quarterly report december 2017€¦ · · 2018-01-151performance figures are calculated using...

Peters MacGregor Capital Management Limited ABN 77 087 181 600 AFSL 225984 APIR WPC0002AU mFund PMW01

Quarterly Report December 2017

Big changes in media

Image Credit: The Simpsons, 8 November 1998

2Peters MacGregor Capital Management Limited P +61 2 9332 2133 W petersmacgregor.com

Peters MacGregor Global Fund December 2017

Global Fund Snapshot

1 Peters MacGregor may on occasion, hedge against movements in the Australian dollar and other currency exchange rates, but the default position is to remain unhedged.2 All fees are inclusive of the net effect of GST.3 Geographical exposure by revenue breakdowns are approximations.4 Active Share is the percentage of portfolio holdings that is different from the benchmark holdings.

Geographical Exposure by Revenue3

Fund Facts

Portfolio Managers Wayne Peters Michael Haddad

Structure1 Global Equity Fund A$ unhedged

Inception Date 10 September 2004

Fund Size A$120million

Distributions Annual, 30 June

Management Fee2 1.35% p.a.

Performance Fee Nil

Buy / Sell Spread 0.10% / 0.10%

Fund Features

Investment Style Value

Portfolio Composition 20-30 stocks

Cash Holding 0 - 20% cash

Benchmark Unaware

Minimum Investment $10,000 ($5,000 with a regular investment plan)

Recommended Investment Timeframe

5 years plus

Stock Sectors

Discovery Communications Broadcasting

Fairfax India Investments

Howard Hughes Real Estate Development

JD.com Internet Retail

Liberty Broadband Cable

Liberty LiLAC Cable

Liberty SiriusXM Satellite Radio

Liberty Ventures Cable

Naspers Internet Services

NVR Homebuilding

Top Holdings in Alphabetical Order

USA 36.6%

Cash 5.9%India 4.4%

Other 8.1%

UK 8.0%

Europe 14.4% China 16.3%

Portfolio Characteristics

Number of Holdings 21

Active Share4 98%

Up Market Capture Ratio 80% since inception

Down Market Capture Ratio 62% since inception

Latin America 6.3%



$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

2004 2008 2012 2016

PMGF MSCI ACWI NR AUD

Monthly Performance - Net %

Financial Year

Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun FYTD

2004-05 0.16 0.95 1.08 0.57 -0.36 0.51 0.06 -1.70 2.02 0.63 3.94

2005-06 1.02 -0.26 0.33 0.93 3.08 -1.76 -1.17 0.12 0.14 0.14 0.83 -0.32 3.02

2006-07 0.58 0.94 1.95 1.66 1.60 0.42 2.48 2.54 3.00 1.86 1.05 0.76 20.52

2007-08 -4.98 1.82 3.93 0.89 0.29 1.71 -5.42 -4.54 -2.49 2.70 -2.01 -8.03 -15.66

2008-09 1.55 5.28 -2.89 -14.76 -12.58 -2.26 -7.60 -11.11 8.79 17.70 6.27 -0.41 -15.83

2009-10 11.63 9.30 -1.28 -5.05 -0.18 4.37 -0.32 3.42 2.31 2.97 1.64 2.08 34.26

2010-11 -0.81 -2.86 0.87 5.45 -1.95 4.17 0.87 -0.25 0.33 -0.30 0.61 -1.88 4.02

2011-12 -1.50 -0.39 -3.66 2.59 -1.32 -0.83 1.11 3.07 6.64 -0.95 0.22 0.01 4.67

2012-13 -1.44 3.56 2.53 -0.09 -1.01 3.58 1.96 2.33 1.84 3.37 6.90 2.33 28.83

2013-14 4.41 -0.49 -1.71 1.38 2.26 2.74 0.02 0.86 -1.83 -0.05 1.27 -0.69 8.28

2014-15 -0.37 0.76 4.46 1.21 4.90 4.21 2.61 4.87 1.82 -3.59 4.52 -1.88 25.70

2015-16 6.53 -1.39 -2.03 3.38 -3.75 -1.70 -3.25 -1.29 -1.65 3.01 4.95 -5.20 -3.09

2016-17 3.69 3.37 -2.09 -0.44 4.59 2.25 -0.74 0.10 0.57 3.87 1.52 -2.46 14.85

2017-18 2.18 0.09 0.55 1.92 1.55 -1.83 4.47

Fund % Index %2 Excess %

1 month -1.83 -1.38 -0.45

3 months 1.59 6.07 -4.48

1 year 7.39 14.77 -7.38

3 years (p.a.) 7.99 10.95 -2.96

5 years (p.a.) 13.71 17.26 -3.55

7 years (p.a.) 11.33 13.01 -1.68

10 years (p.a.) 7.41 5.87 1.54

Since inception (p.a.) 7.83 6.92 0.91

Total return since inception 172.87 143.88 28.99

Fund Performance1Growth of $10,000 Since Inception

1Performance figures are calculated using exit unit price to exit unit price for the given period. Intra year performance figures are unaudited. The returns are net of management fees. They do not include franking credits.2 MSCI ACWI NR AUD



We also sold our small position in Twitter, as management’s priorities are drifting away from those we laid out in our December 2016 quarterly.

The Mouse buys the Fox – An overview of the changing media and distribution landscape

On 14 December, Disney announced a $66bn acquisition offer for 21st Century Fox’s content divisions, including Fox’s film and television studios, cable and international TV businesses and its 30% stake in YouTube rival, Hulu.

That leaves Fox founder Rupert Murdoch to guide ‘New Fox’ with old style media assets including Fox’s broadcasting network and stations, Fox News, Fox Business, sports channels FS1, FS2 and Big Ten Network.

The old media sector was already consolidating, as traditional cable TV subscribers fall and technology titans Amazon, Facebook, Google and Netflix, disrupt media content production and distribution. Below we explain Discovery Communications’ recent acquisition of Scripps Network to create America’s largest non-sports media network.

Disney will become the most powerful movie and television studio in the world. Its unrivalled library of content, including everyone from Mickey Mouse to Wonder Woman and Homer Simpson, will be Netflix’s first real competition, just as it faces pressure to significantly increase prices to manage its debt levels while spending heavily on new content.

Regardless of whether Disney chooses to launch an online streaming service through Hulu (Disney and Fox currently own 30% each, Comcast 30% and Time Warner 10%), Netflix will now have less content to license. In contrast, Disney will own loads of timeless content, such as marquee franchises The Simpsons and Star Wars, to provide endless hours of on-demand content for a new streaming service.

Skinny bundles – Winners and losers

A ‘skinny bundle’ is where, instead of paying a large cable TV bill for scores of channels you don’t want, you might pay, say, $15 or $20 per month, for a small selection of perhaps five channels to watch online any time you wish.

Subscribers may love their channels, but the economics for a content provider change dramatically if you only get paid a small amount per subscriber (known as an affiliate fee) for a small fraction of the ~800m people that pay for cable TV around the world.

Sports channel ESPN, which is owned by Disney, receives almost $8 per subscriber per month, while there’s only daylight between the next highest affiliate fees. As you can see in Figure 1, the hundreds of millions of cable TV subscribers that don’t watch sports have been subsidising the ever-increasing cost of sports content.

Introduction

The Peters MacGregor Global Fund produced a 1.6% return for the quarter and a 7.4% return for the calendar year. The fund’s current cash position is 6% with 21 names in the portfolio.

General commentary

Looking back at 2017, our performance would’ve been much better had we not sold anything. Buying too early and selling too early is an occupational hazard for a value investor. So even though it will be many years before we know if our sales in 2017 were good decisions, they added to the performance anchor created by the fund’s 22% cash weighting at the start of the year in a very strong year for global markets.

The US market is currently the most expensive it’s ever been based on numerous common measures. Yet the names in our portfolio suggest there’s a large discrepancy between the valuations of companies offering a feel-good factor (e.g. high or consistent growth) and those perceived as having permanent problems. It’s a good reminder that in the share market you can’t have good news and cheap prices.

Over time, we make money by taking advantage of mispricing and remain comfortable with the three major themes running through the portfolio – Chinese technology stocks, European banks and broadband internet providers around the globe.

Eventually risk aversion will return and you can feel comforted that the valuations of the businesses you own are supported by the sustainability of their cashflows. Unfortunately, we just can’t tell you when Mr. Market will agree with our valuations.

Portfolio commentary

The only new name to enter the portfolio this quarter was Discovery Communications, which is explained in detail below.

Three positions were exited this quarter having reached our estimate of fair value. They were Berkshire Hathaway, Wells Fargo and Liberty Expedia, which was spun off from our Liberty Ventures holding just over a year ago.

Liberty Expedia’s valuation was no longer compensating for several changes in the industry, including:

1. Falling growth rates in the online travel agency industry as the industry matures;

2. Increasing competition from meta search sites like TripAdvisor and Trivago;

3. Increasing marketing spending to gain market share, which is increasingly difficult; and

4. Lastly, we expect Expedia’s profit growth may not justify the spending required to take on well managed rival Priceline in its home market of Europe where it dominates.

Quarterly Commentary

https://petersmacgregor.com/wp-content/uploads/2017/05/PMGF-Dec-2016-Quarterly-Report.pdf




This is a clear step backwards in our view, as it creates a two-tiered market where monopolistic internet providers can legally reduce access to video streaming players like Netflix, Google (YouTube) and Amazon (Prime Video), to force these companies to pay up for faster internet speeds so their customers can enjoy video content without annoying lags.

Of course, the major internet providers have said they won’t exercise this new power, but we feel it was an unnecessary step despite improving the competitive position of our biggest holding, Charter Communications.

Music royalties increase for SiriusXM

On 15 December, the Copyright Royalty Board increased the price of music royalties to 15.5% of SiriusXM’s revenue for the next five years, up from 11%. As the company has done historically, it should successfully pass these costs on to customers when their contracts renew, so we don’t expect any change to the company’s value.

Fortunately, SiriusXM’s royalty rates won’t converge with those paid by rivals Apple and Spotify, which are above half of their revenue. That’s because their services solely rely on music, while SiriusXM offers a much broader suite of programming, including shock jock Howard Stern and televangelist Joel Olsteen, which boast millions of followers.

With the average American daily commute approaching one hour, at just US$13 per month SiriusXM continues to offer a compelling Netflix style service that produces a growing stream of cash despite the increase in digital music services.

US tax reform and NVR

On 20 December, Trump’s tax reforms were passed into law. One important change starting in 2018 is that homeowners can only deduct interest on mortgages up to US$750,000, down from a previous cap of $1,000,000. Interest on home equity loans and lines of credit will no longer be deductible, either, so how will this impact our investment in home builder NVR?

Fortunately, very little. NVR focuses on the starter home market with an average sales price of just US$382,000. More important is the potential for new home sales to millennials. The average millennial is now turning 28 and with the economy in decent shape and interest rates low, it’s not surprising that home sales have finally jumped after a long fall (see Figure 2).

Figure 2: US homeownership rate (% of homes owned by their occupants)

Source: Bloomberg, US Census Bureau

Figure 1: Average subscriber revenue per month ($)

Source: Forbes Media, SNL Kagan

The yawning gap makes it lucrative for companies like Disney to keep bulking up sports content, the bedrock of cable TV. But with more people turning away from sports and the popularity of skinny bundles growing in an increasingly online media world, what does the Disney/Fox combination mean for the cable TV businesses currently in our portfolio?

Cable TV companies like Charter Communications (which we own via Liberty Broadband and Liberty Ventures), and larger rival Comcast, won’t be impacted too negatively. First, we believe Disney will be more focused on launching a successful new streaming business than extracting higher and higher affiliate fees from cable TV operators.

Second, the key plank of our investment case for Charter Communications is the increasing profitability of its growing, monopolistic internet business. As Disney must work closely with cable operators to promote skinny bundles and its new streaming service (as streaming services are useless without fast and reliable internet speeds), more people should sign-up for faster internet i.e. we believe the extremely high incremental margins of adding new internet customers will outweigh the loss of less profitable cable TV subscribers.

Netflix and Amazon Prime Video are the most negatively affected by the Disney/Fox deal. On the cost side, content costs for scripted content are skyrocketing as new players fight for on and off-screen talent. On the revenue side, more content providers will pull their licensing agreements with Netflix and Amazon, as they merge to maintain their bargaining power or align with certain distributors or dress themselves up for sale.

As for the winners, smaller content providers like Discovery Communications, AMC Networks, Lionsgate Starz, and others, will likely merge or be taken over. In summary, the industry will boast a handful of lions and the antelope will be extinct.

Net neutrality laws repealed

On December 14th, the FCC (Federal Communications Commission) voted along party lines to repeal net neutrality. That means internet providers can now intentionally block, slow or charge money for specific websites and online content.



Conclusion

During 2017 the bull market’s character changed from many years of scepticism to one increasingly defined by risk taking, which calls to mind an investing legend’s timeless warning: ‘The less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.’

Thank you for your support, and if you have any questions about the portfolio or investing with us please don’t hesitate to contact us.

Stock in focus: Discovery Communications

Whether you have Foxtel or not, you’re bound to be familiar with some of Discovery Communications’ most popular TV shows, such as MythBusters, Bear Grylls’s Man v Wild, Deadliest Catch and Shark Week. Ok, maybe not, but these non-scripted reality TV shows, which are cheap to make, have long been a staple of US cable TV bundles.

In addition, the company owns the Discovery Channel, TLC, Animal Planet, Science, EuroSport, Investigation Discovery, Velocity & Turbo, as you can see below.

Image: Discovery Communications channel portfolio

We’ve been watching Discovery’s share price fall from a high of over $40 just over three years ago, to a recent low under $17. In recent years, falling US cable TV subscribers have been the biggest issue. Many US consumers have dropped their cable TV packages in favour of online options such as Netflix. This is known as cord-cutting.

This is bad for Discovery, as it gets paid an ‘affiliate’ fee for every cable TV subscriber it reaches. And the less subscribers it reaches, the less willing advertisers are to spend big, spruiking their wares during the commercial breaks.

While Discovery has been losing US subscribers, it’s the opposite overseas where Discovery earns half its revenues and lower cable TV bills reduce the incentive to dump cable TV (see Figure 3).

Domestic

International

0

500

1000

1500

2000

2012 2013 2014 2015 2016

Domestic and International Subscribers

Figure 3. Growing international subscribers

Source: Discovery Communications, Peters MacGregor

https://petersmacgregor.com/contact-us/



International subscribers are growing as Discovery is investing heavily in overseas content, such as sports. It’s also very cheap and easy to dub international languages over TV content. That means Discovery’s channels travel well abroad, unlike US sporting channels, for example, where there’s little overseas interest. The key point is that total subscribers (US plus overseas) are increasing.

Perhaps surprisingly, the average affiliate fee per US subscriber is also increasing, despite Discovery losing US subscribers. Discovery has been investing in successful shows such as Gold Rush, Naked and Afraid and several others. Their popularity has allowed Discovery to negotiate higher affiliate fees with cable companies.

$1.20

$1.30

$1.40

$1.50

2012 2013 2014 2015 2016 2017e

US Distribution Revenue Per Subscription

Figure 4. Average affiliate fee per US subscriber

Source: Discovery Communications, Peters MacGregor

Sports channel ESPN is by far the most expensive channel in the cable bundle at almost $8 per month. In contrast, Discovery collects less than a quarter of that, which means Discovery channels are likely to keep their place in lower cost (i.e. skinny) bundles due to the small cost of its endless hours of timeless programming.

Scripps Network takeover

In response to US subscriber losses, Discovery announced a takeover offer in July for Scripps Network, owner of HGTV (Home and Garden Television) and the Food Network. By expanding its range of channels, Discovery hopes to increase its affiliate fees and attract more advertising dollars.

There are also opportunities to cut costs. Unlike competitors, such as HBO, Netflix, and other traditional media companies, Discovery and Scripps produce non-scripted content, such as reality TV, personality driven shows, documentaries, how-to shows, and other variations.

As Discovery and Scripps produce and maintain control of their content (instead of licensing programming rights to others), they can also maintain control over content costs.

Though the deal made financial and operational sense in our view, Discovery shares were dumped as it will initially shelve share buybacks until debt levels are reduced.

At $17.00, near where we started buying, we estimated that the combined entity was trading at six times free cash flow (FCF), or conversely a 17% FCF yield. If increasing international subscribers continue to outweigh losses in the US, then that’s a large margin of safety.

To justify the current price of around $22, we estimate international subscriber growth would need to stop and US subscribers would need to fall at 5% per year, which is not what’s happening currently.

Under our base case, which doesn’t include being a potential takeover target but does include an eventual resumption of share buybacks, the business could be worth $35 or more. In five years if Discovery’s debt falls as we expect, the company could be producing enough FCF to buy back over 15% of its shares outstanding each year at current prices.

Only time will tell if our analysis is correct, but Discovery is a good example of the current dichotomy of markets i.e. while the FANG stocks are hogging the headlines and volatility overall is muted, under the surface there are some huge share price movements creating opportunities.

Further reading

• December 2016 quarterly report https://petersmacgregor.com/wp-content/uploads/2017/05/PMGF-Dec-2016-Quarterly-Report.pdf

IMPORTANT INFORMATIONThis document is provided for investors in the Peters MacGregor Global Fund (ARSN 110 619 559) and is not intended to provide advice. While all care has been taken in the preparation of this report (using sources believed to be reliable and accurate), Peters MacGregor Capital Management Limited (ABN 077 087 181 600, AFSL 225984), its officers, employees, agents and associated entities accept no responsibility for and will not be liable in respect of any loss or damage suffered by any person in connection with this, other than under law, which cannot be excluded. You should seek your own financial and taxation advice before dealing with your investment. This report has been prepared without taking into account your investment objectives, financial situation or particular needs. Before investing, or retaining an investment, in the Fund you should read the PDS dated 1 July 2017 and consider whether the Fund is appropriate having regard to those matters. A copy of the PDS is available at https://petersmacgregor.com. Past performance should not be taken as an indication of future performance.



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quarterly report december 2017€¦ · · 2018-01-151performance figures are calculated using...

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