Hearts and minds working together

by Allan Goldstein

Cooper Investors presented at the third Sohn Hearts & Minds investment conference held in Melbourne on November 16.

The conference sees a dozen of Australia’s top fund managers present their best idea for the next year. All of the monies raised are then donated to medical-research partners including the Black Dog Institute, the Murdoch Children’s Research Institute, the Victor Chang Cardiac Research Institute and MS Research Australia.

Funds are raised by ticket sales and the managers sponsoring the event for the privilege of presenting their stock ideas. Since its inception in 2016, Sohn Hearts & Minds has raised more than $8 million to support critical research efforts for the supported organisations.

Medical research charities the big winners

The local investment-management industry has been instrumental in adopting and creating new and innovative ways to produce revenue streams for charities – and in particular, medical-research charities.

At Cooper Investors, we have contributed not only to the Sohn H&M Conferences, this year we are also participating as one of the five core fund managers in Hearts & Minds Investments Ltd, a $500 million listed investment company (LIC).

The LIC is a new initiative and listed at the beginning of November (HM1 on the ASX). It owns a 25-stock portfolio made up of 10 stocks from the investment conference and a further three stocks each from the five core fund managers. The LIC pays 1.5 per cent of net asset value (NAV) annually to medial research charities, providing $7.5 million in year one and more if the NAV grows in future years. The great feature of this LIC is that fund managers are allocated a percentage of the $7.5 million to select the medical research organisations.

Cooper Investors has chosen to use our quota of the LIC fees to allocate and double down on mental health research. We are proud to be supporting Orygen, the National Centre for Excellence in Youth Mental Health, and the Brain and Mind Centre at Sydney and Swinburne universities.

The second-largest investor in the company is none other than Berkshire Hathaway – Warren Buffett’s investment vehicle has $US2 billion invested alongside us.

Helping research to better identify and treat complex mental-health illness and create better access to mental-health services will create great value for many Australians needing support.

A tough yet rewarding challenge

Back to the investment conference, and the key selling point is for fund managers to pitch a single stock idea for an approx. 10-month timeframe.

In 2016, the stock we presented was Brinks (BCO-US) and in 2017 it was TE Connectivity (TEL-US). While you may not be familiar with the stocks mentioned in this article, that’s okay. The value we provide to our clients is to own those fantastic businesses that are run by first-class executives and likely fly under the radar outside key financial hubs. Brinks was up 80 per cent over the judgement period while TE was down 3 per cent.

Unfortunately, our investment thesis for TE has not yet played out. Regardless of this though, we still think TE is a good long-term stock as the world’s leading manufacturer of high-end connectors (connectors go into anything from cars to robotics, to planes and data centres).

All you have to do is open your eyes to see the electrification of everything. For example, an electric vehicle or hybrid car has twice the connector content of a typical combustion-engine vehicle. The stock has sold off recently, as concerns about global growth have hurt companies like TE. We think the growth and margin runway are not being picked up on in today’s 13 times price-to-earnings multiple.

Tuning in to a lucrative investment

This year, our stock pitch was a company called Liberty SiriusXM (LSXMA-US), a tracker stock that owns 70 per cent of SiriusXM (SIRI-US). We own both these companies.

Many Australians won’t be familiar with SiriusXM as they don’t operate here but SiriusXM is the only satellite-radio provider in the USA. In Australia, our radio choice is either AM or FM while in the US, in addition to free terrestrial radio, there is also the option of a paid service transmitted via satellite – and this is provided by SiriusXM. The company charges $15 a month for 200 radio channels (music and non-music content) that are largely ad free. The average US commuter spends 18,000 minutes a year in their car, so it’s a great customer proposition versus free-to-air, which typically plays 25 minutes of ads per hour.

That is what SiriusXM does. But as an investor, business models matter too. SiriusXM is one of the most profitable media assets in the world with 34m subscribers paying $US15 a month generating over $US1.5 billion of free cash flow every year and growing. The ability to grow subscribers and revenues and to control costs is the hallmark of SiriusXM, as you can see from the charts.

However, SiriusXM wasn’t always this profitable. In fact, during the financial crisis the company was loss making and on the verge of bankruptcy until billionaire John Malone came in and wrote a cheque for $US400 million in emergency financing for 40 per cent of the company.

Building the world’s largest audio-entertainment company

Fast-forward to today, and SiriusXM has recently made a bid to acquire streaming-radio business Pandora Media.

The combination of the two businesses creates the largest audio-entertainment company in the world. Pandora is the third-most-used app in the US and has over 70 million subscribers. SiriusXM took a 16 per cent stake in Pandora last year and was able to appoint its management team to the Pandora board. Despite Pandora’s large subscriber base, it is currently loss making. We see a comparison between this acquisition and the initial purchase by Malone of SiriusXM – both loss-making companies with a large subscriber base being acquired at significant discounts (Pandora is down 80 per cent off its highs).

We see several clear opportunities for SiriusXM to generate material free cashflow from the Pandora assets, and think the market is missing this latency with SiriusXM’s stock down 15 per cent since the announcement of the deal. Given SiriusXM will be issuing shares to fund the deal, diluting their share count by 10 per cent or so, you could say the market is assuming Pandora is worth very little to SiriusXM. We disagree.

At Cooper Investors, we put a great deal of emphasis on management, and specifically what we describe as “focused management behaviour”. Management’s track record and its ability to operate the business and allocate capital are vital for long-term shareholder returns.

We’ve closely followed the management team at SiriusXM with an investment over four years, a period during which they’ve delivered consistent growth and returns.

Teaming up with the legendary Warren Buffett

Providing additional comfort is the fact we’re investing alongside controlling shareholder Malone with one of the best investment track records of the past 20 years, benefiting from his critical influence over capital allocation and overall strategy. Finally, the second-largest investor in the company after Malone is none other than Berkshire Hathaway – Warren Buffett’s investment vehicle has $US2 billion invested alongside us.

While we own both SiriusXM and Liberty SiriusXM, we presented the Liberty SiriusXM tracking stock at the investment conference as this is the vehicle in which Malone owns his stake. It trades at a 30 per cent discount to NAV – essentially just the listed SiriusXM shares.

Malone’s comments and our analysis suggests this situation is unlikely to persist over the long term and that patient shareholders will be rewarded as Liberty takes action to close the discount. In the meantime, we own an attractively priced core SiriusXM business with sustainable growing free cashflow and sizeable upside from driving the Pandora business into profitability.

Allan Goldstein, portfolio manager global equities, Cooper Investors Pty Ltd.