Fundamental Value Q3 2016 Client Letter

FV outperformed the market in Q3, returning 5.4% before fees vs 3.8% for the SPDR S&P 500 ETF (SPY). This brings the portfolio’s outperformance, after typical fees, to 2.2% since inception.¹

FV made three new investments in the quarter. They were Humana, Express Scripts, and Twentieth Century Fox.

Humana is a health insurer focused on the Medicare market, providing a product called "Medicare Advantage.” Medicare Advantage is an insurance program through which the US government pays private insurers to provide Medicare-like insurance to individuals. Because of their leadership in this space, Humana was offered a buyout deal of $223 per share by Aetna, one of their main competitors. There is a lot of skepticism around this deal, as some investors feel the Department of Justice (DoJ) will successfully oppose the merger on antitrust grounds. We think the market’s focus on the deal has distracted people from the quality of Humana’s underlying Medicare Advantage business. Humana is a leader in highly-rated Medicare Advantage plans (see page 14 of the DoJ suit), and has dominant market share in many states. Their Medicare Advantage revenues have more than doubled from $16B in 2009 to $35B in 2015, and we think more growth is to come. We think Humana may produce a 10% IRR from current prices even if the merger does not close. Our average price was about $153 per share vs about $178 today.

Express Scripts is a healthcare company that manages pharmacy benefits for its customers. They are a middleman between customers (such as large employers and health insurers) and prescription drug manufacturers, and use their massive scale (roughly $100B of drug purchases per year) to negotiate lower prices for their clients.

Despite generating significant value for clients and cash for shareholders over time, we were able to buy the company at just over 10x earnings due to a contract dispute they are having with a large customer. We feel that the dispute is likely to be resolved more favorably than implied by the stock’s 20% decline this year. In the meantime, Express Scripts will continue to buy back more stock (on a percentage basis) than just about any company in the market. Our average price was about $76 per share vs a last price of about $70.

Twentieth Century Fox is a television and film conglomerate. Some of its most valuable businesses include the Fox Broadcast Network, Fox News, and Fox Sports Networks (which includes Regional Sports Networks like the YES channel as well as Fox Sports 1 & 2) as well as its namesake movie studio. Fox also has another group of assets that are somewhat obscure, but nonetheless quite valuable. For example, they own a satellite TV company in India that we estimate is worth more than $10 billion. They also own 39% of Sky TV, a publicly traded UK satellite TV company, worth about $8B at market prices. Finally, they own a 30% stake in Hulu which we estimate is worth another $3-5B.

If the company converted these assets to cash at the valuations mentioned above, the effective price for Twentieth Century Fox’s core US TV and film businesses would be a mere single-digit multiple of their underlying earnings. We feel this is far too cheap for some of the best media assets in the US. We bought the stock at a little less than $25 (where it still trades) and have made it a larger than average position.

One notable winner in the quarter was Qualcomm, which rose almost 30%. Qualcomm’s earnings release in July was a little better than expectations, and the business managed to break a multi-quarter streak of declining sales. Importantly, they made progress collecting patent royalty payments from certain Chinese smartphone companies that had previously been shirking them. On top of their positive earnings results, in late September rumors circulated that Qualcomm might use its cash pile to buy NPX, another semiconductor company focused on the automotive end market. On this “news” Qualcomm stock appreciated another 10+%. We have always thought Qualcomm should be able to find something productive to do with its $31 billion cash hoard, so are not necessarily surprised with the rumor. We are in the process of evaluating what effect such an acquisition would have on our investment in Qualcomm.

We are grateful for your business and your trust, and a special thank you to those who have referred friends and family. There is no greater compliment.

- Bireme Capital

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¹ Net calculations assume a 1.75% management fee. Fee structures and returns vary between clients. FV inception was 6/6/2016.

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Bireme Capital LLC is a Registered Investment Advisor. Registration does not constitute an endorsement of the firm nor does it indicate that the advisor has attained a particular level of skill or ability. This piece is for informational purposes only. If not specified, quarter end values are used to calculate returns. While Bireme believes the sources of its information to be reliable, it makes no assurances to that effect. Bireme is also under no obligation to update this post should circumstances change. Nothing in this post should be construed as investment advice, and it is not an offer to sell or buy any security. Bireme clients may (and usually do) have positions in the securities mentioned.

Advisory fees and other important disclosures are described in Part 2 of Bireme’s Form ADV. The performance described above is the performance on a dollar weighted average of the securities in all Bireme accounts invested in the FV portfolio. Changes in investment strategies, contributions or withdrawals may cause the performance of your portfolio to differ materially from the performance displayed. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. SPY ETF performance includes expenses as well as reinvested dividends. For current performance information, please contact us at (813) 603-2615.