U.S. equities edged higher during September while posting the best quarterly performance since the 4Q of 2013. Stocks set another record high in late September as the market brushed off the escalating trade war, the undeterred Fed’s rising interest rate policy, and contentious midterm election uncertainties. Global investors continue to be impressed by America’s low tax rate induced economic strength, corporate profit growth, and less regulation. The consumer is doing well with rising wages, lots of jobs, and a record for household net worth and confidence. The U.S. equity market remains in the global sweet spot as the bull market that started in March of 2009 has moved higher and outperformed foreign markets. In Europe markets are worried about the Brexit stalemate and the bickering ECB.
We continue to view the investment backdrop through the lens of the four Ts. The first is Tariffs and we are not overly concerned about the current situation and expect the eventual long term outcome to be accretive to U.S. GDP growth. The second T relates to the U.S. 10-year Treasury note yield which is currently around 3 percent. Are current ‘EBITDA’ less capex multiples sustainable as interest rates rise? Taxes are next. The U.S. moved to a territorial tax system from a global system for corporations, which coupled with a 21% corporate tax rate provides a magnet for business to locate here. Another plus is the 100 percent write-off of capital expenditures for both new and used equipment which drives greater capital expenditures. The fourth T is Technology which creates ‘moats’ or barriers to entry around selective service companies.
In the U.S. political catalyst arena, mid-term elections will be held on Tues Nov 6, 2018. The outcome may be unexpected, as was the case in November 2016 when financial market volatility spiked.
On the global mergers and acquisitions front, activity reached $3.3 trillion in the third quarter, an increase of 37% compared to 2017. The current wave of deal activity is global, as evidenced by cross-border M&A activity that totaled $1.3 trillion in the first nine months of 2018, making it the strongest period for cross-border deal making since 2007. Energy & Power, Healthcare and Technology have been the most active sectors through the third quarter.
There were a number of positive developments in September including:
- Sky plc (SKY LN-London) shares traded higher after the auction process for the British broadcaster resulted in a bid price of £17.28 cash per share by Comcast, or about £37 billion. The auction was mandated by UK regulators after a bidding war broke out between Comcast and Disney-backed Twenty-First Century Fox after Fox launched a deal to acquire Sky for £10.75 in December 2016.
- Express Scripts (ESRX-NASDAQ) shares narrowed the discount to its deal price after the Department of Justice gave the green light to its proposed merger with Cigna. The companies are still awaiting approval from several state insurance departments and expect to close the deal in the fourth quarter.
- Nevsun Resources (NSU CN-Toronto), a gold and copper mining company, agreed to be acquired under improved terms from Zijin Mining Group for C$6.00 cash per share, or about C$1.8 billion. Nevsun hired bankers to sell the company after Lundin Mining launched a bid to acquire the company for C$4.75 cash per share in July 2018.
Notable transactions announced in September included:
- Integrated Device Technology, Inc. (IDTI-NASDAQ), which makes semiconductors and modules used in computers, networking and personal devices, agreed to be acquired by Renesas Electronics Corp for $49 cash per share, or about $6.5 billion.
- LaSalle Hotel Properties (LHO-NYSE), an upscale lodging REIT, agreed to be acquired by Pebblebrook Hotel Trust under improved terms. In May, LaSalle agreed to be acquired by Blackstone for $33.50 cash per share. Subsequently. Blackstone walked from the transaction after LaSalle declared Pebblebrook’s offer superior. Terms of the deal with Pebblebrook allow LaSalle shareholders to elect either $37.80 cash or 0.92 shares of Pebblebrook common stock, subject to proration, or about $5 billion.
- Ocean Rig UDW (ORIG-NASDAQ), an international offshore drilling contractor specializing in ultra-deepwater drilling, agreed to be acquired by Transocean for $12.75 cash and 1.6128 shares of Transocean common stock per share of ORIG, or about $3 billion.
Through this backdrop we continue to evaluate the possibly for a correction in the US markets with potential for increased volatility globally as a result of much of the ongoing developments both politically and economically.
Column by Gabelli Funds, written by Michael Gabelli
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GAMCO MERGER ARBITRAGE
GAMCO Merger Arbitrage UCITS Fund, launched in October 2011, is an open-end fund incorporated in Luxembourg and compliant with UCITS regulation. The team, dedicated strategy, and record dates back to 1985. The objective of the GAMCO Merger Arbitrage Fund is to achieve long-term capital growth by investing primarily in announced equity merger and acquisition transactions while maintaining a diversified portfolio. The Fund utilizes a highly specialized investment approach designed principally to profit from the successful completion of proposed mergers, takeovers, tender offers, leveraged buyouts and other types of corporate reorganizations. Analyzes and continuously monitors each pending transaction for potential risk, including: regulatory, terms, financing, and shareholder approval.
Merger investments are a highly liquid, non-market correlated, proven and consistent alternative to traditional fixed income and equity securities. Merger returns are dependent on deal spreads. Deal spreads are a function of time, deal risk premium, and interest rates. Returns are thus correlated to interest rate changes over the medium term and not the broader equity market. The prospect of rising rates would imply higher returns on mergers as spreads widen to compensate arbitrageurs. As bond markets decline (interest rates rise), merger returns should improve as capital allocation decisions adjust to the changes in the costs of capital.
Broad Market volatility can lead to widening of spreads in merger positions, coupled with our well-researched merger portfolios, offer the potential for enhanced IRRs through dynamic position sizing. Daily price volatility fluctuations coupled with less proprietary capital (the Volcker rule) in the U.S. have contributed to improving merger spreads and thus, overall returns. Thus our fund is well positioned as a cash substitute or fixed income alternative.
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Class I USD - LU0687944552
Class I EUR - LU0687944396
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GAMCO ALL CAP VALUE
The GAMCO All Cap Value UCITS Fund launched in May, 2015 utilizes Gabelli’s its proprietary PMV with a Catalyst™ investment methodology, which has been in place since 1977. The Fund seeks absolute returns through event driven value investing. Our methodology centers around fundamental, research-driven, value based investing with a focus on asset values, cash flows and identifiable catalysts to maximize returns independent of market direction. The fund draws on the experience of its global portfolio team and 35+ value research analysts.
GAMCO is an active, bottom-up, value investor, and seeks to achieve real capital appreciation (relative to inflation) over the long term regardless of market cycles. Our value-oriented stock selection process is based on the fundamental investment principles first articulated in 1934 by Graham and Dodd, the founders of modern security analysis, and further augmented by Mario Gabelli in 1977 with his introduction of the concepts of Private Market Value (PMV) with a Catalyst™ into equity analysis. PMV with a Catalyst™ is our unique research methodology that focuses on individual stock selection by identifying firms selling below intrinsic value with a reasonable probability of realizing their PMV’s which we define as the price a strategic or financial acquirer would be willing to pay for the entire enterprise. The fundamental valuation factors utilized to evaluate securities prior to inclusion/exclusion into the portfolio, our research driven approach views fundamental analysis as a three pronged approach: free cash flow (earnings before, interest, taxes, depreciation and amortization, or EBITDA, minus the capital expenditures necessary to grow/maintain the business); earnings per share trends; and private market value (PMV), which encompasses on and off balance sheet assets and liabilities. Our team arrives at a PMV valuation by a rigorous assessment of fundamentals from publicly available information and judgement gained from meeting management, covering all size companies globally and our comprehensive, accumulated knowledge of a variety of sectors. We then identify businesses for the portfolio possessing the proper margin of safety and research variables from our deep research universe.
Class I USD - LU1216601648
Class I EUR - LU1216601564
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