Below is a copy of Dan Loeb’s Q4 letter to shareholders. Stay tuned for analysis shortly.
Dan Loeb Fourth Quarter 2014 Investor Letter
past. We are looking to add exposure during market dislocations. After a lackluster year for credit in 2014, we are starting to see value in energy-related names and potential opportunities to reload our portfolio.
We have also lowered our gross and net exposures this year. Despite recognizing that volatility had increased last year, in hindsight, our net exposures remained too high for too long due to conviction in our long stock picks and a small short book. This portfolio posturing meant that, for the first time since 2008, we were harmed rather than helped by the market’s five significant drawdowns, missing out on the chance to purchase securities cheaply during periods of panic. These missed opportunities undermined mostly successful stock picking and uniformly favorable resolutions of our constructivist campaigns.
While we obviously believe our top positions will be worth more in the long run, we expect a fair amount of volatility in the interim. Avoiding dramatic downside in individual names and sizeable losses during inevitable sell-offs will be key to succeeding in this market and navigating successfully through the haunted hallways of 2015.
Select Portfolio Positions
Equity Position: Amgen
Our biggest winner in 2014 was our equity position in the biotechnology company Amgen. In our last letter and at the Robin Hood Investment Conference, we highlighted Amgen as a hidden value situation where investor skepticism in three areas – R&D productivity, operating efficiency, and capital allocation – had obscured the company’s fundamental value.
Equity Position: FANUC
During the fourth quarter we invested in Fanuc (the “Company”), the leading factory automation and robotics company in the world with a market capitalization of $33 billion and an enterprise value of $25 billion. Based in Japan and spun out of Fujitsu in the 1970’s, Fanuc is a unique company with a long history of being the best and fastest to market in everything it does. Its visionary founder describes the Company’s mission as “walking the narrow path,” which refers to its relentless focus on producing only a limited number of products that are technically superior with the lowest possible cost structure. This targeted innovation combined with a strong emphasis on reliability and service has made virtually all of Fanuc’s products blockbusters. While serving completely different, cyclical markets, Fanuc reminds us of Apple in its product approach.
In its core Factory Automation division, Fanuc has capitalized on structural growth in automation by creating a huge moat in Computerized Numerical Control (“CNC”) systems and servo motors. It has become the global standard for machine tool control software and motors with a worldwide market share of 60%. The Company has built a global service/aftermarket support organization that is unrivaled by competitors in a business where switching costs are high. The division’s revenue correlates closely to Japanese machine tool orders, which are on the rise for multiple reasons including strong demand from the US and a depreciating yen. Additionally, Chinese factory automation is a substantial growth opportunity as rising wages, low productivity, and quality issues force companies in the region to automate. To get a sense of the opportunity: China’s CNC penetration rate of 30% today equals Japan’s levels 40 years ago. Fanuc is expanding CNC capacity by 40% in the next twelve months to meet these higher demand levels.
Fanuc’s Robots division has achieved a cumulative sales growth of 60% in the past two years, capitalizing on a robust opportunity set across all major economies. In China, automotive industry robot density is still at less than 15% of the levels seen in Japan, while general industry robot density is at less than 5% of Japan’s. In Japan, capital equipment replacement demand, some re-shoring of manufacturing and labor shortages are creating multiple drivers for robot demand. The resurgence in US manufacturing is also providing strong demand, as automotive and general industry customers are increasing orders for lifting, picking, welding, painting, and dispensing robots. Virtually every large manufacturing footprint expansion in North America – from Airbus to Ford to Tesla – is taking place with Fanuc’s robots. Fanuc’s internal development of low cost full artificial vision systems and collaborative robots makes it best positioned to drive adoption in industries that have traditionally been unable to automate. We think that these innovations will double the size of the Robots division in only a few years.
In 2014, Greece’s economy started to improve modestly after a long malaise. This progress proved to be too little too late for Greece’s former Prime Minister, Antonio Samaras, whose New Democracy party was defeated in January elections which were triggered by the
parliament’s failure to elect a President in December 2014. Samaras was committed to keeping Greece in the EU and had implemented unpopular but necessary fiscal and structural changes to pull the country back from the 2012 brink. Greek voters, who had suffered from austerity just long enough to miss out on its emerging benefits, rejected his approach and elected Syriza, a popular but inexperienced leftist party. Syriza’s first move was to form a coalition with a radical right wing party with whom they shared one key interest: aggressively confronting the Troika. The markets naturally reacted with grave concern.
Today, the situation is changing daily as Syriza finds its footing and faces divisions within its ranks. As we have seen many times before, campaigning and actually governing are two completely separate things and unfortunately, in this case, there is no time to learn on the job. The government is currently dealing with a plunge in asset values and tight liquidity for both the sovereign and banks. Tax collections – a significant, if unpopular, focus of the former PM – slowed significantly in the past few months, putting fiscal pressure on the government. Over the last few weeks, Greek banks have needed to borrow emergency ECB funding at high costs in order to meet deposit outflows. We believe that unless an agreement with creditors is reached this month, Greece will begin experiencing extreme liquidity pressures in early March. These liquidity pressures will only escalate leading into April as government treasury bill obligations and interest payments/maturities to private creditors and the IMF begin to pile up. Greece theoretically has enough liquidity to make it through February and possibly March (absent a bank run) but as we have witnessed time and again, the path to insolvency starts slowly but ends very quickly.
Thus far, Syriza has appeared unwilling to adjust its negotiating strategy to these liquidity constraints, instead choosing to remain firm on campaign pledges not to extend the current Troika program. This will soon create a “between a rock and a hard place” moment since Greek voters did not mandate Syriza to take Greece out of the Euro or default on its debts. The country’s only liquidity source is its EU partners, who will insist on continued monitoring and reforms as a funding condition. Syriza is far from omnipotent – it does not have a majority in parliament and its coalition is viewed as relatively weak given that its partner finished sixth in the elections, with less than 5% of votes, meaning only about 40% of voters voted for this government. A potential outcome of failed negotiations is a collapse of the existing coalition and possibly new elections, which would create significant market volatility but most likely produce a national unity government with a clear mandate to prevent catastrophe.