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.
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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 include engineered and industrial pumps, automated and control valves, actuators, and seals. About 40% of FLS revenues are derived from the oil and gas industry, and should benefit from the refurbishment of the aging refineries in developed countries and the first time build out of the infrastructure in developing nations around the world. Further, oil companies are bringing up dirtier, heavier, and harder to access crude from thousands of feet below ground, as the cleaner, lighter, and easier to obtain crude that is closer to the surface is depleted. This demands more highly engineered pumps, valves, and seals that can work under very high pressure, high temperature, or underwater, boding well for FLS products.
Liberty Media Corp (NASDAQ:LMCA) (0.6%; 1.2%) ($47.18; – $46.99) is a diversified investment vehicle guided by cable television pioneer John Malone (Chairman) and former Microsoft (0.4%) CFO Greg Maffei (CEO). The company owns over half of satellite radio provider Sirius XM, 27% of cable operator Charter Communications, the Atlanta Braves baseball club, and stakes in several other public and private entities. Malone and Maffei have created significant value for shareholders over the past several years as they taxefficiently distributed, traded, or sold interests in Discovery Communications Inc. (NASDAQ:DISCA) (1.2%), News Corp (NASDAQ:NWSA) (0.5%), Time Warner Inc (NYSE:TWX) (1.4%), DIRECTV (NASDAQ:DTV) (2.9%), Starz (NASDAQ:STRZA) and QVC among others. Liberty announced it would spin-off its cable investments, including Charter, into a new company known as Liberty Broadband late in 2015. The remaining Liberty Media could then be merged into Sirius XM, a plan proposed and abandoned early in 2014.
The Madison Square Garden Co (NASDAQ:MSG) (2.4%) ($66.12) is an integrated sports and media company that owns the MSG networks (MSG/MSG+ and Fuse), the New York Knicks, the New York Rangers, the Radio City Christmas Spectacular, and the iconic New York venue, Madison Square Garden. These evergreen content assets benefit from sustainable barriers to entry and long term secular growth. We believe the now completed Transformation project and the rising value of sports programming, as demonstrated by the NBA’s recently contract renewal with TWX & DIS, will dramatically increase MSG’s earnings power through 2018.
Newmont Mining Corp (NYSE:NEM) (1.6%) ($23.05) based in Denver, Colorado, is one of the largest gold mining companies in the world. Founded in 1921 and publicly traded since 1925, NEM is the only gold company included in the S&P 500 Index and Fortune 500. We expect the company to produce approximately 4.9 million ounces of gold and 110 million pounds of copper in 2014, with over 60% of this production coming from Australia and Nevada. Newmont is in the process of reviewing its business units and cutting operating costs post the 27% drop in the gold price in 2013. The company has sold non-core assets and has committed to deploy the proceeds from these sales into building new projects, which it expects will generate superior rates of return for shareholders.
Sony Corp (ADR) (NYSE:SNE) (1.1%) ($18.04) is a diversified electronics and entertainment company based in Tokyo, Japan. The company manufactures televisions, PlayStation game consoles, mobile phone handsets, cameras, and operates the Columbia film studio and Sony Music entertainment group. We expect the new PlayStation launch and operational improvements in consumer electronics and entertainment to generate EBITDA growth through 2015. We also think the spin-off of the entertainment assets will be a potential catalyst. Time Warner Inc. (1.4%) (TWX – $75.21 – NYSE), located in New York, New York, is a diversified media company with operations in cable networks through HBO, TNT, TBS & CNN, and film & television production. We like the company’s cable networks, high margins and low capital intensity. We expect the company to use its free cash flow to return capital to shareholders through its $1.27 per share dividend and aggressive share repurchases. Following the $85 per share bid by Twenty-First Century Fox (2.2%), we expect Time Warner could be an acquisition target.
Mario Gabelli’s Value Fund: Investment Scorecard
Top contributors to performance included eBay (1.3% of net assets as of September 30, 2014) (+13%), which announced the long awaited spin-off of PayPal; Madison Square Garden (2.4%) (+6%), in which an activist investor has called for the initiation of a share repurchase program; Republic Services (2.1%) (+4%), which should benefit from a recovery in the US and lower fuel prices; Time Warner Inc. (1.4%) (+8%), the subject of a failed takeover bid from Twenty-First Century Fox (2.2%); and Macquarie Infrastructure (0.7%) (+8%), which reached an agreement to purchase its 50% partner in its liquids storage business.
Detractors from performance included Viacom (7.3%) (-13%) and CBS (3.9%) (-11%), which declined amid concerns about the television advertising market, ratings and pay-television subscriber growth; Rolls- Royce (2.0%) (-15%), which experienced weaker marine aftermarket performance in the first half; National Fuel Gas (2.2%) (-10%), which reflected lower natural gas prices; and Diageo (2.6%) (-8%), whose global footprint has exposed the company to the effects of currency moves.
Mario Gabelli’s Value Fund: Conclusion
As always, in volatile times, our process remains unchanged. We conduct bottom-up research on companies and industries in order to uncover undervalued businesses we would be happy to own for many years. Our Private Market Value (PMV) with a Catalyst™ stock selection process identifies potential acquisition targets and likely candidates for financial engineering. Should volatility return and “Mr. Market” provide us with an opportunity, we remain prepared to increase our ownership of businesses that fit these characteristics, as well as invest in new opportunities as they become available.
October 9, 2014
Note: The views expressed in this Shareholder Commentary reflect those of the Portfolio Managers only through the end of the period stated in this Shareholder Commentary. The Portfolio Managers’ views are subject to change at any time based on market and other conditions. The information in this Portfolio Managers’ Shareholder Commentary represents the opinions of the individual Portfolio Managers and is not intended to be a forecast of future events, a guarantee of future results, or investment advice. Views expressed are those of the Portfolio Managers and may differ from those of other portfolio managers or of the Firm as a whole. This Shareholder Commentary does not constitute an offer of any transaction in any securities. Any recommendation contained herein may not be suitable for all investors. Information contained in this Shareholder Commentary has been obtained from sources we believe to be reliable, but cannot be guaranteed.
Minimum Initial Investment – $1,000
The Fund’s minimum initial investment for regular accounts is $1,000. There are no subsequent investment minimums. No initial minimum is required for those establishing an Automatic Investment Plan. Additionally, the Fund and other Gabelli/GAMCO Funds are available through the no-transaction fee programs at many major brokerage firms. The Fund imposes a 2% redemption fee on shares sold or exchanged within seven days after the date of purchase. See the prospectuses for more details.
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The Gabelli Value 25 Fund began offering additional classes of Fund shares on March 15, 2000. Class AAA are no-load shares available directly through selected broker/dealers. Class A and C Shares are offered to investors who seek advice through financial consultants. Class I Shares are available directly through the Fund’s distributor or brokers that have entered into selling agreements specifically with respect to Class I Shares. The Board of Directors determined that expanding the types of Fund shares available through various distribution options will enhance the ability of the Fund to attract additional investors.