Variety is not merely the spice of life, but the very essence of the annual Barron’s Roundtable. While the 10 market seers on our panel are united in seeking to profit from mispriced assets -- and help you do the same -- each approaches the challenge from an idiosyncratic angle. That is nowhere more apparent than in this week’s third and final installment from our memorable daylong confab, held on Jan. 12 in New York.
 
Part 3 features the 2015 investment picks, pans, and musings of Marc Faber, David Herro, Oscar Schafer, and Mario Gabelli -- four pros who have spent years on the Street, each taking a different path to success. A fearless big-picture thinker with an emerging-markets perspective, Marc is betting against the ability of the world’s central banks to put global growth back on a sustainable path. That means a vote for gold and its precious cousins, as well as long-dated U.S. bonds, whose yields he reckons are destined to stay superlow.

Marc is no bear on Asia, however, and that includes the Russian bear, as you’ll see from his forthright comments and eclectic recommendations.

David, Harris Associates’ go-to guy for international investing, and manager of the Oakmark International fund, is a value investor who searches for blue-chip companies with temporarily tarnished shares. They are harder to find these days than questionable outfits with nosebleed valuations, but in his first Roundtable appearance, David makes the case nicely for an even four.

Underlying his bottom-up analysis is a keen understanding of social, political, and economic trends around the world, whether in China, where the authorities have cracked down on extravagant gift-giving, or in Japan, where the moribund corporate sector could use a deafening wake-up call.
 
A veteran hedge fund manager, Oscar cares little for the macro outlook. You’re far more likely to find him in the trenches, digging through the financials of lesser-known companies with promising prospects, savvy managers, in-demand technologies, and underappreciated shares. He, too, has been known to comb the world for value. But this year, he finds it closer to home, in companies such as Canada’s Maple Leaf Foods  (ticker: MFI.Canada), which could soon enjoy the fruits of a strategic transformation.

Mario, head of Gamco Investors, famously goes where the action is; he favors companies like Graham Holdings (GHC), the former Washington Post, that own a multitude of disparate assets that can be merged, purged, or otherwise rearranged in a value-enhancing and tax-efficient manner. The practice is known as financial engineering, and few do it better than billionaire media investor John Malone, whose praises Mario sings to the skies, and in whose companies he seeks to invest.
 
To learn why, please read on.
 
Barron’s: Where in the world should we invest this year, Marc?
 
Faber: If I could find a way to short central banks, that is what I would do. This is the year that people will lose confidence in central banks, mostly because of the failure of Abenomics in Japan. [Abenomics, the economic policies advocated by Japanese Prime Minister Shinzo Abe to reignite Japan’s economy, encompass monetary easing, fiscal stimulus, and structural reforms.] One way to short central banks is to go long gold. I recommend buying physical gold, silver, and platinum. If you are looking for bigger gains, I suggest either mining-company stocks or the Market Vectors Junior Gold Miners GDXJ [GDXJ] exchange-traded fund. In last year’s first half, when gold rebounded by 15%, the Junior Gold Miners ETF rallied by more than 40%.
 

Secondly, the U.S. market is expensive. Yet, the whole world seems to think it is the only game in town. That suggests it may be vulnerable to a selloff. I hate to short individual stocks because an activist could step in and send a stock soaring. Instead, I would short the SOX, or Philadelphia Semiconductor Index, through the iShares PHLX Semiconductor ETF [SOXX]. I would also short the Global X Social Media ETF [SOCL] and the iShares Nasdaq BiotechnologyETF [IBB].
 
While people think U.S. stocks are the only game in town, U.S. bonds are still attractive. Can someone on this panel explain to me why investors are bullish on the dollar, yet buy low-yielding European bonds instead of U.S. bonds? The market doesn’t believe the dollar will stay strong.
 
Zulauf: European banks are buying European government bonds, financed by free money from the European Central Bank.
Couldn’t they buy U.S. Treasuries with that money?
 
Zulauf: If they buy Treasuries, they have currency exposure. If they hedge the currency exposure, that deducts from the interest-rate advantage.

Faber: Nevertheless, it is a puzzle to me. Japanese government bonds now yield 0.27%. Japan’s government debt exceeds 200% of gross domestic product. Compared to these dynamics, U.S. Treasuries are cheap. Last year, I recommended the 10-year Treasury note. This year, I recommend buying 30-year U.S. government bonds.

Clockwise from top left: David Herro, Marc Faber,Oscar Schafer, Mario Gabelli. Photo: Brad Trent for Barron's

Zulauf: The Japanese central bank already owns about 40% of all outstanding Japanese government bonds. Eventually, it will own a lot more, as the Bank of Japan is buying 70% to 80% of all new issues.
 
Faber: Yes, that is why I want to short central banks. Eventually, they will go bust massively. I have always diversified among gold, bonds, equities, and real estate. On the equity side, I have recommended some Singapore real estate investment trusts in the past. They remain attractive as an asset class, but I would shift from the office-REIT market to hospitality trusts, which own hotels, and to health-care trusts. While office REITs will come under pressure in 2017 because of supply coming on-stream, I am a believer in the growth of tourism in the area. Also, hospital medical expenses are tiny there, in relation to the rest of the world.
 
In Singapore, I like CDL Hospitality Trusts [CDREIT.Singapore] and Far East Hospitality Trust [FEHT.Singapore]. Health-care trusts own hospitals that are leased to hospital operators. In that market, I like Religare Health Trust [RHT.Singapore], Parkway Life REIT [PREIT.Singapore], and also aFirst REIT [FIRT.Singapore].
 
Moving on to currencies, the U.S. dollar was in a bull market between 1981 and 1985 that exceeded expectations. If that happens again, which seems possible, I would short the Australian dollar.

Australia -- and Canada, too -- have overvalued currencies. Mining expenditures for minerals, oil, and gas accounted for 3% of Australian gross domestic product in the 1980s and ’90s. Today such expenditures are more than 7% of GDP.
 
There is a colossal housing bubble in Australia, fed mostly by rich Chinese. Also, bank loans for real estate are 60% of total loans, the highest ratio in the world, followed by Norway. At the moment, the bullish consensus on the U.S. dollar is at a record, and bearish sentiment on the Aussie dollar is high. Many small speculators are short the Aussie dollar. It is possible the situation will reverse in the near term, and the Aussie dollar will rise 3%-5%. That is when I would short the Aussie dollar.
 
The Chinese stock market has been on a tear. What do you see ahead for Chinese stocks?
 
Faber: I predicted in October that the Chinese economy would weaken but the stock market would go up. The Chinese stock market is in a similar position to the U.S. market in 1982. At that time, the U.S. market hadn’t done much for a while, and investors were bearish and underweight stocks. Then the market suddenly took off. There has been huge trading volume in Chinese stocks, and many people are opening investment accounts. The real estate market is done in China; it isn’t going to rise substantially in the near future, so speculators are moving into stocks. The market has shot up about 50% in the past three months. It will correct a bit, and then go higher.

Marc Faber: “The real estate market is done in China; it isn’t going to rise substantially in the near future, so speculators are moving into stocks. The stock market has shot up about 50% in the past three months.” Photo: Jenna Bascom for Barron's

Bank stocks, especially, can move up from here. The sector is widely hated and has huge problems, but Chinese banks also have a big customer base. Gaming and lodging companies tied to Macau were hit hard in the past 12 months and are also worth a look. In December, gaming revenue was down 30%, year on year. The stocks have corrected by 40% to 50%. In the next six months, there will be buying opportunities in the industry. You are paid to wait, because many of these stocks yield about 5%.

Roundtable Report Cards

2014 Roundtable Report Card
2014 Mid-Year Roundtable Report Card


Most members of the Barron’s Roundtable are active money managers who trade their positions and change their investment opinions as market conditions warrant. For those keeping score, here’s how our panelists’ 2014 picks and pans performed through Dec. 31.

Are the yields safe?
 
Faber: Most gaming companies will be able to maintain their dividends. Only 1% of Chinese have been to Macau. About 10% of Americans have been to Las Vegas at least once. If 10% of China’s residents go to Macau, that is huge volume. More facilities will be built. Macau is going to be a huge success. In the next six months, I would accumulate some Macau-related gambling shares.
 
Do you have any favorite bank or gambling stocks?
 
Faber: I would buy Bank of China [3988.Hong Kong]. It is a play on China and Macau.


Marc Faber’s Picks

Company/ Ticker  Price 1/9/15
 
BUY
Gold (spot, per ounce) $1,223.25
Silver (spot, per ounce) 16.51
Platinum (spot, per ounce) 1,233.31
MarketVectors JuniorGoldMiners ETF / GDXJ 27.48
30-Year U.S. Treasurybonds2.53%
Bank of China / 3988.Hong Kong HKD4.44
WynnMacau/ 1128.Hong Kong 20.55
SJMHoldings / 880.Hong Kong 11.62
MarketVectors Russia / RSX $15.21
SINGAPOREREITs
CDLHospitality Trusts / CDREIT.Singapore S$1.76
Far East Hospitality Trust / FEHT.Singapore 0.83
Religare Health Trust / RHT.Singapore 1
ParkwayLife REIT / PREIT.Singapore 2.35
First REIT / FIRT.Singapore 1.28
SHORT
iSharesPHLXSemiconductor ETF /SOXX $92.63
GlobalXSocialMediaETF / SOCL 18.16
iSharesNasdaqBiotechnology ETF / IBB 313.32
Australian dollar* 1AUD=$0.82
*Short after Australian dollar rises by 3%.



Herro: To Marc’s point, the Chinese government has held Macau demand back. It has held back visas and transit permits. Even if they opened things up just a little, all the supply that has been added in Macau would be filled. And, there is limited space for more casinos. You are on good ground recommending Macau.
 
Zulauf: What is the best way to play Macau?
 
Faber: Wynn Macau [1128.Hong Kong] is a good bet. So is SJM Holdings [880.Hong Kong], which is controlled by Macau tycoon Stanley Ho.
 
Russia will not do well, but will survive. There is very low leverage in both the household and government sectors. The Russians know how to tighten their belts.
 
Witmer: The Russians feel that good times are an anomaly, right?
 
Faber: That is a good point. The Market Vectors Russia ETF [RSX] is moving into buying range. The Europeans will break from the U.S. and ease sanctions against Russia. A deal will be done in the next six months. Americans don’t realize that Europe has a lot of trading relationships with Russia. A lot of capital flows between them. An embargo on Russia won’t work.
 
Those are my recommendations.
 
In that case, thank you. Let’s move on to David.
 
Herro: We are long-term value investors looking for low-priced, quality businesses. In some cases, a macroeconomic issue allows you to buy a stock at a low price. In others, there is a temporary industry setback. Some blue-chip European stocks are going to be able to take advantage of the drop in the euro’s value. After many years of currency head winds, the currency will act as a tail wind. Also, some other factors have negatively impacted two of my stocks. China’s slowing economy and a crackdown in China on graft and gift-giving have hurt Cie. Financiére Richemont [CFR.Switzerland].
 
Richemont is a Swiss luxury-goods company best known for the Cartier brand. About 40% of its profit comes from outside the developed West. I would much rather buy established companies with good exposure to the emerging world, especially companies whose brands are extremely hard to compete against. Cartier is a unique brand and generates a lot of cash flow.
 
What are some of Richemont’s other brands?
 
Herro: The company has quite a few brands, including IWC, a watch brand, and Montblanc. Richemont’s growth recently has slowed, but we view the slowdown as temporary and tied to a cyclical slowdown in the emerging world. The Rupert family controls the company through supervoting shares. Richemont is worth 15 or 16 times Ebita [earnings before interest, taxes, and amortization], as opposed to its current multiple in the low double digits. Management is proactive with the balance sheet, using it to expand stores where it makes sense to do so, and buying back stock.
 
To me, Richemont is the perfect example of a quality business hurt because of its location in Europe and exposure to the corruption crackdown in China, but helped by its hard-to-replicate brands.

David Herro: “It is important to try to get big Japanese companies to behave like profit maximizers. Toyota has started to do that, even without government pressure.” Photo: Jenna Bascom for Barron's
 
Diageo [DEO] presents a similar situation. It is the world’s leading spirits company. The number of people who consume beer has been falling, while sales of spirits and wine have been going up. Diageo has done a good job of building its portfolio. Marc probably doesn’t like the company’s Scotch because it is too bottom shelf. Diageo sells Johnnie Walker, as well as various vodka and tequila brands, and Captain Morgan rum.
 
The company is good at holding down costs and allocating capital, and has seen good profit-margin progression over time. It is selectively buying more brands to layer into its monster distribution system.
 
How exposed to emerging markets is Diageo?
 
Herro: It has gone into the emerging world in a big way. The company bought up local brands in India and China, and really knows how to market liquor. The demographic trend is in its favor, as well. But, like Richemont, Diageo has been affected by the crackdown on gift-giving in China. The company has 30%-plus operating profit margins, and ought to be growing in the mid-single digits. But the situation in China and the recent strength of the euro have hurt it. In the next year things could revert to a more positive trend. We value Diageo at 15 times Ebita, versus its normalized 11 times today.
 
Black: We sold the stock last year. Top-line growth has been terrible in the past few years. Guinness has been a big problem for Diageo in the U.K.
 
Herro: But Guinness accounts for only 8% or 9% of Ebita. The only beer companies growing today are craft brewers and beer companies exposed to emerging markets.
 
Black: How do you get to 11 times Ebita?
 
Herro: You have to normalize emerging-market currencies and the U.S. dollar [adjust for exchange rates, tax rates, and sales levels]. When you do that, you’ll see a much greater lift in revenue and profit.
 
Faber: David, I agree with you that Richemont has a lot of good brands, but I see two problems. First, the company is catering to the economy of the superrich, and that economy could be vulnerable, especially if asset markets no longer rise in value. No. 2, many luxury chains have to pay very high prices for stores in the best locations, whether it is in Hong Kong or Zurich, or at the airports. Airport shops cost a fortune.
 
Luxury-goods companies have high fixed costs, and they have to sell a lot of merchandise to cover them.
 
Some luxury manufacturers, such as Prada [1913.Hong Kong], have had disastrous results of late. I agree that luxury-goods companies are attractive investments long term, as people will buy Cartier and other brands. But I would be relatively careful about these brands and companies in the near term. Tiffany [TIF] just reported that fourth-quarter sales were disappointing, and its shares are off sharply today. [Tiffany fell 14% on Jan. 12.] There could be some disappointments among luxury-goods manufacturers.
 
Herro: There have been disappointments. The things you are talking about have happened. That’s where the value is.
 
Moving on, Toyota Motor  [TM] is tied to the global consumer. Although the company is based in Japan, more than 30% of its output is exported. It has good exposure to emerging markets. Toyota has increased its dividend. It is sitting on a huge pile of cash and is the world leader in low-cost automotive production. Sales of its luxury brand, Lexus, are rising again after sinking for a while. Toyota added some pizazz to its Lexus models. The brand is hugely profitable, by the way. Assuming a normalized operating margin on industrial operations of 8.5% and no change in the value of the yen, the stock could have 45%-50% upside. It could trade at 8.5 to nine times enterprise value to Ebita, although enterprise value gets reduced by that pot of cash.
 
What will Toyota do with its cash?
 
Herro: We want the company to use the cash to create shareholder value. Japanese management teams have been atrocious capital allocators. Cash accounts for 30%, 40%, 50% of the market capitalization of many Japanese blue chips, and it is earning only 15 or 20 basis points [hundredths of a percentage point].
 
Companies don’t look at that money as the stockholders’, but things are slowly starting to change.
Rightly or wrongly, there has been a lot of pressure put on Japanese companies to earn a better than 10% return on equity. ROE would increase if Japanese companies deployed cash more efficiently, by buying back stock, paying more dividends, and engaging in smart mergers and acquisitions. When Japanese companies’ ROE is 6% to 7%, aiming for 10% is a good idea. But I fear that the Japanese are doing it for the wrong reason. They are quintessential box checkers. They should hit a 10% ROE target not just to check the box, but because it creates value for the owners -- the shareholders.


David Herro’s Picks

Company/ Ticker  Price 1/9/15
 
Cie. FinanciéreRichemont/
CFR.Switzerland CHF 90.05
Diageo/DEO $110.89
ToyotaMotor/TM 126.08
BNPParibas / BNP.France € 44.94
Source: Bloomberg



Getting Japan’s moribund corporate sector to wake up starts on the micro side. It is important to try to get big Japanese companies to behave like profit maximizers. Toyota has started to do that, even without government pressure, as a result of the quality crisis it had a few years ago, and the Japanese earthquake.
 
To sum up, Toyota is the world leader in efficiency; it has good exposure to emerging markets, and it appeals not just to rich people, although the Lexus line is doing well. It seems a good place to put your money, long term, especially if you don’t think the yen is going to rally any time soon.
 
Cohen: Several years ago, Toyota got a lot of credit for repositioning its production facilities. For example, most of the cars it was selling in North America were produced in North America. It was producing in dollars and selling in dollars. Is that still the situation, and if so, how does the company benefit from the yen’s weakening?
 
Herro: In the past 25 years, Toyota has done more to align costs and revenue. But it still has a huge manufacturing footprint in Japan. It tries to keep intellectual property and research and development in Japan. Many expenses are still allocated to Japan, and the company is still an exporter. It exports a million-plus vehicles a year, although that number used to be around two million.
 
With my last stock, I am throwing some controversy into the conversation. 
 
BNP Paribas [BNP.France], France’s biggest bank, has been hurt by regulatory actions. It was fined nearly $9 billion by the U.S. for doing business with Sudan and Iran. Yet, even after paying this fine, the bank will have a Tier I capital ratio of more than 10%. It hasn’t cut the dividend. The bank has well-diversified businesses, each of which it runs quite well. It bought the Belgian bank Fortis during the financial crisis at a fire-sale price. Fortis accounts for roughly 20% of profit, and corporate banking in France, 15% to 20%. BNP Paribas also has an investment bank that does well, and some exposure in the U.S. Loan losses haven’t grown materially and costs continue to fall. This is a well-run financial institution.
 
What is the stock price?
 
Herro: The stock trades for 44.94 euros, or 8.5 times next year’s expected earnings, and below book value. The bank should be able to achieve a return on equity of 13% to 15%. If you apply a multiple of 1.5 or 1.6 times book value, there is decent upside in the shares, and a dividend yield of 3.5%. The bank hasn’t lifted its payout because of the fine. Hopefully, there won’t be any more fines, and the dividend will start rising.
 
Is BNP Paribas well reserved against nonperforming assets?
 
Herro: It hasn’t had a big problem. Residential real estate loans in France and Italy have a loan-to-value ratio of 15%, 20%, 25%. People own their own homes, or have inherited them. Real estate assets aren’t highly leveraged, and the savings rate is relatively high. As a result, the nonperforming portfolio is somewhat stagnant. BNP Paribas owns Bank of the West, which isn’t seen as a core asset. Some Japanese banks have been sniffing around and might want to make a bid for it. In a sale, it might go for as much as two times book.
 
Gabelli: Great ideas, David. Welcome to the panel.
 
Hey, that’s our line. Thanks, David. Now let’s hear from Oscar.
 
Schafer: I’m ready. My first pick, Cogent Communications Holdings [CCOI], is a company with a long history of growth, run by a fantastic owner-operator. Cogent is an Internet service provider that operates one of the largest Tier 1 fiber networks in the world. The stock was down 12% in 2014, although we believe the company’s issues are temporary and that the stock could double in the next few years.
 
Cogent has two product lines, both focused on selling a single broadband product. In its corporate segment, the company provides 100-megabit Internet connections to midsize corporations in high-rise office buildings. Its ’Net-centric business offers data-transport services to telecom carriers, media companies, and other large users of Internet bandwidth. Cogent meets these customers in any one of the 720 carrier-neutral data centers on its network, and offers transport on its 85,000 miles of metro and intracity fiber. Cogent is led by Dave Schaeffer, who founded the company in 1999. Schaeffer has a long history of creating value for shareholders.

Oscar Schafer: “In the Roundtable I recommended Maple Leaf Foods. The situation is even more interesting today, as the business will complete a five-year-plus transition this year, boosting...free cash flow.” Photo: Jenna Bascom for Barron's
 
 
Witmer: Is he your brother?
 
Schafer: No relation. He created the company by assembling a network on the cheap, after the Internet bubble bust. He spent $60 million on 13 acquisitions that had collectively raised $14 billion and already deployed $4 billion into property, plant, and equipment. Schaeffer continues to be opportunistic. He repurchased Cogent’s convertible bonds at 50 cents on the dollar during the financial crisis.
 
Cogent is unique in the telecom world in that it has always operated on the principle that broadband is a commodity. Whereas most telecom companies live in fear of becoming a “dumb pipe,” Cogent has embraced this destiny as a business model. As optical-switching equipment has improved, Cogent has been able to carry more bits at lower prices. The company has aggressively passed these savings on to its customers, typically guaranteeing a price 50% lower than the competition. The company has effectively driven down the price of bandwidth by 24% annually for a decade and a half. Yes, that is a cumulative price decline of 98%. Furthermore, the company’s focus on selling a single product has allowed it to minimize subscriber-acquisition costs. Cogent employs a call-center-based sales force that is significantly more efficient than its competitors.
 
So why is the stock depressed?
 
Schafer: The financial results of Schaeffer’s strategies have been impressive. The company has grown revenue by an average of 16% a year in the past 10 years, and Ebitda [earnings before interest, taxes, depreciation, and amortization] margins have expanded by about 200 basis points [two percentage points] annually, into the mid-30% range.
 
There are two key investor concerns that drove the share price lower in 2014. First, as a bandwidth provider to Netflix [NFLX] and other large content-distribution companies, Cogent has been caught up in the past year in a high-profile dispute between Netflix and several large carriers about Internet peering, or demands that Netflix pay certain Internet service providers directly for carrying its data-heavy content. Based on our research, we expect the issue will be resolved favorably from Cogent’s perspective, and that these carriers eventually will upgrade their peering ports to allow for a return to the previous status quo, or so-called neutral peering. Meanwhile, the issue has impacted only 5% of Cogent’s revenue.
 
Secondly, Cogent’s top-line growth rate has slowed in the past three years from the high teens to around 10% annually. The company has taken appropriate steps to address the issue, hiring a new head of sales and significantly expanding the sales force. The CEO has also tied his compensation over the next three years to targets of 15% revenue growth and 20% Ebitda growth. As growth reaccelerates and capital spending on fiber deployment slows, management is committed to returning a substantial amount of capital to shareholders. The company has increased its dividend in each of the past nine quarters.
 
What is the current dividend?
 
Schafer: Cogent pays $1.24 a share, and yields 3.2%. Between regular and special dividends and share buybacks, Cogent plans to return $450 million to shareholders in the next nine quarters, representing nearly 30% of the current market cap. By 2017, the company will be generating $3 a share of free cash flow. We expect the shares to trade north of $60, compared with $34 today.
 
My second stock is NICE Systems [NICE]. It offers investors at least 50% upside as a result of recent management changes. NICE is a $3 billion market-cap software company based in Israel. It is comparable to Verint Systems [VRNT], which I have discussed here in the past, and whose stock has nearly doubled in the past 18 months. NICE’s biggest business is call-center monitoring software.
 
This is a mature but stable market. It could grow as higher-priced analytical software allows companies to utilize big data. Currently, mid-single-digit revenue growth is being driven by NICE’s financial-fraud and compliance products, as well as video-surveillance analytic software.
 
By any metric, NICE is a cheap stock. It is trading for $50 a share. Excluding cash, it trades for only 13 times estimated 2015 free cash flow of $3 per share, and five times recurring maintenance revenue, which is about 45% of total revenue. That is a valuation more typical of a legacy enterprise-software company that is declining than a company that is growing.
 
What is happening in the management suite?
 
Schafer: The business has been undermanaged for years. NICE’s new CEO, Barak Eilam, offers a catalyst for significant value creation by focusing on the company’s bloated expense structure and over-capitalized balance sheet. In the past five years, NICE doubled revenue with minimal improvement in operating profit margins. Operating margins are 18%, compared with Verint’s 23%. As far as the balance sheet goes, $8 per share, or 20% of the company’s value, is in cash. NICE could add at least $1.50 a share of cash flow from Eilam’s initiatives, which could result in a potential gain of 50% in the stock.
 
In the midyear Roundtable [“Picking Up the Pieces,” June 16, 2014], I recommended Maple Leaf Foods. The situation is even more interesting today, as the business will complete a five-year-plus transition this calendar year, boosting operating margins and free cash flow. Putting a typical industry multiple on the new margins could drive the stock up between 50% and 75%.
 
Where is the stock trading now?
 
Schafer: Maple Leaf is based in Canada. Shares are trading for 19.40 Canadian dollars [US$16.35] and the company has a C$2.7 billion market cap. It controls the No. 1 and No. 2 retail pork brands in Canada, with a combined market share of nearly 50%. Maple Leaf produces branded ham, hot dogs, sausages, and poultry, and it has a small hog-raising business. Despite strong revenue and a dominant market share, profit margins historically languished below U.S. peers’, as the company’s manufacturing and distribution systems had never really been modernized. Ebitda margins in the meat business were 4% to 6%, versus 10% at Hormel Foods [HRL], ConAgra Foods [CAG], and Hillshire Brands. But in 2009, Maple Leaf announced a plan to spend nearly C$800 million to modernize the meat business. This involved a 12% workforce reduction companywide, the implementation of SAP [SAP] software, five new manufacturing plants, and the consolidation of 17 distribution centers into two.


Oscar Schafer’s Picks

Company/ Ticker  Price 1/9/15
 
CogentCommunications
Holdings / CCOI $33.99
NICESystems/ NICE 50.06
MapleLeafFoods/
MFI.Canada C$19.40
RealD / RLD $11.07
Source: Bloomberg


How did things work out?
 
Schafer: The transition will be complete by the third quarter of this year. When that happens, margins immediately could climb to about 10%, and the business could achieve a run rate of at least C$300 million in Ebitda. With US$500 million of idle cash on the balance sheet and the ability to add two to three times that in leverage, Maple Leaf has the balance-sheet capacity to repurchase about 50% of the company.
 
Valuing the company’s new earnings stream at more than 11 times Ebitda and 20 times earnings per share -- multiples comparable to peers -- yields a stock price in the mid-C$30s. If Maple Leaf were to be acquired at the recent industry-takeover multiple of 17 times Ebitda, there would be significant upside from here.
 
Gabelli: Michael McCain, who controls Maple Leaf, is unlikely to sell. But he could be open to a tax-inversion strategy.
 
Schafer: RealD [RLD] is another stock I talked about in the midyear Roundtable. The stock is down a little since then, but there have been several positive developments at the company, and the shares are even more interesting now. It was a down year for Hollywood, and the summer box office was particularly bad. RealD, which licenses 3-D-film-related technologies, takes a percentage of ticket sales for 3-D movies. The 3-D market has stabilized after several years of decline. Also, the company recently announced cost cuts above and beyond initial reductions that were announced at the end of 2013.
 
In October, Starboard Value, an activist investor that owns 10% of the stock, made an offer to acquire the rest of RealD for $12 a share. The board rejected the offer, as the company disclosed in its most recent conference call. We agree with the company’s decision to reject the bid and believe the shares are worth materially more. But we also think the presence of an activist investor with a stalking-horse bid is motivating the management team to act quickly to create value for the shareholders.
 
What more can management do?
 
Schafer: Substantial research-and-development spending has been allocated to products that don’t contribute to revenue. The company has announced that it has hired advisors to explore strategic alternatives for this product portfolio. Within the next year, management will either cut the remainder of the expense or demonstrate a clear route to commercialization of the products. Most important, the company likely will announce a large share buyback in the near term. RealD has net cash on its balance sheet and is trading at an attractive valuation ahead of a strong wave of 3-D films.
 
The 2015 slate of 3-D films looks to be the best in years, with sequels to Avengers, Jurassic Park, and Star Wars hitting theaters. The following year looks just as strong, with the much-anticipated sequel to Avatar, the most successful 3-D movie of all time, set for release. [Release of the Avatar sequel has been delayed to 2017.] Of the top 20 highest-grossing films of all time, half have 3-D sequels scheduled to come out in 2015 and 2016. With no share buyback, RealD is trading for eight times estimated free cash flow for the year ending in March 2016, excluding the monetization of R&D assets. If the company buys back $150 million of stock, or 35% of its shares outstanding, the multiple drops to seven times. Again, that is before additional cost cuts or the benefits of monetizing R&D assets.
 
RealD continues to make theatrical installations in China and Russia, where 3-D viewership rates are high in local-language films. We think the shares will rise 50% in the next 12 to 18 months, from a current $11.07.
 
Thanks, Oscar. Mario, you’re last but by no means least. And you’re immensely patient.
 
Gabelli: Oscar’s ideas are splendid. Thanks for recommending Maple Leaf. There is a lot going on there.
 
Schafer: You own it.
 
Gabelli: My clients do. My first idea today is Graham Holdings, which used to be the Washington Post. There are 5.8 million shares, including a million A shares, which have 10 votes apiece and elect 70% of the directors. The B shares have one vote and elect 30% of the board. The company is controlled by the Graham family, which sold the Washington Post to Jeffrey Bezos in 2013. Last year, in a so-called cash-rich spinoff, Graham swapped its ownership in a Miami television station, and cash, for Graham stock owned by Warren Buffett’s Berkshire Hathaway [BRKA]. Graham also sold some other assets separately.
 
Mario Gabelli: “Kaplan’s non-U.S.-college business has done OK. Based on deals done for comparable companies, Kaplan could be worth as much as $800 a share.” Photo: Jenna Bascom for Barron's
 
           
Today, the company holds cash, cable-TV assets, television stations, the Kaplan education business, a marketing company called Social Code, some real estate, and other assets. Graham has $120 a share in cash. The TV stations are worth about $250 a share. Cable ONE, its cable business, is worth $500 a share.
 
Altogether, that’s $870 a share in assets. Graham has announced a spinoff of Cable ONE, which will occur sometime this year. If Cable ONE is bought by another company after the spinoff, shareholders avoid a double tax.

                               
cat

Schafer: How does that work, exactly?
 
Gabelli: If Graham sold the cable business, it would pay a tax on the proceeds, and shareholders would pay a tax on the gain. If the business is spun off and then sold, there is only a tax at the shareholder level. A cash-rich spinoff is a terrific tax benefit, too. John Malone [chairman of Liberty Media (LMCA)] and Buffett have done well with cash-rich spinoffs. Graham has an overfunded pension fund, so it has assets to buy other businesses.
 
Graham is trading for $870 a share. Shareholders are getting the Kaplan business for free. In addition, the cable asset is going to be monetized. Broadcasting Ebitda was about $190 million for 2014. That will drop to $160 million this year because of a decline in election-related advertising spending. Next year, however, there will be a tsunami of spending on political advertising. Graham’s TV stations are in markets such as Houston, Detroit, Orlando, San Antonio, and Jacksonville. They could also get a benefit from spectrum auctions.
 
The cable business has about $300 million in Ebitda. It will be spun off with about $450 million of debt.
 
How much is Kaplan worth?
 
Gabelli: Kaplan is the wild card. It runs a for-profit college. In the U.S., the for-profit education industry is facing challenges. Kaplan also has a test-preparation division, which has about $30 million in Ebitda. Kaplan’s non-U.S.-college business has done OK. Based on deals done for comparable companies, Kaplan could be worth as much as $800 a share.
 
Next, I was looking for a company with a database of Christian contemporary and country and western songs. I found Gaylord Entertainment in Nashville. After selling a lot of assets and acquiring new management, the company changed its name to Ryman Hospitality Properties RHP [RHP]. It converted to a REIT on Jan. 1, 2013. Our clients got $6.84 a share in cash and stock on the conversion. We have been one of the largest shareholders for a while.
 
Thanks for sharing that.
 
Gabelli: Ryman has 50 million shares outstanding. The stock is selling for $54, and the market cap is $2.5 billion. The company has two businesses -- Hospitality and Opry and Attractions, which includes two entertainment venues and some other assets. The hospitality business includes hotels and convention centers operated by Marriott International [MAR] near Dallas, Orlando, Nashville, and Maryland, outside Washington, D.C. MGM Resorts International  [MGM] has a license to build a casino megaplex in that area.
 
Ryman generated about $200 million in funds from operations in 2014. It pays an annual distribution of $2.20 a share and yields 3.9%. Apply an appropriate capitalization rate [rate of return, achieved by dividing yearly income by total value] to the REIT, and you get a value of $55 a share.
 
Ryman also owns WSM, a radio station in Nashville famous for country music. Ryman is likely to engage in financial engineering and spin off the entertainment assets. In the right hands, the entertainment assets could be worth as much as $15 a share. Ryman shareholders could benefit from rising occupancy and room rates, and financial engineering. We value the company at $70 per share.
 
Next, why would you give your money to Steve Schwarzman or Henry Kravis, or David Rubenstein? [All three run private-equity companies.]
 
You mean, instead of giving it to Gabelli?
 
Gabelli: I mean, why would you pay 2-and-20 [management fees equal to 2% of assets and 20% of profits] and tie your money up for 10 years? When I buy what John Malone controls, I am buying at a discount. I am not paying 2-and-20, and I have liquidity. Malone has his fingerprints on $115 billion of equity value, with investments in companies that include, among others, Liberty Media, Liberty Broadband  [LBRDA], Discovery Communications [DISCA], and DirecTV  [DTV]. His personal net worth in these companies is about $8 billion, marked to market. I like following Malone, and have been doing so for 35 years. He is now getting involved in an old-line British company that I started following in the early 1990s because I wanted exposure to Hong Kong. I am talking about Cable & Wireless Communications, which owned Hong Kong Telecom, which it has since sold.
 
Cable & Wireless is selling for about 49 pence. The stock trades in London, but the company has relocated its headquarters to the Miami area, as it provides telecom and video service in the English-speaking Caribbean, including Barbados and Jamaica. There are 2.75 billion shares outstanding, and the market cap is about $2 billion. Cable & Wireless has about $200 million of debt.


Mario Gabelli’s Picks

Company/ Ticker  Price 1/9/15
 
GrahamHoldings /GHC $870.47
RymanHospitality Properties / RHP 54.33
Cable&WirelessComm./CWC.UK 49 pence
Chemtura/CHMT $23.20
Post Holdings / POST 41.33
Kinnevik / KINVA.Sweden SEK 247.90
Patterson Cos. /PDCO $50.43
Source: Bloomberg

What is the company’s connection with Malone?
 
Gabelli: A transformative transaction is in process. Cable & Wireless is buying privately held Columbus International, in which Malone is a large shareholder. Columbus provides voice, video, data, and everything that you heard Oscar talk about with regard to Cogent Communications.
 
Columbus gives Cable & Wireless an expanded footprint in the region. When the deal is done, Cable & Wireless will issue 1.5 billion of new shares and have $1.7 billion of added debt. Pro forma, Cable & Wireless will have 4.3 billion shares outstanding, and an enterprise value of about $5.6 billion. Columbus adds $600 million of revenue to Cable & Wireless for the year ending March 31, 2016. Cable & Wireless is becoming an interesting Caribbean play.
 
In exchange for his Columbus shares, Malone will acquire Cable & Wireless shares with a put. Tax structure is fundamental to everything he does. Scale and consolidation and deal structure are in Malone’s DNA.
 
Malone will own 13% of Cable & Wireless after the deal closes; he will have a $250 million stake in the company, which isn’t a big piece of his net worth, but he isn’t going to ignore it. He loves these sorts of dynamics. John Risley, one of the founders of Columbus, will own 20% of the combined company. The company could have significant growth in the next three or four years. You could double your money, or do even better than that.
 
It’s good to have John Malone on your side.
 
Gabelli: Now I am revisiting Chemtura [CHMT], which I recommended last year. It came out of bankruptcy protection in 2010. The CEO, Craig Rogerson, said that Chemtura would sell its AgroSolutions unit. It did so, for $950 million, and has used the proceeds to reduce debt and buy back shares. Following a Dutch auction, Chemtura had 72.7 million shares outstanding, and $50 million of debt. The company is buying back $200 million of stock, and by the time we see the next published share count, it will have about 67 million shares. Chemtura has two remaining businesses: an oil-lubricants business and a bromine business that generate about $2 billion of annual revenue.
 
Schafer: That is the old Great Lakes Chemical.
 
Gabelli: That’s right. There is overcapacity in the bromine business, which is causing a short-term hiccup for the company. Chemtura could generate $400 million of Ebitda three years out. Chemtura still has $650 million of NOLs [net operating losses from prior years that can be used to offset future taxes]. It will be able to shelter [from taxes] about $80 million a year of earnings.
 
The balance sheet is wonderful. The CEO is doing good things with the company. Notwithstanding the current air pocket, he is committed to growing Ebitda, getting a high stock market value for it, and buying back a significant amount of stock.
 
Next, I have talked about Post Holdings [POST] in years past. It was spun out of Ralcorp three years ago. Post is in the cereal business, which has lost some pricing power in the short term. Cereal as a breakfast option has been replaced by protein. The company has increased its market share to 11% of the cereal industry. There has been some talk of consolidation in this market. I have called Bill Stiritz, the chairman, a “cereal acquirer.” In the past two years, he has bought 12 companies for $4.4 billion. Most recently, he acquired Michael Foods, which sells egg whites, among other food products. Post could benefit from buying something in the organic area.
 
What are the numbers for Post?
 
Gabelli: Post has about 62 million fully diluted shares. The company posted revenue of $2.4 billion for the fiscal year ended last September. Helped by acquisitions and organic growth, revenue could climb to $4.5 billion in the current fiscal year. Ebitda this year will be about $575 million, growing nicely in the next three or four years due to synergies and consolidation. Post is rolling up food companies with a management team that understands financial engineering. Earnings will march higher in the next few years, helped by lower interest expense. Post could earn $2.10 a share for fiscal 2017. The company could have some near-term challenges, but it has good longer-term prospects.
 
Black: From an operating standpoint, didn’t Post have disappointing revenue and operating earnings in the past few years?
 
Gabelli: Stiritz has been buying companies in the private-label food business that fit into Post’s distribution network. He has also been buying branded products and companies in the nutritional-foods business. When you buy 11 or 12 companies in a short amount of time, you will have some short-term challenges. This is true in any roll-up business. It is worth looking two or three years down the road.
 
In the midyear Roundtable, I recommended Kinnevik [KINVA.Sweden]. The company is based in Stockholm and run by Cristina Stenbeck, a granddaughter of one of the founders. There are 42 million supervoting A shares, of which the controlling family owns 34 million. There are 235 million B shares that have one vote apiece. The stock is selling for 248 Swedish kronor [$29.98]. When a company in Sweden owns more than 10% of another company and sells its stake, it doesn’t have to pay a tax on the profits. That isn’t the case in the U.S., where you would have to engage in all sorts of financial engineering to avoid the tax.
 
Kinnevik owns other companies, and has a marked-to-market portfolio worth about SEK300 a share. One of its biggest holdings is a stake in Millicom International Cellular [MIICF], a wireless telecom company serving Africa and Latin America. It could be an attractive asset as the industry consolidates.
 
Remind us what else Kinnevik owns.
 
Gabelli: Kinnevik has been investing in Rocket, an e-commerce business incubator. Rocket is an investor in many e-commerce companies. Rocket went public three months ago. Kinnevik is selling at a significant discount to its holdings. It is constantly juggling its assets.
 
Last, but not least, I want to talk about pet care [puts on a baseball cap that says “WOOF”]. VCA [VCA] handed out these hats when it went public. There are 96 million companion cats and 83 million dogs in the U.S. Spending per animal is rising. You don’t have to worry about the Affordable Care Act when you take care of your dog or cat. AmerisourceBergen [ABC] announced today [Jan. 12] that it is tendering for MWI Veterinary Supply [MWIV] at $190 a share, or close to 20 times Ebitda. In the past, I recommended Patterson Dental, now called Patterson [PDCO], which distributes dental and veterinary supplies. There are 104 million shares, and the stock is around $50. The market cap is $5 billion.
 
On the dental side, Patterson is the exclusive distributor in the U.S. for Cerec, Sirona Dental Systems  [SIRO] industry-leading dental CAD/CAM system. Patterson’s exclusive relationship with Sirona and Cerec could end as early as 2017. In addition, lumpiness for dental-equipment buying patterns has caused lumpiness in reported revenue and earnings.
 
Patterson could earn $2.30 per share in the year ending April. Earnings could top $3 in the next three or four years. Based on those earnings and Ebitda assumptions, Patterson could command a price of more than $80 per share. The MWI acquisition price puts a focus and a valuation baseline on Patterson.
Thank you, Mario, and everyone.