Fundamental Value Q4 2016 Client Letter

Fundamental Value (FV) had an exceptional 2016, returning 16.8% before fees vs 7.5% for the SPDR S&P 500 ETF (SPY). The majority of FV’s return came in the fourth quarter, as it gained 10.1% vs a 4.0% return in the benchmark. This brings the portfolio’s outperformance, after typical fees, to 8.3% since inception.¹

We made three significant trades in the fourth quarter: selling Qualcomm, selling Viacom, and purchasing Time Warner.

Qualcomm was a big winner in the third quarter, appreciating 30%. Besides the change in price, another factor significantly changed our estimate of the prospective returns to Qualcomm investors: the announcement of the massive acquisition of automotive semiconductor specialist NXP. In our last quarterly letter, we noted that we were “in the process of evaluating what effect such an acquisition would have on our investment in Qualcomm.” We decided that the deal would dilute returns to QCOM investors and that it was time to take our profits and move on.

Unfortunately, it was not a positive price move, but poor business results that drove our divestment of Viacom, a media conglomerate that owns Nickelodeon, MTV, and Paramount Pictures. Although Viacom’s cable revenues have been declining for a few quarters, we had expected an eventual stabilization. Instead, the decline accelerated noticeably in the second and third quarters of this year. This fact, combined with our skepticism about the likelihood of a rumored deal with CBS, caused us to throw in the towel. Luckily, a rising market and our cheap purchase price of <8x earnings allowed us to exit the stock without incurring significant losses.

These two disposals were replaced in part by a new long position in Time Warner (TWX), the target of a merger deal with telecom giant AT&T. We purchased shares of TWX at about $88, a significant discount to the $106 AT&T was willing to pay, implying a ~20% annualized return if the deal closes next year. In an interesting twist, then-candidate Trump came out in opposition to the deal when it was announced in late October, likely contributing to the size of the spread. Trump even called out CNN (owned by TWX) by name, saying that the deal would “concentrate too much power in the hands of too few,” implying his administration would attempt to block the deal on antitrust grounds. However, we are confident that a Department of Justice led by Jeff Sessions, who publicly opposed Microsoft’s antitrust prosecution, will act similarly to previous Republican-led DoJs, sparing all but the most egregious mergers from antitrust enforcement. We also doubt Trump would oppose the transfer of CNN from a NY Democrat (TWX CEO Jeff Bewkes) to an Oklahoma-born Republican (AT&T CEO Randall Stephenson). Finally, we think that Time Warner’s assets have significant standalone value, providing some downside protection in the event that the deal does not go through and creating an  attractive risk/reward ratio.

We would also like to highlight one of our most successful investments of 2016: Samsung Electronics Preferred Shares. Despite its large size, Samsung trades at a valuation that indicates it is badly misunderstood. As both the largest manufacturer of memory chips AND one of the largest manufacturers of cell phones, it has a unique place in the electronics industry. In mobile phones, it is the only company with the quality and brand recognition to consistently compete with Apple at the high end of the North American and European cell phone market. But more importantly, Samsung’s massive scale in semiconductor manufacturing (40-50% share in both NAND and DRAM chips) means that it can remain profitable even through downturns in the industry.  The last two years in particular have borne this out, as Samsung’s memory division has maintained operating margins above 20% while its competitors have seen their margins crash.

Samsung’s shares deserve an earnings multiple consistent with its dominant industry position. But even after meaningful appreciation in 2016, Samsung’s common shares trade at 13 times earnings, a sharp discount from the roughly 20x PE of our benchmark, the S&P 500 Index. The preferred shares are even cheaper than the common, trading at a 20% discount despite equal economic ownership. Samsung Electronics Preferred Shares continue to be one of Bireme’s largest investments. If you are interested in learning more about why an investment in Samsung Electronics is so compelling, we encourage you to read Elliott Management’s detailed presentation on the company.

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.