Value Investing

Weitz Value Fund 4Q 2016 Commentary: Returns Hit By Liberty; Gains On Wells Fargo

Weitz Value Fund commentary for the fourth quarter ended December 31, 2016.

H/T dataroma

2016 Hedge Fund Letters

The Weitz Value Fund’s Institutional Class returned +1.27% in the fourth calendar quarter, compared to +3.82% for the S&P 500 and +3.83% for the Russell 1000. For the calendar year, the Value Fund’s Institutional Class returned +3.13%, compared to +11.96% for the S&P 500 and +12.05% for the Russell 1000.

Weitz Value Fund

Weitz Value Fund – Calendar Year Contributors

Liberty Broadband is a holding company for Liberty’s ownership stake of Charter Communications. Shares of Charter, and cable companies broadly, have performed well in the wake of the U.S. election. Although much remains to be seen, investors generally believe that regulatory pressures will ease as a result of a presumably more “industry friendly” Federal Communications Commission (FCC) as well as a Justice Department that may look more favorably on further industry consolidation. Investors are also hopeful that either the FCC or a Republican-controlled Congress will revisit actions of the previous FCC, including the more controversial actions taken as part of its “Net Neutrality” packages. We have invested in Liberty Broadband because we like the operating strategy at Charter, and while regulatory relief would certainly be a benefit, it’s not an explicit part of our investment thesis. Liberty Broadband shares trade at a discount to their underlying Charter investment due to the added complexity of Liberty’s involvement. We are confident Liberty’s management will ultimately collapse this discount, thereby making Liberty Broadband a cheaper opportunity to invest in Charter’s future.

Berkshire Hathaway is a conglomerate holding company owning subsidiaries engaged in a number of business activities. Shares benefited from optimism that a combination of higher interest rates, lower taxes and increased domestic activity would increase earnings at Berkshire’s insurance and industrial businesses.

Range Resources is an independent producer of natural gas and natural gas liquids (NGLs) based in Fort Worth, Texas, with operations in the Marcellus shale and emerging Terryville field. Range’s stock cooled some during the second half of the year following a strong first half rebound from its January lows. A more normal start to winter and low overall drilling activity has led to much needed draws on natural gas storage, with present levels now below the 5-year average for the first time in almost two years. Near-term gas prices have rebounded accordingly, but uncertainty around mid-cycle gas prices continues as oil drilling activity resumes (increasing competition from “associated” gas production) and Appalachian pipeline capacity increases significantly later this year. Range should be a direct beneficiary of the latter, supporting the company’s 20% production growth aspiration in 2018. While gas prices will likely always be volatile, we believe that at $2.75 or better, Range shares offer significant value.

Calendar Year Detractors

Liberty Global is the largest international cable company, with operations across Europe providing video, broadband Internet, fixedline telephone and mobile services to its customers. Throughout 2016, Liberty Global suffered as the translational impact of a stronger U.S. dollar muted its reported financial results. Liberty’s revenues and expenses are generally denominated in the local currencies of its European operations, but its dollar denominated stock can create mismatches from time to time. Shares weakened, particularly in the wake of this summer’s “Brexit” vote, as the UK is the company’s largest market. Shares have recouped some of these losses as the market has further digested the Brexit event. Meanwhile, the results from the company’s new build program in the UK appear to be solid, and the pace of adding newly connected homes should accelerate into 2017. We remain confident in management’s plans to drive cost efficiencies and their new build investment strategy to provide future growth.

Allergan – Please refer to Quarterly synopsis.

Endo International is a specialty healthcare company engaged in developing, manufacturing, marketing and distributing branded pharmaceutical and generic products and medical devices. Endo experienced significantly worse-than-anticipated erosion at Qualitest, its legacy generic drug platform. The competitive environment changed quickly, and we were slow to recognize it. After conversations with both management and a couple of the larger drug buying consortiums, we could not gain comfort in the durability of Endo’s now lower earnings base. The company’s balance sheet and potential legal obligations (liabilities relating to the company’s legacy vaginal mesh products) leave less room for error given growth challenges on the branded side of Endo’s business. Considering the erosion in our investment thesis, questions about management’s ability to identify and navigate risk, and a growing list of unknowns surrounding the business, we elected to close our position in the second calendar quarter and refocus our capital in more attractive opportunities.

Quarterly Contributors

Berkshire Hathaway – Please refer to Calendar Year synopsis.

Wells Fargo is a diversified financial services company. Shares rose materially during the quarter largely due to three tailwinds. First, the U.S. election results provided a boost to all bank stocks on expectations that industry regulatory burdens may ease. Second, higher interest rates and a steeper yield curve raised prospects for net interest margin (NIM) expansion. Third, the company took additional steps to address the “bogus account” scandal, including high-level management changes. The company’s very low-cost deposit base, ubiquitous distribution, ample capital and diverse business lines further our continued confidence. Wells Fargo’s stock trades at less than 14x expected earnings and a modest discount to our value estimate.

Twenty-First Century Fox is a diversified media and entertainment company. Sentiment has been generally positive as investors were reminded of the power of live, must-have content. The month of October featured two of the most widely watched presidential debates in history and five of seven World Series games that delivered the best ratings in over a decade. Investors have been further comforted by Fox’s presence in all of the major “skinny bundles” announcements and new online Pay-TV distribution packages. Finally, in December, Fox announced an offer to acquire the remaining shares of Sky plc. The announced offer for Europe’s premier satellite Pay-TV and content (sports and entertainment) company resolves a long-standing question of how to resolve Fox’s 39% minority stake in the entity. We continue to be encouraged by the prospect for continued improvement at Fox’s domestic channels and continued growth opportunities internationally.

Quarterly Detractors

Liberty Global is the largest international cable company, with operations across Europe providing video, broadband Internet, fixedline telephone and mobile services to its customers. In early November, Liberty Global reported third quarter results that were generally positive. The early results from the company’s new build program in the U.K. appear to be solid, and the pace of adding newly connected homes should accelerate into 2017. The strength of the U.S. dollar continues to be a headwind from a reporting standpoint–though most of the company’s revenues, expenses and borrowings are matched to their local currencies. We remain confident in management’s plans to drive cost efficiencies and new build investment strategy to provide future growth.

Allergan is a global specialty pharmaceutical company focusing on the development, manufacturing, marketing and distribution of brand name, biosimilar and over-the-counter pharmaceutical products. Following a brief post-election rally, the majority of the biopharmaceutical sector retreated to prior price levels as capital continued to flow out of healthcare and into industries seen as potential beneficiaries of policy shifts under the new administration. After