Inside the Mind of a Top Value Manager

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In this article I analyze Baupost Group's current holdings. In my blog, we explain the importance of tracking institutional holdings. Baupost is a hedge fund founded and run by Seth Klarman. From its founding the firm's three private partnerships have generated an average annual return of 19%.  In the article I analyze what Baupost currently holds, bought and sold.

Top positions

Baupost holds BP (NYSE: BP) as its top postion. I think that BP is a very interesting pick from a value investor's perspective considering that the settlement from the legal proceedings relating to the Gulf oil spill remains an overhang on the company's operations. If these concerns abate, which I think will happen over time, there is a value to be unlocked in BP's share. In addition, the company is divesting its non-core upstream properties. For example, BP sold the refinery in California and Texas while holding the refieneries with the greatest competitive advantages (Cherry Point, Toledo and Whiting). BP trades at just a 7x P/E and 0.35x P/S. Both Chevron and Exxon trade higher.

In addition, Baupost holds concentrated positions in Oracle (NYSE: ORCL) and News Corp (NASDAQ: NWS).

Oracle trades at just 11x forward P/E and its free cash flow continues to be very strong. There is a strong dislocation in Oracle's current valuation and what management expects as future growth. In the last analyst meeting (October 4), management projected earnings growth of 20% over the next few years. Is this reflected in Oracle's P/E ? I don't think so. In addition, management explained that software will be the growth driver and they are very confident in the company's suite of applications for the cloud. The firm is clearly focused on driving its growth in the cloud with several new offerings announced in the past months. 

News Corporation generates 73% of its operating profit from TV content and some value investors think that the current price is low because of the phone hacking scandal. The stock is cheap trading at just 10x 2013 consensus earnings and the new CCO, Chase Carey, is more shareholder friendly than the Murdoch family. I also think that the recent split-up between the entertainment and publishing segments is good for shareholders. Baupost holds 10% of its portfolio in this stock.

Is this stock a great value pick ?

Baupost initiated a position in Rovi (NASDAQ: ROVI) at an average price of $15. The stock is currently consolidating in the range of $15-$16 and seems to trade in bottom-valuation levels. In the last earnings report, the company reported better earnings while it missed top line growth. The company is under a deep restructuring that management is optimistic will drive improved results and margins in the near future. In the recent earnings call, management explained that after undertaking comprehensive, product-by-product operational reviews across the whole business, they finally start getting results. In fact, management focused on product rationalization and cost reductions last quarter and eliminated almost $31 million in annualized costs and an additional $5 million dollars in annual spending. This frees up funds to invest in new value-creating strategic initiatives and puts Rovi on the path to achieving an operating margin more appropriate for Rovi´s historical business measures. Remember that this stock traded at $70 just 2 years ago.

Klarman is bearish on PC related stocks

Baupost rarely buys or sells stocks for short term gains, preferring to hold its picks for years. In fact, they are value-oriented, long term investors. It caught my attention that the fund almost liquidated recently initiated positions in both Hewlett Packard (NYSE: HP) and Microsoft (NASDAQ: MSFT).

There is no doubt that both stocks are cheap in terms of multiples. Microsoft trades at just 8.2x P/E and 3x P/S while HP trades at a poor 3.9x forward P/E and a very low P/S of 0.23x. Compare HP´s multiples against the industry 2x sales and 13x P/E and is very easy to realize that the market has very low expectations in this stock. Baupost likes these kind of picks so, why did he sell both stocks at these levels ?

I think that probably Baupost analyzed that the technological shift that is enabling more computing tasks to be completed on smartphones and tablet computers is hurting both Microsoft and HP. This trend could be more secular than what the hedge fund projected when it initiated both positions. This could be evidenced in HP's decision to cut nearly 30k jobs due to poor PC demand in May or Microsoft's soft Windows 8 sales. The fund probably thinks that the lower PC demand theme is a deep secular problem.

During the last reported quarter, Baupost took advantage of the stock market rally to trim some positions. The fund used to pursue this strategy: sell when the market is bullish and buy when there is panic. In general, Baupost sells between 10 to 15% of a concentrated position during market rallies to lock some gains and buy those stocks again when panic and corrections come back. In the case of HP and Microsoft, Baupost acted differently. The fund sold 46% of its HP position and almost liquidated Microsoft, selling 80% compared to Q2 holdings.

Conclusion

Always track what professional investors are doing or thinking because this gives you fundamental clues or ideas on what to buy or sell. I recommend to track hedge fund holdings and use a list of the best fundamental oriented hedge funds in the market, those that buy stocks for the long run and deeply study each stock they hold.

 


martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of Microsoft and Oracle. Motley Fool newsletter services recommend Microsoft. 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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