operating results, and management activity helped drive higher appraisals. Our two biggest positions declined slightly, and their portfolio weights made them among the notable detractors to our strong gains. Our investment cases and our high conviction for these companies remain unchanged. Not only were our absolute returns well beyond our goal of inflation plus 10%, but our relative results also benefitted from our lack of exposure to health care, which was among the top performing index sectors in 2015 but was the S&P 500’s worst performing sector in the quarter.

Stock prices in the first quarter embodied Ben Graham’s description of “Mr. Market,” whose manic short-term swings are driven by investor emotions. The market fell -10.3% at its February 11 low point but then rallied over 13% by the end of March, a 2300 basis point swing. While economic and political uncertainties fostered the volatility, our appraisals proved much more stable, highlighting the importance of anchoring investment decisions to the long-term cash flows and underlying asset values of each company.

The volatility provided opportunistic points to add to two of our more undervalued stocks, sell three positions, and trim several positive performers as they became overweight and traded closer to our appraisal values. Our on-deck list of adequately discounted new investments is limited.

Longleaf Partners Fund

Longleaf Partners Fund - Contributors/Detractors

(gross return of the stock for 1Q; impact to Fund return for 1Q)

Wynn Resorts (+36%; +2.7%), the luxury gaming and hotel operator with prime real estate in Las Vegas, Macau, and Boston, was the largest contributor in the quarter. Wynn preannounced positive results to enable management to buy more stock. CEO Steve Wynn demonstrated his confidence in the business by purchasing nearly one million shares, bringing his total stake in the company to 12%. Wynn Las Vegas reported better-than-expected 4Q results. Although pressure continued in Macau’s lower margin VIP segment, mass gaming revenues in Macau stabilized, and year-over-year gross gaming revenue comps in February were the strongest in almost two years. Wynn remains well below our appraisal and offers a compelling long-term opportunity for significant growth with a proven owner-operator at the helm. The value of properties in the development pipeline is not yet reflected in the stock price. The opening of Wynn Palace in Macau later in 2016 could spark additional stock appreciation as capital expenditures (capex) ends and revenues begin.

Scripps Networks (+19%; +1.4%), the media company that owns cable channels, including HGTV, The Food Network, DIY Network, Cooking Channel, Travel Channel, and Great American Country, reported a strong quarter with all six networks adding new viewers as millennial growth continued. Advertising revenue grew at a mid-single digit rate. The company’s advertising is better than most competitors, with more exposure to stable categories than others have. Affiliate fee revenue growth is expected to grow at a mid-tohigh- single digit rate, and programming cost growth should continue to decelerate. Part of the stock’s discount is related to its international expansion opportunity which has not produced profits yet but has created startup costs and noncash amortization. The company purchased the remaining 35% of The Travel Channel that it did not own and sold its 7.25% stake in Fox Sports South & Southeast.

CONSOL Energy (+43%; +1.3%), the Appalachian coal and natural gas company that was among top detractors in 2015, added meaningfully to first quarter results. Management adjusted to lower commodity prices by adopting significant cost controls and expects positive free cash flow (FCF) in 2016. Early in the quarter, CONSOL announced it was lowering capex by more than 50% from previous guidance. The company also reduced operating expenses, effectively decreasing its Debt/ Operating Cash Flow ratio from 3.8 to 3.6. As we continued our constructive dialogue with management regarding asset monetization, CONSOL announced the addition of three new board members, two of whom we suggested. Additionally, Will Thorndike, whom we previously recommended as a board member, replaced Brett Harvey as Chairman. Shortly thereafter, CONSOL sold its Buchanan mine and other met coal assets for $420 million to a private equity-backed firm. The sale was accretive to the value of CONSOL, and management is pursuing additional asset sales.

CK Hutchison (-4%; -0.6%), a Hong Kong-based global conglomerate comprised of four primary businesses (retail, telecommunications, infrastructure and ports), is our second largest position and was the main performance detractor in the quarter. China economic fears and weakness in the Hong Kong dollar (HKD) weighed on the stock. Conversely, the businesses’ values remained stable with less than 15% of its economic exposure in China and Hong Kong. Chairman Li Ka-shing and his son, Victor Li, have demonstrated a compelling track record of building companies, compounding net asset value at double-digit rates, and buying and selling assets at attractive prices. Last year, CK Hutchison announced plans for its Three U.K. telecom business to acquire U.K. telecom company O2. Although still pending regulatory approval, the deal would allow the company to recognize significant synergies, estimated at £3 billion.

Longleaf Partners Fund

Longleaf Partners Fund - Portfolio Changes

We exited three holdings during the quarter, including our successful long-term investment in Aon. We first purchased the stock in the second half of 2002, when the low point fell to near $14 per share. We bought again in 2009 and 2010 between the mid $30s and low $40s. Over time, the company went from being the second largest insurance broker in the world to the largest and also built its benefits and consulting business into a leading global competitor. Under the leadership of Greg Case, Aon grew revenues, expanded margins, reduced corporate taxes, and repurchased substantial shares at discounted prices. Value per share grew, and ultimately we exited in March at more than $100 per share. We are grateful for Greg’s superior stewardship, and we hope to have an opportunity to partner with him in the future.

We sold National Oilwell Varco (NOV), a global provider of equipment and components used in offshore and land drilling, negatively impacted performance before we sold it in March. When we initiated the position in the third quarter of 2015, we believed that NOV’s higher margin rig aftermarket business would grow, even as new oil rig purchases were canceled or delayed in the lower oil price environment. Our thesis did not hold up as rig operators cannibalized used parts from idled rigs, pressuring prices and ultimately lowering NOV’s aftermarket margins. We exited at a loss when the stock price partially recovered after oil moved from below $30 toward $40. As discussed in our year-end report, we sold our small remaining position in global quick service restaurant operator McDonald’s as 2016 began. During the year plus that we owned the stock, it gained almost 30% and was among the strongest contributors to performance. We appreciate the board’s and management’s solid execution.

Longleaf Partners Fund

Longleaf Partners Fund - Outlook

We believe the strong absolute and relative returns we posted in the first quarter should be indicative of our expectations going forward. Many of our top performers rallied from unsustainably low levels to a more normal discount range and have substantial additional upside potential. The portfolio price-to-value (P/V) in the mid-60s% offers an attractive buffer between our conservative appraisals and our companies’ underlying stock prices, especially in a market where we are finding very few new opportunities. Our 19% cash position reflects the limited qualifiers but will enable us to take advantage of additional market volatility or the next great business that becomes deeply discounted. Many of our holdings have management teams pursuing operational improvements as well as strategic alternatives that can build material value.