Year-End Investor Update: 2017
He that can have patience can have what he will. Benjamin Franklin The Big Money is not in the buying or the selling. But in the waiting. Charlie Munger
Happy New Year to you and yours! We greet you as one extraordinary year ends, and another that promises to be no less exciting begins. With our elected officials more likely to engage in schoolyard-style name-calling than measured diplomacy, and our political processes more likely to be about party identity than personal character, one may well be excused for thinking (and behaving) more like Chicken Little, and less like Mr. Spock. Indeed, in an age when our political class rashly and emotionally lashes out at perceived enemies, and each new day brings more examples of once-respected leaders exhibiting wholly inexcusable behavior, one may well lose long-term vision and allow short-term emotion to influence every aspect of life... including investments. In that environment, we offer the foregoing quotes by Dr. Franklin and Mr. Munger as a reminder of your relationship with GDS Investments, LLC, and our commitment to remain calm, disciplined, and focused... regardless of whatever storm might be raging outside our window. From our post in West Chester, Pennsylvania, we take our national tumult not as a cause for concern, but as an opportunity to assure you again of our unwavering belief in that one virtue most important in our business... patience. Patience is the foundation of our inviolable rules. While the rest of the investment world buys and sells on the daily news cycle, we have simple rules that govern our work for you: ignore all of the tweets, all of the television and internet gurus, and all other background noise. Invest only on a long-term basis, and in positions with significant upside. Do your research. Never react to the “news flash.” Plan. Plod. Premeditate. Acquire undervalued positions, and hold them while others buy-in at ever increasing prices. With the benefit of our own internal research, and decades of experience, we identify, secure, and own value positions with lots of blue sky. Let others attempt to make their fortunes on snap buying and selling. We wait, and in the waiting, deliver your results. For, as Dr. Franklin noted, those who have patience can, ultimately, have whatever else they want. Here, we highlight several examples of new positions which we intend to hold until the market catches up with long-term reality, as well as positions where your patience is now handsomely rewarded. New Positions. We begin with General Electric Company (NYSE: GE), in which we initiated a position in late-2017. Twelve months ago, General Electric traded above $30. The price of the stock declined precipitously throughout the year (>40%), and we purchased in the high-teens to low-$20’s. Though the stock is now trading at approximately 10% below our purchase price, we expect General Electric to deliver exceptional long-term gains. Foremost in our mind is Chief Executive Officer John Flannery, who took office on August 1, 2017, after more than two decades of service to the company. Flannery begins his tenure with a substantially new leadership team by his side, a commitment to examine anew every aspect of this bruised American icon, and a significant demonstration to the market (in the form of a 60,000 share stock purchase) of his belief that he and his team have the balm to heal those bruises. Under Flannery, the company is reconsidering its underproductive divisions and renewing General Electric’s commitment to its industrial roots. By unloading non-core businesses through a variety of mechanisms, General Electric will orient itself to maximize the value created by a focus on what the company does best: Aviation, Healthcare, Renewables, and Power. General Electric is appropriately priced only if one can conclude that (A) Flannery and his team cannot and will not create value, (B) the plan for a return to core competencies which the company is implementing does not create value, and (C) the power sector will not regain its strength. We don’t believe any of those things and, though patience will be required to realize an appreciable increase in General Electric’s share price, the reward should be worth the wait. QUALCOMM, Inc. (NASDAQ: QCOM) is also well-situated for long-term growth. We initiated that position in the mid-$50’s, and acquired more shares throughout the year as the market continued to devalue the semiconductor giant. Most of that decline was due to (A) the ongoing legal clash between Qualcomm and its fellow technology titan Apple, Inc. (NASDAQ: AAPL) and (B) the struggle to bring to fruition Qualcomm’s $39B acquisition of Netherlands-based NXP Semiconductors N.V. (NASDAQ: NXPI). While the market might see those as reasons to devalue Qualcomm stock, we incorporated those factors into our long-term view and, on at least two points, see upside. Firstly, though we offer no comment on the merits of either party’s legal position, we conclude that Qualcomm has the wherewithal to deal with all but the most negative outcome of the Apple litigation. That most negative outcome, however, is unlikely as both companies have reason to settle. Secondly, there is now every reason to believe that Qualcomm’s acquisition of NXP will close in early 2018 when the regulators who are reviewing the transaction are expected to complete their work. That deal will place Qualcomm even deeper into the connected automotive technology and driverless car markets, where NXP is a recognized leader.
While it battles Apple, and attempts to complete its acquisition of NXP, Qualcomm is the subject of a hostile takeover bid by Broadcom Limited (NASDAQ: AVGO). Much like the world champion Houston Astros, who for years invested heavily in their farm system while more marquee teams attempted to buy championship teams, Qualcomm devotes a huge amount of capital to research and development (i.e. $40B over the last decade) while Broadcom grows through financial engineering and strategic acquisitions. In early November, and following that pattern, Broadcom announced plans to acquire Qualcomm for $70 per share. That price, which would be paid as $60 cash and $10 in Broadcom equity, represented a 28% premium over the prior day’s closing and is consistent with our view that the value of the company has significant upward mobility over the long-term. Qualcomm immediately rejected the Broadcom offer on the bases that it (A) undervalues the company and (B) creates regulatory problems which the company would rather avoid. Rather than quickly increasing its offer, Broadcom signaled that it will attempt to replace the current members of the Qualcomm Board of Directors with individuals sympathetic to Broadcom when the entire Qualcomm Board stands for election in the spring of 2018. In essence, Broadcom is attempting an end-run around the current Qualcomm Board of Directors, and is placing the decision as to whether to sell the company firmly into the hands of Qualcomm shareholders. If Broadcom acquires Qualcomm (one way or the other), we expect that acquisition will happen at a price-per-share well above $70. Regardless of whether (and how) Broadcom’s acquisition of Qualcomm plays out, Qualcomm is well-positioned for the market to recognize that the true value of the company is substantially higher than where it traded throughout most of 2017. That recognition, however, may not come for some time. We intend to hold our position in Qualcomm, and you should be well-rewarded for your patience when the market comes around. Another relatively new position which we intend to hold for some time is Under Armour, Inc. (NYSE: UAA). We initiated that around the beginning of November after the stock price dove to approximately $12 per share. That reduction came after the price hovered in the mid- to high-teens for most of the year following a precipitous decline from the high-$20’s in February. Overall, the stock price is down approximately 50% in 2017 and is now trading at less than a quarter of the all-time high of more than $50 per share (September 2015). In the short-term, the stock price may be further depressed by what are expected to be poor fourth quarter results. There are, however, many reasons to conclude that Under Armour’s true long-term value is well above its current price per share. Foremost of those is the company’s remarkable brand cache and the fact that the company has a large share of the marketplace, with nearly $5B in sales. Those tools should allow the company to reduce internal disorganization while also giving it room to develop better and more consistent products. Those products should, then, perform well in the international market, where Under Armour is experiencing healthy growth. In 2017, we also initiated what we expect will be long-term positions in TripAdvisor, Inc. (NASDAQ: TRIP) and Gilead Sciences, Inc. (NASDAQ: GILD), the former of which we featured in our 2017 Mid-Year Letter, and the latter of which has us very excited. Like Qualcomm, Gilead Sciences invests heavily in research and development, while also being able to maintain a cash-rich balance sheet ($22 per share in cash-equivalents). The company has very large shares of the Hepatitis C and HIV treatment markets and, through its August 2017 $11.9B acquisition of Kite Pharmaceuticals, Inc. (NASDAQ: KITE), is positioned nicely in emerging treatments of Non-Hodgkin’s Lymphoma. Finally (in terms of new positions), during 2017 we purchased a basket of high-yielding Bank Preferred Stock. The credit fundamentals of the banking sector are improving, and we are comfortable that this investment represents a good alternative to cash and an appropriate hedge against increased interest rates and inflation. Long-Term Positions. Meanwhile, in 2017 we reaped growth from positions we initiated long ago. These include Republic First Bancorp, Inc. (NASDAQ: FRBK) and BYD Company Limited (OTCMKTS: BYDDF). We began our investment in Republic Bank firm in our confidence that any institution which entrusted Commerce Bank founder Vernon Hill in a leadership role was destined for long-term growth. In 2016, Republic Bank elevated that role when it named Hill as the Chairman of its Board of Directors. Hill continues to bring to that institution the same customer-oriented approach which produced Commerce Bank’s more than thirty-year run of resounding success. Republic Bank is now continuing the “Power of Red” campaign, in which Hill’s retail vision is prominently featured. Over the first three quarters of 2017, Republic Bank increased its revenue by a third, while net income rose nearly 80% and core deposits were up nearly 20%. The bank now has twenty-two stores, and has another twelve in various stages of development. With its stock price having doubled in 2017, and up more than 140% since late-2016, Republic Bank was a significant driver of our success this year. We see little reason to conclude that the stock will not continue its upward movement while the market recognizes the bank’s true long-term value. We also hold a long-term position in Chinese battery and electric car manufacturer, BYD. We began that position when the stock was trading at approximately $2.25 per share, and remain invested now that the company is priced at $9.00. With leverage to, and an integrated position in all aspects of, the electric car market, BYD is oriented for a leadership role in China’s clean-energy economy. The company should do well by taking advantage of what (at the national level) remains a Chinese government commitment to subsidize electric vehicles. Of course, our sustained and future confidences in BYD are only strengthened by the fact that the sage of value investing, Warren Buffett, owns 10% of the company. On to 2018! At GDS, we will remain committed to your long-term financial health, and the sometimes boring nature of our strategies. Whether through a new position which we intend to hold for some time, or a long-term position which bore fruit in 2017, patience is an important part of the foundation upon which we build our investments. In the sometimes extended waiting, which is that "patience-in-practice," we realize the rewards to which Mr. Munger and Dr. Franklin referred.