A Top 2 Positions of a Successful Opportunity Fund

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Mike Lippert, the portfolio manager of Baron Opportunity Retail Fund, has managed to generate outstanding returns in the past ten years. This fund gets a four star rating from Morningstar, delivering a sweet 10-year-annualized return of 12.40%, beating the S&P 500’s return of only 8.05% during the same period. Year-to-date, it gained by nearly 21%, a bit higher than S&P 500’s gain of 19.62%. The top two stocks in its portfolio were Illumina (NASDAQ: ILMN) and Gartner (NYSE: IT). Let’s take a closer look to see whether or not we should follow Mike Lippert into those two stocks.

The biggest player in the sequencing market

Illumina is Baron's largest position, accounting for nearly 4.1% of the total portfolio. Incorporated in 1998, it is the leader in manufacturing and developing of life science tools and integrated systems for genetic analysis. The company generated around $568.4 million, or 49.5% of its total revenue, within in the U.S., while Asia-Pacific ranks second with nearly $232.5 million in sales. The company reported that most of its revenue (64%) derived from consumable sales, while instrument sales accounted for 27% of total 2012 revenue.

In the past four years, Illumina has consistently grown its top line and generated positive cash flow. Revenue increased from $666 million in 2009 to nearly $1.15 billion in 2012, while free cash flow fluctuated in the range of $119 million to $279 million during the same period. For the full year, Illumina expects to grow its revenue by 20%, and its non-GAAP EPS might come in at around $1.68 - $1.72, including the acquisition impact of Verinata and Advanced Liquid Logic. Illumina is trading at $78.80 per share, with a total market cap of $9.86 billion. The market values Illumina at as much as 38.9 times its forward earnings.

Mike Lippert likes Illumina was the best company with the dominating position in the DNA-based tests business, with around 100% share of the sequencing instruments in the U.S. He likes the high amount of recurring revenue coming from consumables, which was sold in every test the customers do.

Much more expensive than Life Technologies

Compared to one of its peers, Life Technologies (NASDAQ: LIFE), Illumina has a much higher valuation. Life Technologies is trading at $74.80 per share, with a total market cap of $12.90 billion. The market values Life Technologies much more cheaply, at only 16.4 times its forward earnings. Life Technologies is the global biotech company, offering around 50,000 end-to-end solutions to more than 75,000 customers in more than 180 countries. What I like about Life Technologies is its high level of recurring revenue, accounting for 85% of total revenue, along with strong free cash flow generation. In the past twelve months its operating cash flow was $772 million, while the free cash flow stayed at around $635 million.

Life Technologies is positioned for much more growth ahead with its global franchise system. It has around 1,200 scientists with broad expertise, owning 5,000 patents and licenses. In a long run, it would expand its business footprint with local distributions, localized products, local sales team with distribution acquisitions in China, Chile and South Korea, and local relationships.

Gartner - a global leader in IT research and consulting

The second largest position in Mike Lippert’s portfolio is Gartner, representing 3.95% of his total portfolio. Gartner, founded in 1979, is the world’s leader in providing technology-related insight to more than 13,300 distinct organizations in 85 countries. Most of its revenue (nearly $1.14 billion) was generated from the Research segment, while the Consulting and the Events segments contributed only $304.9 million and $173.8 million, respectively, in sales.

In the past four years, Gartner has managed to consistently increase earnings and cash flow. EPS has risen from $0.85 in 2009 to $1.73 in 2012 while the free cash flow has grown from $147 million to $235 million during the same period. Looking forward, Gartner expects to expand the Research business, optimize the Events portfolio, and increase the profitability of the Consulting business. The company hopes to grow its revenue by around 11%-16%. Most of the growth would come from the Research business, at 15%-20%. Gartner expects to experience a 50-150 basis points per year margin improvement in normalized EBITDA. Gartner is trading at $58 per share, with a market cap of around $5.4 billion. The market values Gartner quite expensively, at 24.6 times its forward earnings.

My Foolish take

In the long run, Illumina, Life Technologies and Gartner will manage to deliver decent operating performance, due to their global-leading positions, growing free cash flow and a lot of potential growth. Among the three, I like Illumina the most with its huge market share in the sequencing market and its huge recurring revenue, which makes the revenue stream more predictable. Nevertheless, with quite a high earnings valuation, I would rather wait for short-term price correction before I initiate a long position.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends Gartner and Illumina. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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