To Our Shareholders,
For the quarter ended September 30, 2015, the net asset value (“NAV”) per Class A Share of The Gabelli Value 25 Fund Inc. decreased 11.6% compared with a decrease of 6.4% and 7.0% for the Standard & Poor’s (“S&P”) 500 Index and the Dow Jones Industrial Average, respectively. See page 2 for additional performance information.
The Summer of Our Discontent
The market declined in the third quarter, starting with a slide over the summer and continuing through much of September. Almost no segment of the market was left unscathed — large caps and small caps, previous high fliers and stocks already beaten down, as well as nearly every sector and industry group finished the quarter lower.
While many seeds sowed the correction, there are a few proximate causes. At the forefront is continued GDP growth deceleration in China, coupled with failed attempts by the government to prop up the stock market and the devaluation of the yuan. This has the secondary effect of impacting nearly any security or geography relating to commodities output, as prices for oil and other resources continued to slide on fears of oversupply and low global growth. Internationally, the continued conflict in Syria with refugees spilling into Europe and throughout the world is another market wildcard.
The Fed's decision to leave rates unchanged in September further stoked the market’s unease. This left investors with many questions, including whether the Fed thinks GDP growth will be lower than market expectations, whether other unintended consequences of keeping rates so low for so long will be able to be controlled, and whether the Fed will ever be able to extricate itself from its ultra-accommodative stance without real harm being done to the economy.
Finally, heightened concerns over the market dynamics of lack of liquidity, exchange traded funds, flash trading, high frequency trading, and no short sale ‘uptick’ rule all converged to put selling pressure on stocks.
Focusing on fundamentals, the U.S. economic backdrop is relatively good. The U.S. consumer sector comprises about 70% of GDP. The U.S. consumer should benefit from lower gasoline and food prices, rising wages and home prices, and improving household balance sheets.
The good news from all of this is, as value investors, our holdings now trade at even greater discounts to our estimates of Private Market Value. Financing is still available at extremely attractive rates and the Mergers and Acquisitions (M&A) boom continues. Financial engineering has left many of our holdings as pure-plays, ripe for consolidation. Finally, valuations are as attractive as we have seen in a long time. While the near term is uncertain and continued volatility would not surprise us, we are very positive about prospects for the Fund and its holdings in coming years.
Deals, Deals and More Deals
M&A activity has remained robust in 2015 with year to date activity at $3.2 trillion globally, up 32% from the first nine months of 2014. While the total value of announced M&A deals was down from second quarter 2015, the third quarter was again over $1 trillion in value, for the second consecutive quarter. U.S. M&A activity, at $1.5 trillion year to date, was particularly strong, up 46% over 2014 levels. Cross border M&A also continues to be strong at $1.1 trillion year to date, up 18% from last year.
In September, New York area cable operator and longtime holding Cablevision Systems (4.4% of net assets as of September 30, 2015) agreed to be acquired by European telecommunications operator Altice for $34.90 per share in cash. The deal values Cablevision at approximately 9.6x our 2015 EBITDA estimate, which we believe is a good outcome for Cablevision shareholders.
Let’s Talk Stocks
The following are stock specifics on selected holdings of our 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 share prices are listed first in United States dollars (USD) and second in the local currency, where applicable, and are presented as of September 30, 2015.
Cablevision Systems Corp. (CVC, Financial)(4.4% of net assets as of September 30, 2015) (CVC – $32.47 – NYSE) provides broadband, television, and phone service to approximately three million subscribers in the New York metropolitan area. An industry pioneer, CVC developed the most advanced cable plant in the country and converted over 70% of its subscribers into triple play (video, phone, and broadband) customers. After years as a potential acquisition candidate, in September 2015 Cablevision agreed to a sale to Altice for $34.90 per share in cash. The deal represents the culmination of efforts to surface value through transactions such as the spin-offs of Madison Square Garden (3.2%) and AMC Networks (1.7%) in February 2010 and June 2011, respectively.
CBS Corp. (CBS, Financial)(4.6%) (CBS – $44.90 – NYSE) operates the CBS television network and the premium cable network Showtime. It also owns twenty-nine local television stations and 130 radio stations. We believe that CBS has a number of opportunities to generate incremental non-advertising revenue from the sale of existing content to online video distributors 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 that financial engineering, including the announced $3 billion share buyback, could act as a catalyst for shares.
DISH Network Corp. (DISH, Financial)(1.6%) (DISH – $58.34 – NASDAQ) is the third largest pay television provider in the U.S. with approximately 14 million subscribers. As a satellite operator unburdened by local franchising requirements and wired plants, DISH can market and deliver video extremely efficiently across the entire country. As founder of the company, Charlie Ergen owns approximately 53% of DISH’s shares and lends his strategic vision to its benefit. DISH has accumulated a significant spectrum position at attractive prices and unsuccessfully attempted to enter the mobility market via the acquisition of Sprint. DISH could monetize its spectrum through a sale of the spectrum or the whole company, or, more likely, a partnership with an existing wireless operator.
Edgewell Personal Care Co. (EPC, Financial)(1.4%) (EPC – $81.60 – NYSE), based in St. Louis, Missouri, is the personal care division of Energizer Holdings (0.6%), which split its personal care and household products divisions on July 1, 2015. Edgewell generates approximately $2.5 billion of revenue through its principal businesses: wet shaving, including Schick branded razors and blades, Edge and Skintimate shaving preparation and private label shaving products; sun care, including the Banana Boat and Hawaiian Tropic brands; feminine care, Playtex and o.b. tampons and Carefree and Stayfree liners and pads; and infant care, utilizing the Playtex and Diaper Genie brands. As a pure-play personal care company, Edgewell competes in high margin, attractive categories with leading brands. We expect management to focus on improving margins through product mix, restructuring savings, and operating leverage, which should afford it flexibility to reinvest in growth opportunities. At the outset, the company has estimated $830 million of net debt providing management with sufficient flexibility to invest in internal growth, make acquisitions, and/or repurchase shares. EPC is a likely acquisition target as a multinational competitor with a strong international infrastructure would benefit from scale, cost synergies, and the ability to accelerate international expansion.
Honeywell International Inc. (HON, Financial)(3.3%) (HON – $94.69 – NYSE) operates as a diversified technology company with highly engineered products, including turbine propulsion engines, auxiliary power units, turbochargers, brake pads, environmental and combustion controls, sensors, security and life safety products, resins and chemicals, nuclear services, and process technology for the petrochemical and refining industries. One of the key drivers of HON’s growth is that the company is constantly developing new products and services for the marketplace. One new product the company has developed is Solstice, a fluorocarbon with zero depleting ozone qualities and negligible global warming contribution. The product will be used in various aerosol applications and in the air conditioning systems of vehicles. Driven by consumer demand and European Union regulation, demand for Solstice is expected to increase significantly. A new service that the company is providing is connectivity in airplanes, as well as residential, commercial, and industrial buildings. In airplanes, HON has products across the entire connectivity chain, from hardware to apps and data services, which can provide high speed Internet service. In buildings, the company has a large installed base of devices, including security and fire systems, room controls, and smoke detectors that can be connected with smart devices to increase productivity, efficiency, and safety. These products and services should continue to drive HON’s future earnings higher.
Liberty Media Corp. (LMCK, Financial)(1.2%) (LMCK – $34.46 – NASDAQ), (0.6%) (LMCA – $35.72 – NASDAQ) is a diversified investment vehicle guided by cable television pioneer John Malone, the Chairman, and former Microsoft CFO Greg Maffei, the CEO. The company owns over half of satellite radio provider Sirius XM, 34% of Live Nation, 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 tax efficiently distributed, traded, or sold interests in Discovery Communications (0.9%), News Corp. (0.5%), Time Warner Inc. (1.2%), DIRECTV, Starz, and QVC, among others. Liberty currently trades at a discount to the sum of the public values of its component parts and could pursue transactions, such as a merger with Sirius XM, to eliminate that discount.
Madison Square Garden Co. (MSG, Financial)(3.2%) (MSG – $72.14 – NYSE) is an integrated sports and entertainment company that owns the New York Knicks, the New York Rangers, the Radio City Christmas Spectacular, The Forum, and that iconic New York venue, Madison Square Garden. These evergreen content and venue assets benefit from sustainable barriers to entry and long term secular growth. We believe the now complete transformation project, the rising value of sports franchises (as demonstrated by the sale of the Clippers), and share repurchases, should dramatically increase MSG’s per share value.
Republic Services Inc. (RSG, Financial)(3.0%) (RSG – $41.20 – NYSE), based in Phoenix, Arizona, became the second largest solid waste company in North America after its acquisition of Allied Waste Industries in December 2008. Republic provides nonhazardous solid waste collection services for commercial, industrial, municipal, and residential customers in thirty-nine states and Puerto Rico. Republic serves more than 2,800 municipalities and operates 193 landfills, 200 transfer stations, 338 collection operations, and 66 recycling facilities. Since the Allied merger, Republic has benefited from synergies driven by route density, beneficial use of acquired assets, and reduction in redundant corporate overhead. Republic is committed to its core solid waste business. While other providers have strayed into alternative waste resource technologies and strategies, we view Republic’s plan to remain steadfast in the traditional solid waste business positively. We expect continued solid waste growth acquisitions, earnings improvement, and incremental route density and internalization growth in already established markets to generate real value in the near to medium term, highlighting the company’s potential.
Swedish Match AB (OSTO:SWMA)(3.1%) (SWMA – $30.19/253.32 SEK – Stockholm Stock Exchange) produces tobacco products that include snus and snuff, chewing tobacco, cigars, and lights. The company has been benefiting from the growth of the smokeless tobacco market in both Scandinavia and the U.S., as public smoking bans and health concerns are driving consumers to seek alternative tobacco products to cigarettes. In October 2010, Swedish Match combined its European and premium cigar portfolios with Scandinavian cigar and pipe tobacco company STG, creating a new company that will benefit from enhanced scale and synergies. The company’s standstill with STG expired in October 2014, so Swedish Match now has the flexibility to opportunistically monetize this asset. As a more focused company, we expect Swedish Match to grow sales and earnings over time as the smokeless tobacco category continues to develop. We also believe the company could be an attractive takeover candidate for a global tobacco company that wants to increase its presence in the smokeless segment.
Xylem Inc. (XYL, Financial)(1.4%) (XYL – $32.85 – NYSE) is a global leader in the design, manufacturing, and application of highly engineered technologies for the transportation, treatment, and testing of water. The company is expected to benefit from favorable long term fundamentals in the water industry, driven by scarcity, population growth, aging of the infrastructure, and the need to improve water quality. Further, with a large installed base of pumps and systems, the company is well positioned to increase aftermarket revenue, which currently represents roughly 40% of total revenues. Xylem’s attractive business mix also generates strong cash flow, which is expected to support acquisitions across geographies and end markets and increase returns to shareholders. The company most recently provided a 5 year plan that outlined favorable organic growth and margin targets that Xylem believes it can achieve.
Investment Scorecard
The top contributors to performance during the third quarter included Cablevision Systems Corp. (+36%), which agreed to be acquired by Altice for $34.90 per share in cash; O’Reilly Automotive (0.7% of net assets as of September 30, 2015) (+11%), which reported another strong quarter in Q2 and should benefit from lower gas prices for consumers; Energizer Holdings (+14%), which was spun-off from the “old” Energizer Holdings on July 1 and rose on optimism about the company’s prospects for margin improvement and cash generation; and H&R Block (0.8%) (+23%), which closed its divestiture of H&R Block Bank and announced a $3.5 billion share repurchase program through 2019, including a $1.5 billion self-tender it launched in September.
Detractors from performance included media companies CBS (-21%), Viacom (5.5%) (-31%) and Grupo Televisa (1.3%) (-33%), all of which declined along with the broad media sector following subscriber losses by Disney’s ESPN channel, which led to investor concern about growing “cord-cutting” by cable subscribers; Grupo Televisa (-33%), based in Mexico, was also hit by investor concerns about a slowdown in emerging markets. Other detractors from performance included Rolls Royce (1.5%) (-25%) which has had execution issues and suffers from concerns over a slowdown in aerospace cycle; Navistar (0.6%) (-44%), which has not recovered heavy truck market share as quickly as expected and Circor (1.1%) (-26%) which has meaningful exposure to energy markets.
Conclusion
While the third quarter was the market’s most difficult in several years, there are many reasons to be optimistic about prospects for the Fund. Valuations are as attractive as have been seen in a long time, especially in sectors which are our core competency. Strong recent M&A activity reinforces our view that we are in a building "Fifth Wave" of takeover activity. We continue to stick to our long term investment philosophy and hope to use any opportunity “Mr. Market” provides to us. We seek high quality companies trading at a discount to Private Market Value—the price an informed industrialist would pay to own an entire business. We also look for catalysts to surface value, such as a takeover of the company, financial engineering, new management, regulatory changes, or a change in cash flow allocation.
October 12, 2015
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.
Portfolio Management Team Biographies
Mario J. Gabelli, CFA, is Chairman and Chief Executive Officer of GAMCO Investors, Inc. that he founded in 1977 and Chief Investment Officer – Value Portfolios of Gabelli Funds, LLC and GAMCO Asset Management Inc. Mr. Gabelli is a summa cum laude graduate of Fordham University and holds an MBA degree from Columbia Business School and Honorary Doctorates from Fordham University and Roger Williams University.
Christopher J. Marangi joined Gabelli in 2003 as a research analyst. He currently serves as a portfolio manager of Gabelli Funds, LLC and manages several funds within the Gabelli/GAMCO Funds Complex. Mr. Marangi graduated magna cum laude and Phi Beta Kappa with a BA in Political Economy from Williams College and holds an MBA with honors from Columbia Business School.
