Multi-Cap Alternative Strategy : Commentary

Portfolio Manager: Wallace Weitz

As of 3/31/2016

The Multi-Cap Alternative Strategy returned +2.60% (gross of fees), +2.12% (net of fees) during the first quarter, compared to +1.35% for the S&P 500® and +0.97% for the Russell 3000®.  For the trailing twelve months, the Strategy returned -7.39% (gross of fees), -9.21% (net of fees) compared to +1.78% for the S&P 500® and -0.34% for the Russell 3000®.

Fiscal Year Contributors

Martin Marietta Materials is a producer of sand, gravel, aggregates and cement (products for the construction industry). During the trailing twelve months, Martin’s aggregates volumes, pricing, and incremental margins exceeded investor expectations, as non-residential and public construction showed broad-based strength. The outlook for public volumes over the next several years improved with the passing of the 5-year federal highway bill, dubbed Fixing America’s Surface Transportation (FAST) Act, and with state Department of Transportation budgets expanding. Martin also increased, for the third time, its synergy cost-savings target for the 2014 Texas Industries acquisition from the original $70 million to $120 million. They sold their California Oro Grande cement operation for $420 million the proceeds of which will be used towards their 20 million share repurchase program. The culmination of these positive events pushed Martin Marietta’s stock price above our estimate of intrinsic value, and we exited our position during the third quarter of 2015. 
Angie’s List is a nationally-based, local services review provider and marketplace.  The business, which began as a consumer pay subscription service, has been progressively lightening the load on subscribers and shifting the cost of the model to advertising service providers.  This transition has caused a flattening of top-line growth.  The stock appreciated in the fourth quarter of 2015 when IAC/InterActiveCorp (a company we have owned in the past) made an opportunistic cash offer to buy Angie’s List for slightly less than $9 per share.  We felt the offer undervalued Angie’s business and precluded any opportunity to participate in the upside of the combined entity. The Market apparently agreed, and Angie’s stock price traded through the offer price to about $11 per share.  We sold our position, as the stock price exceeded our revised estimate of business value.
Alphabet is a multinational technology company generally specializing in Internet related services and products.  Alphabet’s core search business (Google) delivered strong operating results which eased investor fears that the company’s primary search advertising products would not be as relevant on mobile phones as on desktops.  Alphabet’s shares rose, as investors priced in a higher rate of long-term growth, renewed operating expense discipline and the announcement of the company’s first capital return program. We opportunistically trimmed our position, as the stock price approached our estimate of business value.

Calendar Year Detractors

Valeant Pharmaceuticals is a multi-national, specialty pharmaceutical and medical device company that develops, manufactures and markets a broad range of brand name, generic and over-the-counter products in over 100 countries.  We closed our position in Valeant toward the end of October last year.  The stock came under heavy selling pressure as a result of increased political scrutiny around drug pricing and possible wrongdoing at one of its “alternative fulfillment” pharmacy partners.  Our decision to sell was ultimately based on a combination of important questions we had difficulty answering regarding potential long-term reputational damage to Valeant’s business, the likelihood of difficult payer negotiations, future business model uncertainty and financial leverage.  While our investment in Valeant ended on a disappointing note, it was a healthy multi-year contributor to Strategy performance.    
Liberty Global is the largest international cable company, with operations in 14 countries providing video, broadband Internet, fixed-line telephone and mobile services to its customers. Liberty Global’s portfolio of businesses produced mixed results during the fiscal year.  Continued strong results in the UK and Belgium were partially offset by continued competitive pressures and merger integration missteps in Holland, and a poorly received price increase in Germany. Furthermore, the continued strengthening of the US Dollar put a damper on Liberty’s results (reported in US Dollars).  We believe the company is restoring investor confidence by learning from these missteps, taking actions within the portfolio as needed (e.g., moving the Dutch business into a joint venture with Vodafone-See Quarterly Detractors) and outlining an achievable three-year growth plan.
Iconix Brand Group is a brand management company and owner of a diversified portfolio of global consumer brands across entertainment, home segments and fashion for men and women. Over the trailing 12 months, Iconix’s share price fell in response to a change in senior management, an accounting restatement, an SEC review and disappointing operating results resulting in a reduction of revenue and cash flow guidance.  These events led to additional worries over the ability to refinance near-term debt maturities. As a result, we exited the position.  

Quarterly Contributors

Berkshire Hathaway is a conglomerate holding company owning subsidiaries engaged in a number of business activities. Berkshire shares were helped by the closing of the Precision Castparts acquisition and improved operating performance at its Burlington Northern railroad subsidiary. Berkshire’s insurance unit continues to show excellent discipline in underwriting, which results in temporary declines in premium, but means the company will have significant capacity when insurance pricing returns.
Wesco Aircraft is a distributor and provider of supply chain management services to the global aerospace industry. Wesco continues to execute on plans by new management to drive operational excellence and to transition the business to emphasize supply chain and logistics services rather than a prior emphasis on “Ad Hoc” sales dependent on temporary supply shortages. 
Colfax Corp is a leading manufacturer of pumps, gas handling products and welding equipment. Colfax shares rallied as the company maintained 2016 earnings guidance and demonstrated that the Colfax Business System, a management philosophy and a set of tools based on the concept of continuous improvement, is helping the company to move forward in difficult markets. Although the company is experiencing declining sales in several of its primary end markets including oil & gas, power generation and mining, we believe that Colfax will manage through this period and emerge larger and stronger.  

Quarterly Detractors

Express Scripts is the largest stand-alone pharmacy benefits manager (PBM) in the United States, helping health benefit providers improve access to (and the affordability of) prescription drugs.  Negotiations with Anthem, Express Scripts’ largest customer, hit an impasse early in the quarter.  Anthem elected to bring the details of the disagreement public at a widely attended industry conference in January, providing the investment community a lens into how far the two companies were apart on the economics of their existing contract.  Since then, Anthem has also filed a lawsuit against Express Scripts.  While we hope a mutually agreeable solution will eventually be achieved, it remains possible (some believe likely) that Anthem will choose not to renew its contract with Express in 2019. We have run scenarios encompassing a range of different outcomes, and we believe Express Scripts’ shares are undervalued in all but the most dire.  We continue to monitor contract-related developments and are otherwise heartened by improved execution across the other 84% of Express Scripts’ enterprise.        
Liberty Global is the largest international cable company, with operations in 14 countries providing video, broadband Internet, fixed-line telephone and mobile services to its customers. Its shares price fell early in the quarter after an influential Wall Street analyst downgraded his outlook for the stock, principally due to concerns over continued competitive struggles in Holland (one of Liberty’s largest markets).  Since that time, Liberty announced it would move its Dutch operations into a 50/50 joint venture with Vodafone.  The joint venture structure allows Liberty to combine its strong cable and broadband businesses with Vodafone’s mobile offering to create a more competitive, “converged” offering.  Liberty also provided Wall Street with an attractive three-year growth outlook during its fourth quarter earnings call, helping shares recover some of the earlier declines.  We remain confident of continued growth for Liberty’s cable offerings and management’s abilities to deliver on their outlook. 
Liberty Ventures is best described as an investment vehicle, with its principle asset being an 18% stake in publicly traded Expedia, Inc.  Expedia’s stock produced very strong returns in calendar 2015 (+47%); however, Expedia shares declined in the broader market sell-off during the initial six weeks of 2016 before partially recovering.  Liberty Ventures also owns a stake in Time Warner Cable.  Charter Communications has proposed acquiring Time Warner Cable, subject to Federal Communications Commission (FCC) approval.  Under this proposal, (a) Liberty Ventures would exchange its shares of Time Warner Cable for shares of Charter and (b) Liberty Ventures would provide additional capital for the transaction by paying cash for to-be-issued shares of Liberty Broadband, which in turn would pay cash for to-be-issued Charter stock. Although the structure of this transaction is more complex than most, we believe it represents a significant opportunity for value creation at Liberty Ventures.

New Holdings

Allergan is a global specialty pharmaceutical company focused on the development, manufacturing, marketing and distribution of generic, brand name, biosimilar and over-the-counter pharmaceutical products.  Formerly Actavis, the “new” Allergan is a collection of significant acquisitions made over the past 4-5 years, including Watson Pharmaceuticals, Warner Chilcott, Forest Laboratories and legacy Allergan.  During the summer of 2015, Allergan announced the divestiture of its global generics business to Teva at a terrific price ($40.5 billion). While closing has been delayed approximately three months by the Federal Trade Commission review, we believe the Teva transaction will ultimately be approved.  Allergan should then emerge as a pure-play branded pharmaceutical manufacturer with the potential for high single-digit, organic growth and significant balance sheet optionality.  
Lions Gate is a global entertainment company, producing film and television programming for distribution around the globe.  Lions Gate has established itself as a mini-major film studio in Hollywood.  It pursues a unique model of pre-licensing international distribution rights to its films in order to help fund the production of their film slate.  By doing so, Lions Gate reduces their direct investment in their films, mitigating some of the risk from a box office dud.  On the television side, Lions Gate does not own or operate a large suite of TV networks, making them indifferent to consumers’ preferences for how they receive content.  Lions Gate is positioned as a “content arms dealer” in the race for high-quality, exclusive programming between traditional TV companies and online services like Netflix, selling their wares to the highest bidder.  In recent years, Lions Gate shares were strong as the company enjoyed the success of The Hunger Games film franchise, and investors appreciated their enviable position in the changing television landscape.  Recently, however, a string of box office disappointments in the large film segment has overwhelmed the strength of its TV results. We believe Lions Gate’s box office fortunes will eventually reverse, and in the interim, its strong television business will continue to grow and lessen the company’s overall reliance on the motion pictures segment.

Eliminated Holdings

ADT Corp – We sold ADT at a gain after a private equity group agreed to acquire the company for a price near our business value estimate.
Precision Castparts  – We sold Precision Castparts at a gain when Berkshire Hathaway completed its acquisition of the company.
Iconix Brand Group  – We sold Iconix Brand Group at a loss, as the company’s risk profile deteriorated due to a combination of soft business results, high financial leverage and increased funding costs.



Quarterly Top Performers

Return
Average
Weight
Contribution
Wesco Aircraft Holdings, Inc
 20.22%
 4.13%
 0.94%
Berkshire Hathaway Inc. Class B
 7.45
 11.17
 0.88
Colfax Corporation
 22.44
   2.91
 0.75
Liberty Broadband Corp. Class A/C
 12.17
   6.09
 0.75
Range Resources Corporation
 31.66
   1.62
 0.54

Quarterly Bottom Performers

Return
Average
Weight
Contribution
Liberty Interactive Corporation Ventures Series A
-13.28%
 4.01%
 -0.67%
Liberty Global plc Class C
   -7.87
    7.53
 -0.60
Express Scripts Holding Company
 -21.42
    2.02
 -0.56
Wells Fargo & Company
 -10.34
    2.94
 -0.33
SPDR S&P 500 ETF Trust
    1.34
 -20.42
 -0.24
Contributions to performance are based on actual daily holdings. Securities may have been bought or sold during the quarter. Return shown is the actual quarterly return of the security or combination of share classes. Source for return shown is FactSet Portfolio Analytics. It should not be assumed that recommendations made in the future will be profitable or will equal the performance of the securities in this list. The holdings identified do not represent all of the securities purchased, sold or recommended for Weitz Inc.’s advisory clients. Contact Weitz Inc. to obtain the methodology for the calculations above. You may reach Weitz Inc. at 1125 S 103rd Street, Suite 200, Omaha NE 68124, at 1-800-304-9745 or at weitzinvestments.com.
Performance information in this letter is the weighted-average performance of accounts managed by Weitz Investment, Inc. (“Weitz Inc.”) under its Multi-Cap Alternative Strategy (the “Strategy”). Performance of particular securities in this letter is shown for an entire time period. All other portfolio holdings information is for a particular “Representative Account” in the Strategy.

Index performance is hypothetical and is shown for illustrative purposes only. The returns above also include fee waivers and/or expense reimbursements, if any; total returns would have been lower had there been no waivers or reimbursements. Contributions to performance are based on actual daily holdings. Comparative returns are the average returns for the applicable period of the S&P 500® and the Russell 3000® Indexes. The S&P 500® is an unmanaged index consisting of 500 companies generally representative of the market for the stocks of large-size U.S. companies. The Russell 3000® Index measures the performance of the largest 3,000 U.S. companies representing approximately 98% of the investable U.S. equity market.
Investors should consider carefully the investment objectives, risks and charges and expenses of the Strategy before investing. Past performance does not guarantee future results. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk.