Horizon Kinetics Core Value Strategy selected holdings commentaries.
AutoNation, Inc. (“AN”) is the largest automotive retailer in the U.S., owning and operating 269 new vehicle franchises from 228 stores located predominantly in the “Sunbelt” region, from Southern California to Florida. It often clusters dealerships within markets, allowing them to share inventory, cross-sell to customers, and reduce marketing costs.
Going forward, the long-term growth component to this investment is tied to the fragmented nature of the U.S. auto dealer industry. Despite being the country’s largest auto dealer by market share, AutoNation has only a roughly 1.5% market share. Furthermore, most dealerships in the U.S. are privately held, with many of their owners nearing retirement age. Therefore, the opportunities for consolidation are substantial. These dynamics were no doubt a significant part of the reason Berkshire Hathaway recently acquired the largest privately-owned auto dealer in the U.S., renaming it “Berkshire Hathaway Automotive”. AutoNation now trades at valuation multiples that, for the most part, are slightly lower than those of the broad equity market. At this price level, and given the tremendous opportunities for growth in the coming years, we believe the risk/reward dynamics of AutoNation are quite favorable.
- Valuation: As of November 24, 2014, AN traded at a price to earnings ratio, or P/E, of 17x, as compared to a P/E of 19x for the S&P 500 Index.
- Index ownership: Weight in S&P 500 Index: 0.02%
- Return on equity: 18.6% for FY 2013, representing a compound annual growth rate of 18.6% over the 2010-2013 period.
- Net income growth: 18% compound annual growth in net income over the 2010-2013 period. However, EPS increased 25% (compound annual growth rate) over the same period, reflecting the impact of aggressive share repurchases by the company.
- Balance Sheet: Debt to Equity ratio of 0.95x as of September 2014.
- Share repurchases: AN has repurchased shares aggressively since 2000, reducing the number of shares outstanding by 66% over the 14 year period.
- Number of analyst estimates: 15
- Selected Predictive Attributes:
- Owner-operator management: Mr. Lampert owns approximately 30% of shares outstanding.
- Industry History: Mr. Lampert has a long-term record of shrewd decision-making and investment success.
Horizon Kinetics: DreamWorks Animation is a significantly misunderstood company
We believe that DreamWorks Animation SKG Inc. (“DWA”), a producer of animated feature films, is a significantly misunderstood company. Though it has created successes, such as the Shrek, Madagascar, and Kung Fu Panda franchises, Wall Street appears to trade the shares based on the box office success or failure of the latest release?opening weekend results of each film have an outsized impact on the company’s stock price, ignoring the financial contributions of the 30 or more films that it has created and released since 1998.
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Because of the peculiarities of movie accounting, films tend to be fully expensed by the time of, or shortly after, their initial release. Accordingly, new films sometimes appear unprofitable, since they are subject to significant upfront costs, and huge amortization expenses once the films begin to generate revenues. A follow-on effect, though, is that any future revenue associated with movies from the library (films that are at least 4 years past release) has very little associated cost and is largely converted to pre-tax earnings. In 2013, these revenues were $173 million. Assuming that such revenues were comprised of all pre-tax earnings, and that the company would have paid a 26% tax rate (in line with its 2013 overall tax rate) on those earnings, its library would have generated $129 million in net profits. At a multiple of just 10x earnings, the library would thus be worth $1.3 billion, which should be compared to the $1.95 billion valuation for the entire company.
Therefore, the resultant “stub” value of the new film business is only $650 million, which can be compared to a current book value for the equity of approximately $1.5 billion. The largest component of equity book value is inventory ($1.015 billion), which is the carrying value of animated content net of amortization, where applicable, for “in release” films and television specials. Hence, inventory is the cost of all of the content that is yet to be amortized. In a sum-of-the-parts analysis, the company can be viewed as a film library business trading at 10x earnings and a new content business trading at less than 50% of book value.
This valuation is compelling, but also fails to consider the qualitative aspects of the business model that certainly have the potential to add value. These include recent efforts in foreign film studio joint ventures, theme parks, consumer products and various additional digital businesses. By purchasing the “non-library” businesses at less than 50% of book value, we believe an investor receives significant potential upside in these recent initiatives at little to no cost.
- Valuation: As noted above, applying a conservative multiple to the revenues generated from the library results in a $1.3 billion valuation for that portion of the business, compared to a $1.95 billion market cap for the entire company. Furthermore, given its low valuation and the growing demand for content to fill an expanding number of distribution channels, we believe that DWA is an attractive acquisition candidate.
- Index ownership: Weight in S&P 400 Midcap Index: 0.10%
- Balance Sheet: Debt to Equity ratio was 0.21x as of 12/31/2014.
- Number of analyst estimates: 14
- Selected Predictive Attributes:
- Owner-operator: Jeffrey Katzenberg controls 60.1% of DWA voting power
- Scalability: Revenues generated from the library have negligible associated costs
- Industry History: The founders (Steven Spielberg, Jeffrey Katzenberg, and David Geffen) have all had significant success in the entertainment industry.
- Long Product Lifecycle: The movies created by DWA will likely be viewed by generations to come, and their characters can be licensed for follow-on television shows, characters at theme parks, and toys.
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