In this article we are going to share highlights from Jana Partners’ 2017 Q4 investor letter. JANA Master Fund returned 5.6% net of fees and expenses in 2017 and underperformed S&P 500 Total Return Index’s 21.8% gain. Since inception this fund generated an annualized 10.9% gain vs. S&P 500’s 7.2%. Here is what the fund said about its Q4 performance:
“JANA’s performance in the fourth quarter was driven primarily by our activist positions. Tiffany & Co. (TIF) ended the year on a high note as the late November earnings report was ahead of expectations and in anticipation of the operational improvements that Alex Bogliolo will implement. HD Supply Holdings Inc. (HDS) moved higher on improved earnings that resolve the controversy that erupted in the wake of the June earnings report and because earnings will benefit materially from tax reform. Bloomin’ Brands, Inc. (BLMN) moved higher on the announcement of JANA’s 13D filing. Zimmer Biomet Holdings, Inc. (ZBH) was up on the announcement of Bryan Hanson as the new CEO. The notable laggard was EQT Corp. (EQT), which sold off in response to the closing of the dilutive RICE transaction.”
Jana Partners is very optimistic about 2018. They believe certain parts of the financial markets (like the cryptocurrency space) are overvalued but corporate earnings will continue to go higher even though the overall market seems overpriced based on the market cap to GDP ratio. “Commodity prices have found their footing, increasing rates will help financials, the weaker dollar is a tailwind for overseas revenues, the tax cut is a major tailwind for domestic earnings and we are starting to see signs of corporations putting more money into workers’ pockets, which we would argue is good for America, good for the economy and good for the market,” the fund said.
Jana Partners discussed the following 4 new positions:
1.TEVA Pharmaceutical Industries (TEVA) – We have been following TEVA for years and have had a consistently bearish outlook for the company as we observed negative pricing trends in generics, risk of loss of exclusivity in COPAXONE, poor capital allocation (the purchase of the Allergan plc (AGN) generics business at a peak multiple in 2015 just as pricing was about to roll over), and a heavily indebted balance sheet. This is not the setup we usually look for in a new long! But the audacity of the restructuring plan laid out by new CEO Kåre Schultz in December grabbed our attention and we quickly built a long position. Kåre’s track record driving outstanding shareholder returns at Novo Nordisk A/S (NOVOB DC) and H. Lundbeck A/S (LUN DC) also caught our attention. We believe he will be successful in achieving $3 billion of cost cuts, which will put TEVA on a footing to alleviate its balance sheet problems and return to a future of profitable growth. We pencil in a $30 price target, giving full credit for the cost cuts and debt paydown and an EV/EBITDA multiple of just over 9x on 2020 numbers.
2-3. Autodesk, Inc. (ADSK) & PTC Inc. (PTC) – We have been increasing our focus on software businesses for the last few years. Our thesis is that the good ones are monopoly like businesses with durable pricing power that can benefit meaningfully from the change in customer purchase behavior away from license and maintenance and towards subscription contracts. Microsoft Corp. (MSFT) was a successful investment in 2015 and Salesforce.com Inc. (CRM), which we wrote up in our year end letter for 2016, was one of our most profitable positions in 2017. We have been following ADSK for several years and are still kicking ourselves for not getting involved in the first quarter of 2016. At the time though we admired the monopoly position Autodesk enjoys in the architectural vertical we struggled to find grounding in a valuation framework as the transition the company was making to monthly service contracts resulted in declining revenues and negative free cash flows. Roll the tape forward to present day and we have greater confidence in the new leadership at ADSK, proximity to the inflection to positive FCF (which should occur in 2018) and an attractive entry point following a 20% pullback in the wake of the late November earnings report. We see FCF of $6.25 per share in 2019, which justifies a target price north of $160 given that we believe FCF could double from that level going out to We do not need to believe in a doubling in out-year FCF to justify our target – but we think it is a lot easier to peer that far into the future with a business of Autodesk’s quality. PTC is sort of the Autodesk for industrial applications. It is not quite that good, because PTC has some legitimate competitors in its market, but PTC also has a potentially big opportunity in the Internet of Things (IoT) that could be as big as the core CAD and Product Lifecyle Management businesses if the IoT franchise grows at the rates management expects. We got involved early in the fourth quarter after the stock had traded sideways for a few months following a minor setback in their Japanese business. We think EPS can hit $5 in calendar 2021 once the transition to a subscription model has stabilized. We have an undiscounted target price north of $100. We like the business standalone, but PTC also looks to us like an attractive acquisition candidate.
4.Northrop Grumman Corp. (NOC) – Our investment thesis for NOC is simple. When we take into consideration the accretion from the Orbital ATK (OA) transaction, which should close in the second quarter and the benefits from tax reform, our 2019 numbers are more than 25% above the Street. As a leading prime defense contractor NOC will also benefit from increased defense spending, which is now at a cyclical trough after years of little to no growth following the 2011 sequestration. We are estimating 2019 EPS of more than $20; at 20x we see a $400+ stock.
We will share our opinions regarding these three stocks in separate articles.