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Grey Owl Capital Management 1Q17 Letter – ESRX, LILA, TRIP, IRT, CLNS, HBI, NLY

Grey Owl Capital Management 1Q17 Letter, May 3, 2017

“If you take care of the small things, the big things take care of themselves. You can gain more control over your life by paying closer attention to the little things.” – Emily Dickinson

Express Scripts (ESRX)

  • On April 24, 2017, reported strong earnings: EBITDA up 3% and raised earnings guidance to a range between $6.90 and $7.04/share
  • Company also announced that Anthem contract would not renew after the current term expires at end of 2019; Anthem provides 18% of revenue and thus immediately lost 10% of value
  • Even without Anthem, ESRX is worth in the mid-$80s
  • Anthem has very few PBM choices: other than Express, CVS is the most viable option. The only other PBM is UnitedHealth but they are a direct competitor on the health insurance side so that seems unlikely. Final option is to re-internalize the PBM function
    • Any of the options other than Express would have significant switching costs
  • Anthem’s CEO stated on their investor call that they made no decision on its pharmacy benefit management contract and Express was still a viable option
  • Today, the risk of losing Anthem should be fully priced into ESRX but there remains a call option on the possibility that Anthem remains after all

LiLAC Group (LILA)

  • On April 6, 2017, purchased a starter position in LILA at $22.87/share
  • On July 2, 2015, the first day of trading post distribution out of Liberty Global, LILA closed at $49.61/share. Then in 2016, Liberty acquired Cable & Wireless and subsequently issued another distribution for the Cable & Wireless business
    • Since then, traded lower and lower and 52-week low is $19.10/share
  • Overdone from a long-term perspective but sell-off is understandable
    • Investors who were happy to have a large cap telecommunications firm received shares in a small cap developing market telecommunications firm and many likely sold
    • The follow-on transaction was very complex, likely alienating an additional group of shareholders
    • The LiLAC / CWC integration hit some bumps
  • Excited to partner with John Malone, the controlling shareholder, and believe assets are technologically superior to the majority of their competitors
  • Geographies are certainly development-stage economies but bandwidth usage is growing quickly; penetration rates and average revenue per user are low, leaving ample space for LiLAC to grow

TripAdvisor (TRIP)

  • After initial purchase on January 6, 2017 at $49.54/share, stock proceeded to decline
  • This was despite reporting solid traction in Instant Booking signaled by flat branded-click and transaction revenue
  • Marketing costs were up and that is what investors seemed to focus on
  • Announced on April 27, 2017 that InterContinental Hotels Group joined Instant Book
  • Took the lower stock price as an opportunity and purchased additional shares on April 28, 2017 at $44.75/share

Independence Realty Trust (IRT) – Exited

  • On February 7, 2017, sold entire position in IRT at $9.10/share (purchased IRT in October 2016 at $9.01/share and earned 4 monthly dividends)
  • Company used stock offering to internalize the management company, pay down debt, and repurchase shares owned by a third-party, publicly-traded firm
    • Prior to the deal, communicated their intention to make post-deal capital allocations that would lead to full dividend coverage in early 2017
  • Shortly after the deal, management communicated a change in capital allocation plans that would leave dividend uncovered through the end of 2017
  • This change of plans combined with a decrease in monthly apartment rents through much of the country caused us to sell the stock at a modest gain

Colony Northstar (CLNS) – Exited

  • On February 8, 2017, sold entire position at $14.57/share (purchased on September 8, 2016 at an adjusted price of $12.90/share; earned one regular and one special dividend)
  • NSAM purchase was in anticipation of the three-part merger of NSAM, NRF, and CLNY into what became CLNS
  • Prior to the merger, NRF traded at a significant discount to private market NAV. However, NRF was obligated to pay NSAM a fixed base management fee
  • Believed NSAM traded at the largest discount to our expectation for the pro-forma merged company
  • Valuation gap closed quickly after the merger’s completion and were able to sell the new CLNS in February 2017 at an overall return just under 23%

Hanesbrands (HBI) – Exited

  • First purchased on August 16, 2016 at $27.24
  • Despite suffering of retail equities in general, believed that HBI could navigate these issues given their #1 and #2 brand positions
  • Following the election of Trump, share prices for almost all manufacturers with significant offshore capability sold at lower prices and took that as an opportunity to add position at $21.51 in January 2017
  • Unfortunately, fourth quarter results lent significant credence to the bear arguments
    • Growth in ecommerce could not offset traffic losses at brick-and-mortar retailers
    • Innerwear was down 8% overall and operating cash flows were far below managements’ previous guidance and thus there was less deleveraging than expected
  • Original thesis might still prove correct but after two quarters of missed guidance, only modest deleveraging progress, and the ongoing risk of punitive tariffs from a protectionist administration, decided to move on
  • On February 23, 2017, sold entire position at $21.24/share; including several dividends, exited at a loss of just under 13%

Annaly Capital Management (NLY) – Exited

  • At its heart, NLY is a simple business – essentially a bank
    • Company borrows money short-term and buys Federal Agency-backed mortgage bonds, earning a spread
  • When it was purchased in September 2015, stock traded at less than 85% of book value with a double-digit dividend yield
    • Assets are liquid, publicly traded securities; one could buy the whole company and realize book value in a relatively straightforward way
  • Stocks were out of favor given the absolute low level of interest rates and everyone’s belief that rates would rise
    • Felt the risk of rising rates was more than factored into the discount to book value
  • When stock price reached 98% of book value in March 2017, we sold
    • Including dividends, total return was close to 44%
  • Would look to re-buy at either a meaningful discount to book value or a scenario where rates are higher than today and the environment was developing in such a way that rates were likely to go lower from there
Image Source: Grey Owl Capital Management
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