Seeking Opportunity within Complexity
Franklin Mutual Beacon Fund
Author: Ticker Magazine
Last Update: Nov 29, 1:18 PM EST
|Investors prefer to put their trust in companies that are easier to understand rather than invest in complicated businesses. As a result, the market tends to be wrong on many occasions, especially when analyzing complex situations. Portfolio Manager Christian Correa and the team at the helm of the Franklin Mutual Beacon Fund specialize in determining underlying asset values in such contexts with the objective of unlocking hidden value.
ďWe have a real passion for finding opportunity within complexity, for identifying potential catalysts, and for actively engaging with company management.Ē
Q: How has the fund evolved over the years?
The Franklin Mutual Beacon Fund has a long history as a deep value equity investor. Originally launched in 1962, it became part of Franklin Templeton Investments in 1996 when Franklin Resources acquired Mutual Series and its flagship funds.
At Mutual Beacon, we look for value in places often missed by others, relying on our ability to analyze complicated business, legal, and regulatory factors. We have a real passion for finding opportunity within complexity, for identifying potential catalysts, and for actively engaging with company management.
The Fund invests primarily in equities and has the ability to hold debt or other instruments as well. Generally, we donít consider ourselves debt investors; the fund doesnít buy and hold bonds just to collect interest. Instead, our interest is in acquiring the securities of companies in severe crisis or bankruptcy Ė circumstances where success or failure depends on figuring out things like underlying asset values and legal claims. Then we actively participate with management to unlock that value.
Recently, the fund has evolved in two key ways. Historically, no more than 35% of assets could be invested outside of the United States, but the portfolio no longer has that limitation and is fully global. Also, over the last five years our holdings have decreased from approximately 100 positions to a core of 40 to 50 mid- and large-cap equities, plus a few special situations like merger arbitrage or distressed debt.
The fundís objective is capital appreciation, with income being secondary to that. Currently, assets under management are about $4 billion; as a whole, the Mutual Series Group manages approximately $68 billion as of September 30, 2017.
Q: What core tenets guide your investment philosophy?
Fundamentally, we are value investors and believe that value is tangible and can be measured by things like assets, cash flow, or the worth of a break-up or an acquisition.
Like most value investors, itís our belief that the markets are inefficient. While markets are reasonably efficient in the long run and in the aggregate, they can be widely inefficient in the short-term and in specific situations. And because the marketís tendency to be wrong increases in tandem with complexity, our best opportunities are found when things are highly complicated and require specialized knowledge.
One of the advantages of this fund is its fairly low turnover; on average, positions are held for four to five years. As a result, when confusion surrounds a company to the degree that thereís a strong chance the market will get it wrong, we can remain patient while working with management to unlock value.
Q: What is your investment process?
Because we arenít macro-political analysts, we seek misvalued companies or credits and donít pay great attention to macro events. Our focus is 100% on places where we have an advantage at understanding market misevaluations. Typically, these are at a company-specific level, but sometimes require legal or regulatory analysis
When a disaster happens that sends other investors running Ė like a stock thatís down by 20% one morning Ė itís our tendency to run towards the disaster, to figure out what happened and why, and determine whether the marketís reaction is appropriate. Corporate events, such as mergers and acquisitions, spinoffs or break-ups, or management changes, can also offer us the chance to unlock value.
If the market is wrong about a company and itís also trading at an extremely low multiple of cash flow, we then consider whether the prospects for its business are actually as dire as everyone else seems to think. Our analysts build a financial model and we talk to the company, its competitors, and others in the industry to isolate the key issues and what the business is actually worth.
Often, thereís an element of mystery surrounding valuation, so trying to scale these unknowns relative to valuation is important. So we hone our estimates based on what the reasonable scenarios and valuations might be, then look for the biggest asymmetries between upside and downside.
Q: Can you describe your research process with a couple of examples?
Symantec Corporation illustrates how we use complexity to our advantage. At the time of our initial investment the market was pessimistic about the companyís prospects, but we were able to unlock value over multiple years.
Originally a provider of software tools, Symantec had expanded into software security. Its biggest consumer brand is the antivirus solution Norton, which is a great business.
However, things werenít going so well when we started looking at Symantec: it had gone through several management changes, its margins were significantly worse than those of its peers, and it wasnít growing particularly quickly. Also, a few years earlier, Symantec had made an expensive acquisition when it merged with the storage company Veritas Software in 2006. It was trying to create growth, but there werenít any real synergies between the businesses.
All this was bad, but we would argue that it was priced into the stock. It was trading at roughly 10% free cash flow yield, which basically means the market thinks earnings will never grow again.
However, we saw the potential for things to get better because Symantecís software business generated strong cash flow and it had a lot of cash on the balance sheet. The company could simply improve margins and become more efficient, or it could separate its two business segments which would probably be worth more individually. That cash flow could then be used to manage the balance sheet more aggressively, retire shares, and improve the earnings per share Ė even if the top line didnít grow.
After investing and actively engaging with management about strategy, Symantec split its businesses. The security side has since made smart acquisitions, expanding further into security with the purchase of Blue Coat Systems and becoming a leader in identity protection with its purchase of LifeLock.
Simultaneously, Symantec sold the storage side of the business. This was about a year-and-a-half ago when the high-yield debt market was really poor. After tapping into the expertise of our debt team, we realized we could buy a lot of the Veritas debt at about a 15% yield to maturity. Not only did we like the business, but also we took advantage of this disruption in the credit market.
Today, Symantec is much more well-run and is focused on enterprise and consumer security, an industry which has a big tailwind. All the factors where there was potential to unlock value have been realized: a sleepy management has been replaced, the businesses broken up, margins are rising from significant cost-cutting programs, and capital has been forcefully deployed after some debt was taken out.
Q: Could you cite another example from a different country?