Grey Owl Capital Management commentary for the first quarter ended March 31, 2017.

“If you take care of the small things, the big things take care of themselves. You can gain more control over your life by paying closer attention to the little things.” – Emily Dickinson

Dear Client,

During the first four months of 2017, we were relatively active on the buying and selling front. With a reasonable amount of information to report on individual positions, we will dispense with any broad economic and asset class commentary and dig right into each of the transactions that occurred between January and April. We will start with a brief update on Express Scripts. While we did not affect any transactions in Express during the beginning of 2017, it is one of our biggest positions, and the company did report a significant development related to its largest client, Anthem.

Grey Owl Capital Management

Grey Owl Capital Management – Large Position Update

Express Scripts (ESRX). While we made no buys or sells in ESRX during the first four months of 2017, there was an important development at the company. On April 24, 2017, Express reported strong earnings. EBITDA for the quarter was $1,496.2mm, up 3% compared to the year earlier. Adjusted earnings per diluted share were $1.33, up 9% compared to the year earlier. In addition, the company raised 2017 earnings guidance to a range between $6.90 and $7.04 per diluted share. Yet, the company also announced that they were now assuming the Anthem contract would not renew after the current term expires at the end of 2019. Today, Anthem provides 18% of Express Scripts revenue and thus the stock immediately lost 10% of value. (We would argue that the market sold both the rumor and the news in this case, but that sometimes happens.)

We wrote about the ESRX/Anthem ongoing negotiation in our third quarter 2016 letter. As we wrote there, we recognized the risk that Anthem would not renew, yet at the time ESRX was trading around $70/share and we believed then (and still believe now) that even without Anthem, ESRX is worth in the mid-$80s. Importantly, while the announcement hurt ESRX’s price in the short-term, it may have been a terrific negotiating tactic on the part of Express’ management. Recall from our previous writing, Anthem has very few PBM choices: other than Express, CVS is the most viable option. The only other PBM that has the scale to service Anthem is UnitedHealth, but they are a direct competitor on the health insurance side so that seems unlikely. A final option would be to re-internalize the PBM function (Anthem previously sold their PBM to Express.) Any of the options other than Express will have significant switching costs. Perhaps that explains why when Anthem reported quarterly earnings just two days later, the CEO stated on their investor call that they had made no decision on its pharmacy benefit management (PBM) contract and Express was still a viable option. It seems that today the risk of losing Anthem should be fully priced into ESRX, but there remains a call option on the possibility that Anthem remains after all.

Buys – January through April 2017

LiLAC Group (LILA). On April 6, 2017, we purchased a “starter” position in LILA at $22.87/share. Liberty Global (LBTYA) issued LiLAC as a tracking stock in July 2015 to represent the Latin American and Caribbean telecommunication and cable assets of Liberty Global. On July 2, 2015, the first day of trading post distribution, LILA closed at $49.61/share. Then in 2016, Liberty Global acquired Cable & Wireless (CWC) and subsequently issued another distribution from Liberty Global to LiLAC for the Cable & Wireless business. Since the initial distribution, LILA has traded lower and lower. The 52-week low is $19.10/share.

While overdone from a long-term perspective, we think the sell-off is understandable. To begin with, investors who were happy to have a large-capitalization, European telecommunications firm, received shares in the small-capitalization developing market telecommunications firm and many likely sold. Then, the follow-on transaction to acquire Cable & Wireless was very complex, likely alienating an additional group of shareholders. Finally, the LiLAC / CWC integration hit some bumps. For us, all of this has created an opportunity.

We are excited to “partner” with John Malone, the controlling shareholder (again… he is also the controlling shareholder of TRIP through Liberty TripAdvisor Holdings, LTRPA). We believe LiLAC’s assets are technologically superior to the majority of their competitors (i.e. greater bandwidth). With CWC, LiLAC acquired Columbus International, a sub-sea backhaul network that provides LiLAC cost advantages and contributes its own revenue stream. LiLAC’s geographies are certainly development-stage economies, but bandwidth usage is growing quickly. Penetration rates and average revenue per user are low, leaving ample space for LiLAC to grow.

TripAdvisor Inc. (TRIP). We described our TRIP thesis in last quarter’s letter. After our initial purchase on January 6, 2017 at $49.54/share and near its 52-week low at the time, the stock proceeded to continue its decline. It hovered at a low near $42/share for all of March and most of April. This was despite reporting solid traction in Instant Booking signaled by flat branded-click and transaction revenue. In just the prior quarter, branded-click and transaction revenue was down 10%. (Recall from our thesis, TRIP is currently in the midst of a migration from click-based advertising revenue to the new Instant Book platform.) Marketing costs were up and that is what investors seemed to focus on. More recently, TRIP announced on April 27, 2017 that InterContinental Hotels Group (IHG) joined Instant Book – further validation of the platform. We took the lower stock price amidst increasing signs of Instant Booking progress as an opportunity to add to the position and purchased additional shares on April 28, 2017 at $44.75/share.

Sells – January through April 2017

Independence Realty Trust (IRT). On February 7, 2017, we sold our entire position in IRT at $9.10/share. We had purchased IRT in October 2016 at $9.01/share and earned four monthly dividends during our holding period. Prior to our purchase, the stock sold down from its all-time high in anticipation of a large secondary stock offering. The company used the stock offering to internalize the management company, pay down debt, and repurchase shares owned by a third-party, publicly-traded firm. Prior to the deal, the company communicated their intention to make post-deal capital allocations that would lead to full dividend coverage in early 2017. Shortly after the deal was completed, management communicated a change in capital allocation plans that would leave the dividend uncovered through the end of 2017. This change of plans combined with a decrease in monthly apartment rents through much of the country (and especially in a few key IRT geographies) caused us to sell that stock at a modest gain.

Colony Northstar Inc. (CLNS). On February 8, 2017, we sold our entire position in CLNS at $14.57/share. We originally purchased CLNS (as NSAM) on September 8, 2016 at a CLNS-adjusted price of $12.90. We earned one regular and one special dividend during our holding period. The NSAM purchase was in anticipation of the three-part merger of NSAM, NRF, and CLNY into what became CLNS. Prior to the merger, NRF traded at a significant discount

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