Research Fund : Commentary

Portfolio Managers: Jonathan A. Baker, Barton B. Hooper, Nathan F. Ritz, Dan Walker

As of 3/31/2016

Investment Style: Multi-Cap Value

Fiscal Year Contributors

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.
Motorola Solutions is a global leader in commercial radio systems and public safety communication infrastructure products and services.  Motorola Solutions’ shares benefited from board membership and capital infusion by respected technology private equity firm SilverLake Partners, and reduced fears that the company’s core public safety radio products were becoming obsolete.  Furthermore, Motorola’s aggressive share repurchase throughout the last 12 months increased per share value.  We believe Motorola Solutions will continue to repurchase shares as long as the stock price remains at attractive levels.  
Post Holdings is a consumer packaged goods holding company whose products are sold through a range of channels, such as grocery, drug stores, foodservice and the Internet.  While Post has been transforming itself from a branded cereal manufacturer into a food holding company with a more growth-oriented portfolio, fiscal year appreciation was due to the acquisition of Malt-O-Meal brands, which strengthened the company’s cereal business.  In addition, a strong performance of the Michael Food’s segment and improvements in the company’s protein-focused brands contributed to good results.  Post also benefited from a capital raise of equity and debt, which decreased its financial leverage, putting the company in a better position to take advantage of future value-enhancing mergers and acquisitions.  We eliminated the position in the fourth quarter of 2015 when the stock traded above our business value estimate.

Fiscal 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 Fund performance.   
Range Resources is an independent producer of natural gas and natural gas liquids (NGLs) based in Fort Worth, Texas.  Despite a healthy rebound during the first calendar quarter, Range shares remain well below last year’s levels thanks to stubbornly low natural gas and NGL prices. Following one of the mildest winters in recent memory, the one-month New York Mercantile Exchange (NYMEX) natural gas futures contract settled in early March at $1.67/MMBtu, its lowest level since 1999.  While we cannot predict the timing of a recovery in natural gas prices, the present state of oversupply is unlikely to be permanent.  Domestic drilling and completion activity levels are now nearing record lows, with even the industry’s most efficient players pulling back (Range is down from 15 active drilling rigs to three).  In the meantime, the company’s balance sheet has improved (via the monetization of non-core assets), it is drilling more efficient wells and its cost structure has continued to fall (finding and development costs are trending toward $0.20/Mcfe).  We expect Range to emerge from the downturn in position to generate attractive per share cash flows in the years ahead.
Fossil Group is the fourth-largest producer of watches and the largest global licenser of watches and jewelry. Over the trailing 12 months, Fossil’s stock was weighed down by concerns surrounding watch category global growth. In the US this is being driven by sluggish foot traffic in malls and department stores coupled with broad based de-stocking by Fossil’s partners, as they remain cautious on the wearables category and on consumer sentiment in general. Additionally, Fossil’s largest licensed brand, Michael Kors, slowed and experienced declines in same-store-sales in North America to start the year; however, the brand rebounded later in the year with management presenting a better than expected outlook for 2016. Fossil Group will have less exposure to individual brands as they add licensed brands to their portfolio, including recent additions Kate Spade, Tory Burch and Ralph Lauren’s Chaps. Finally, management postponed share repurchase for 12 months in conjunction with their acquisition of Misfit, a wearable products developer.  While we would have preferred a joint venture with Misfit and continued share repurchase at extremely attractive prices, the stock fell substantially more than the decline of our valuation creating an even more compelling investment opportunity.  

Quarterly Contributors

Range Resources is an independent producer of natural gas and natural gas liquids (NGLs) based in Fort Worth, Texas.  Range shares rallied during the quarter, as the company reduced its debt load by roughly $1.0 billion following the divestiture of two non-core assets (Nora and Bradford County).  The company is continuing to pursue a sale of its central-Oklahoma oil properties, which will likely be used to retire additional long-term debt. Other positives included improving natural gas price sentiment (for 2017) and a general thawing in the high yield debt markets. Falling drilling activity in the Marcellus and Utica shales (collective rig counts are down from 170 at peak to 40 at present) and the continued drop in domestic oil production, in time, should bring both oil and natural gas prices up closer to their marginal costs of production.  In the interim, Range has 80% of its 2016 gas production hedged at $3.24/MMBtu and is locking in additional 2017 production with the current gas strip close to $2.85.  We continue to believe Range will emerge from the downturn a significantly more efficient–and more valuable–company.           
Fossil Group is the fourth largest producer of watches and the largest licenser of watches and jewelry globally. Fossil outperformed during the quarter, as the company reported a rebound in same-store-sales, which grew 1% during the fourth quarter, including positive growth in watches. This calmed some fears of secular decline in the category, including headwinds from the Apple Watch and other wearables. Moreover, Fossil guided to flat revenue in 2016 excluding foreign currency translation, which was well ahead of consensus forecasts.  Management reported good reception of their connected accessories product launch and announced a broad product offering across brands which will incorporate Misfit technology and design, in time for the holidays in 2016. 
Summit Materials is a US based construction materials company with cement, aggregates and downstream operations (ready-mix concrete, asphalt, paving) in the Midwest, South and Mid-Atlantic regions. During the quarter, Summit reported strong fourth quarter volumes and strong pricing in aggregates and cement, which calmed investor fears of a slowdown in residential and non-residential construction. Additionally, given the drop in energy prices, investors feared that Summit’s largest market, Texas, would contract during 2016. However, the company reported solid growth in Texas (including Houston), and industry data points throughout the quarter alleviated fears of a Texas recession. Finally, strong 2016 guidance from Summit and peers led to a rebound for the entire group during the quarter. 

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.
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.  A combination of factors contributed to the decline in Allergan’s stock during the quarter, including continued discussions of potential drug price regulation, regulatory delays in closing the company’s sale of its generic drug operations to TEVA and uncertainty around the viability of the proposed merger with Pfizer (which, subsequent to quarter end, has officially been called off).  We believe the risk of the TEVA sale transaction falling through is low, and the company’s collection of durable growth assets, management acumen and balance sheet optionality create multiple paths for durable shareholder value creation in the years ahead.  We added to our position during the quarter.           
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. 

New Holdings

Laboratory Corp. of America Holdings is the world’s leading healthcare diagnostics company, providing comprehensive clinical laboratory services and end-to-end drug development support.  The company’s strong competitive position, durable excess cash flow and exemplary management have been mainstays of the Laboratory Corp. investment thesis over many years. Various Weitz managed portfolios have been investors in the company over the past 10+ years. We initiated the position, as both the diagnostic lab and drug development market continued to experience healthy demand.  A little over one year in, LabCorp’s $6 billion acquisition of Covance appears to be bearing early fruit in the form of new customer wins and central lab market share gains.  With revenue and cost synergies on track, financial leverage returning to target levels and stable reimbursement, we believe this stock can compound wealth for years to come.
Summit Materials is a US based construction materials company with cement, aggregates and downstream operations (ready-mix concrete, asphalt, paving) in the Midwest, South and Mid-Atlantic regions. Summit was established by industry veteran Tom Hill in 2009 as a vehicle to take advantage of the housing recession and contribute to the roll-up of the building materials industry.  We continue to like the aggregates industry, with its high barriers to entry and strong pricing power, derived from the products’ low price-to-weight ratios (limited competition), and significant permitting and regulatory barriers. Summit also owns two of the most attractive cement operations along the Mississippi river, with the option to expand capacity as demand continues to recover in the Midwest. We expect continued growth for Summit, as their largest end-market, public infrastructure, will benefit from the first long-term highway bill in almost a decade (Fixing America’s Surface Transportation (FAST) Act) in addition to state led funding propositions, gas tax increases and higher overall tax receipts. 
Redwood Trust invests in mortgage-related and other real estate-related assets, and is engaged in residential and commercial mortgage banking activities. Various Weitz portfolios have been investors in the company during the bulk of the past 20+ years. Despite a volatile interest rate environment, increased competition and difficult market conditions over the past few years, Redwood has remained profitable in each of its business segments. Redwood recently took meaningful steps to right-size its cost and business structure in light of market conditions.  The company remains competitively advantaged across its platforms and is well positioned to benefit from potential government-sponsored enterprise reform, the eventual revitalization of private-label residential securitization and future commercial investment opportunities.  We believe that the market valuation of less than book value now overly discounts Redwood’s future earnings capabilities. While we wait for the value to be realized, a dividend yield of nearly 9% should enhance future total return.   
Apple, creator of the iPhone, iPad and Mac, makes a return to the Research Fund (previously eliminated in the third quarter of 2014). Investors, in our view, have become too pessimistic about Apple’s ability to grow sales of the iPhone and to globally monetize its large installed base of iOS devices. In addition to its growth prospects, Apple continues to return significant amounts of cash to shareowners.   
Guidewire is a provider of software products for property and casualty insurers.  We believe Guidewire, by a wide margin, is the global leader for modern policy, billing and claims system software. Most insurance companies are using outdated software (close to 30 years old), providing ample growth opportunities.  Guidewire has excellent management and has focused on adding ancillary products to its core offerings, widening its global franchise.  

Eliminated Holdings

MRC Global  - Conditions in the oil patch have continued to worsen over the past six months, with several oil field service executives describing the downturn as the worst they have seen in over 30 years.  Despite a dour forecast for each of MRC’s end markets during 2016, the company’s stock rallied in late February on news that an activist investor had taken significant positions in MRC and competitor Now, Inc. (with hopes of convincing the two companies to merge).  Additional diligence led us to believe that the combination was unlikely, so we elected to close our position at a modest discount to our lower business value estimate.       
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.
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.
Brown & Brown – We sold Brown & Brown at a modest gain when the stock exceeded our revised business value estimate.
Omnicom Group – We sold Omnicom Group at a healthy gain when the stock approached our business value estimate.
Monsanto Company – We sold Monsanto to pursue better risk/reward opportunities.

As of 3/31/2016: Range Resources Corp. 6.9% of the Weitz Research Fund’s net assets; Allergan plc 6.2%; Fossil Group, Inc. 5.5%; Liberty Global plc-CL C 5.5%; Apple, Inc. 3.0%; Summit Materials, Inc.-CL A 1.8%; Redwood Trust, Inc. 1.7%; Guidewire Software, Inc. 1.6%; Laboratory Corp. of America Holdings 1.5%; and Express Scripts Holding Co. 1.2%.
Investors should consider carefully the investment objectives, risks and charges and expenses of the Fund before investing. The Fund's Prospectus contains this and other information about the Fund and should be read carefully before investing. 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.
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