Below is the full letter to shareholders
Year-to-date, the fund has achieved a return of 27.1%, compared with 32.4% for the S&P 500 index. Since inception, the fund has achieved a return, net to investors, of 887.9%. The S&P 500 index has returned 121.2% during that time.
The fund was up 12.3% in the quarter ended 12/31/13 net of fees, comprised of monthly returns of 4.2%, 5.0% and 2.7% for October, November and December, respectively. In comparison, the S&P 500 was up 10.5% over the quarter, comprised of monthly returns of 4.6%, 3.0% and 2.5%. The Barclay Hedge Fund Index was up 3.7% over the quarter, comprised of monthly returns of 1.7%, 0.8% and 1.1%.
Since inception, the fund is up 887.9% net of fees. In comparison, the S&P 500 is up 121.2% and the Barclay Hedge Fund Index is up 40.6% during that time.
Our top five positive contributors were UHAL (AMERCO), NTG:LN (Northgate PLC), LABB:MX (Genomma Lab Internacional), Jones Lang LaSalle Inc (NYSE:JLL) and ETFC (E*Trade Financial Corporation). Our top five negative contributors were Turkish Banks, Short A, Short B, CTB (Cooper Tire & Rubber Co.), and HOMEX Bonds.
Jones Lang LaSalle Inc (NYSE:JLL)
Jones Lang LaSalle (JLL) is currently our third largest position. JLL is a global commercial real estate (“CRE”) brokerage firm with operations in 1,000 locations across 70 countries. The JLL brand name, recognized worldwide, is synonymous with high-quality commercial real estate advisory work, corporate lease advice, valuation consulting, and property management services. Alongside CB Richard Ellis, JLL is one of only two CRE brokers with global scale and a fully-integrated product suite. A customer like Proctor & Gamble can sell a building in New York, acquire office space in India, and receive development consulting on a project in Germany using solely Jones Lang LaSalle. Clients are generally risk-averse and prefer to rely on top-notch service providers. Just like a Board can’t get fired for hiring Goldman Sachs or Morgan Stanley as their investment bankers or one of the top four auditors to complete financial audits, clients often lean on the brand names of Jones Lang LaSalle and CBRE to handle important commercial real estate transactions.
We began acquiring shares of JLL in August 2013 after a quarterly miss caused great consternation amongst the sellside and shares fell from $95 to the low $80s. The earnings miss allowed us to acquire a growing,world-class business that had temporarily re-rated on a non-recurring event. Currently, JLL trades at 15x next year’s earnings, roughly in-line with the market, but we believe JLL can grow earnings per share at 20%+ annually for the foreseeable future due to its superior roll-up platform, margin expansion, and continued recovery in the global real estate market. JLL currently trades at $106/share, but we believe JLL’s embedded earnings growth warrants a price closer to $150.
Proper historical context is helpful to fully explain the opportunity. After the bursting of the credit bubble in late 2008, commercial real estate transaction volume cratered by more than 70%. This caused havoc amongst less diversified regional brokerages and even caused formerly prominent firms like Grubb & Ellis to declare bankruptcy. Owing to its aversion to principal risk and affinity for recurring property management contracts, JLL benefited from a speedy recovery and has since positioned itself as a market consolidator. JLL generally pays just 7 to 8x EBITDA for bolt-on deals, thereby earning double-digit returns on M&A. Regional brokerages are attracted to JLL’s platform thanks to cross-selling opportunities, such as property management and valuation work. The ability to continually reinvest cash flows into a steady stream of bolt-on deals and international expansion allows JLL to compound value much more effectively than a business focused on deploying capital through share buybacks or dividends.
Though the CRE market has recovered from its 2009 trough, transaction volume remains 35% below itspre-recession level. Europe, in particular, has been slowest to recover. But early signs of resuscitation have emerged: JLL’s European revenue grew by 30% in the third quarter; opportunistic private equity funds are directing capital to European real estate; and consumer confidence in the region has begun to expand. Longer term, we are attracted to JLL’s growing emerging markets business, now representing about 15-20% of revenue. CRE investment in the Asia Pacific region grew by 29% in 2013, the strongest year on record. JLL could also benefit from last year’s hiring of Christie Kelly, a 25-year veteran of GE, into the CFO position. JLL’s EBITDA margin has stubbornly remained 300bps below CBRE’s since the recession, partially due to business mix but also due to inefficiencies that Ms. Kelly hopes to remedy. This combination of macro tailwinds and micro cost management should be a powerful driver of earnings growth over the next few years.
InterActiveCorp (“IAC”) is a $6bn media conglomerate run by Barry Diller, the former Chief Executive of Paramount, Fox, and USA Broadcasting. IAC owns a pool of disparate operating businesses, each with their own end markets, growth rates, and margin profiles, making IAC tough to value on a consolidated basis. IAC’s mature segments are highly free cash flow generative, defensible, and asset-lite, while several growth businesses operate near or below break-even profitability. The financial metrics are further complicated by a collection of early-stage, VC-like assets that burn cash but provide significant optionality. IAC’s headline 2013
EV/EBITDA and P/E multiples are 10x and 18x, respectively.
IAC has five reportable segments: i) Match.com and other dating websites such as OkCupid.com, BlackPeopleMeet.com, Meetic, and the China-based Zhenai; ii) Search & Applications, which includes the websites Ask.com, About.com, and Dictionary.com, as well as an array of downloadable toolbar applications (Mindspark); iii) CitySearch and HomeAdvisor, grouped together as ‘Local ‘; iv) a diversified Media portfolio including Electus Media, CollegeHumor, News Beast, and DailyBurn; and v) Other, a catch-all segment that includes Shoebuy and Tutor.com. The Search & Applications business is a major eyeball aggregator for Google, generating Google-based ads on its websites and reselling query search traffic in its applications. This $400m EBITDA business has minimal capital requirements, continued organic growth, and remains highly free cash flow generative. IAC’s Match.com is the largest dating website in the world, has grown at double-digit rates in each of the past four years, and generates $275m of EBITDA. Meanwhile, IAC’s still immature investments in Local, Media, and Other are reinvesting profits into growth, resulting in negative EBITDA but potentiallylonger-term value creation.
Recent events suggest that IAC/InterActiveCorp (NASDAQ:IACI) recognizes the hidden value of Match.com and that a value-unlocking event could be imminent. On December 19th of last year, IAC made a significant change to its management team. The Company moved Greg Blatt, the former CEO of IAC, to Chairman of a newly created “Match Group”. The Match Group consists of Match.com, Tutor.com, DailyBurn, and IAC’s investment in Skyllzone. Interestingly, IAC did not hire a new CEO to replace Mr. Blatt. The CEOs of Search & Applications and Vimeo will now report directly to Diller. Diller is not an empire builder; he has proven himself to be shareholder friendly in the past. In 2008, IAC broke itself up into five different publicly traded companies: HSN (Home Shopping Network), Interval Leisure Group, TicketMaster, Lending Tree, and the RemainCo, IAC. IAC also spun off Expedia in 2005.
As a standalone entity, we think that Match is worth about three-quarters of IAC’s current market capitalization. Greg Blatt recently gave long-term guidance for the Match businesses, stating that he foresees Match to grow into a $500m EBITDA business by 2016. This would imply a rapid 23% EBITDA CAGR over the next three years. Investors clamor for high-growth, subscription-based businesses, and we believe a 10x forward multiple on 2016 EBITDA would not be unreasonable. At this valuation, a Match spin-off would be worth about $55 per IAC share.
Investors typically pause when assessing IAC’s Search & Applications segment given its dependence on third party search engines like Google and Yahoo for ad-based payments. For example, investors were spooked in Q3 2013 when Google lowered its per-unit pricing, impacting IAC’s website business. While its position as aprice-taker with Google limits its profitability, IAC continues to grow the business with minimal incremental investment. Revenues at S&A have grown from $1bn in 2011 to $1.6bn LTM and the business is expected to generate $430m of EBITDA in 2014. Even if we assume a conservative, no-growth valuation of 6x next year’s EBITDA, we derive a $30 per IAC share value for Search & Applications. If sold to a strategic like Yahoo or Bing, we think Search & Applications could be even more valuable.
IAC’s next most valuable standalone asset is likely Vimeo. Vimeo is the main alternative to YouTube for uploading high-quality video. While YouTube remains about 15x larger than Vimeo, the Vimeo platform has become the preferred option for artists, filmmakers and others in the creative community. The business was rumored to hold a $300m valuation in early 2012, but we believe Vimeo’s continued growth and potential value to a strategic acquirer justifies a value of $500m, or $6 per IAC share.
We would next ascribe a 3x revenue multiple to the Local, Media, and Shoebuy assets, which we believe is conservative for growing internet properties. After deducting the capitalized costs for IAC’s corporate overhead, these remaining assets add in an incremental $10 per share to IAC’s valuation. In total, these assumptions result in a $100 price target, or more than 40% above IAC’s current price.
This price target ascribes little optionality value to Tinder or Aereo, both of which have asymmetric upside. Facebook’s $3bn offer for Snapchat is indicative of the price that incumbents will pay for high-growth mobile platforms. Tinder’s millennial following may attract similar approaches. Diller has also been very public with IAC’s minority interest in Aereo. Aereo is a content aggregator that downloads free-to-air TV and streams
shows directly to its customers, thereby bypassing the entrenched networks of the cable providers. This potentially disruptive business model has been frequently challenged by cable operators, leading the U.S. Supreme Court to decide to hear the case this month. If the Supreme Court rules against the broadcasters in their suit against Aereo, IAC could make multiples of its investment. While an Aereo win appears to be alow-to-medium probability event, it’s nonetheless indicative of the many hidden assets lying dormant under IAC’s corporate umbrella.
Even if IAC chooses not to spin off the Match businesses, we still believe IAC’s growth is undervalued. We think the business can generate $1bn of free cash flow over the next two years and end 2015 with more than $500m ofrun-rate CFO less capex. At the current market capitalization of $6bn, this results in a free cash flow yield of more than 10% on a completely unlevered balance sheet. With plenty of investors happily paying 20x revenue for unprofitable, subscription-based internet businesses, we think IAC at a 10% 2015 FCF yield is a bargain.
We continue to be confident about the composition of the current portfolio. Regardless of how the overall market performs, we expect our portfolio to fare well over the long term.
Thank you and please don’t hesitate to contact me with any questions.