Southeastern Asset Management

Webcast Transcript
May 6, 2015 11:00 AM ET

Disclosure Information:
The statements and opinions expressed are those of the speaker and are as of the date of
this presentation. All information is historical and not indicative of future results and
subject to change. Reader should not assume that an investment in the securities
mentioned was or would be profitable in the future. This information is not a
recommendation to buy or sell. Past performance does not guarantee future results.
Before investing in any Longleaf Partners fund, you should carefully consider the
Funds investment objectives, risks, charges, and expenses. For a current Prospectus
and Summary Prospectus, which contain this and other important information, visit
longleafpartners.com. Please read the Prospectus and Summary Prospectus carefully
before investing.
Average annual returns for the Longleaf Partners Funds are their respective indices for
the one, five, ten, and since inception periods ended March 31, 2015 are as follows:
Longleaf Partners Fund: 3.50%, 11.35%, 5.82%, 11.14% (inception April 8, 1987). S&P
500: 12.73%, 14.47%, 8.01%, 9.70%.
Longleaf Partners Small-Cap Fund: 13.35%, 16.50%, 10.52%, 11.60% (inception
February 21, 1989). Russell 2000: 8.21%, 14.57%, 8.82%, 9.86%.
Longleaf Partners International Fund: -17.61%, 3.20%, 2.84%, 7.59% (inception
October 26, 1998). MSCI EAFE: -0.92%, 6.16%, 4.95%, 4.69%.
Longleaf Partners Global Fund: -9.73% (1 year), 8.04% since inception December 27,
2012. MSCI World: 6.03%, 14.70%.
Returns reflect reinvested capital gains and dividends but not the deduction of taxes an
investor would pay on distributions or share redemptions. Performance data quoted
represents past performance; past performance does not guarantee future results. The
investment return and principal value of an investment will fluctuate so that an investor's
shares, when redeemed, may be worth more or less than their original cost. Current
performance of the fund may be lower or higher than the performance quoted.
Performance data current to the most recent month end may be obtained by visiting
longleafpartners.com
The total expense ratios for the Longleaf Partners Funds are as follows: Partners
Fund 0.91%. Small-Cap 0.91%, International Fund 1.25%, Global Fund 1.58%.
The expense ratio of the Partners and Small-Cap Funds is subject to a fee waiver to the
extent the Funds normal annual operating expenses exceed 1.5% of average annual net
assets. The expense ratio of the International Fund is subject to a fee waiver to the extent
the Funds normal annual operating expenses exceed 1.75% of average annual net assets.
The expense ratio of the Global Fund is subject to a fee waiver to the extent the Funds
normal annual operating expenses exceed 1.65% of average annual net assets.

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Southeastern Asset Management

Webcast Transcript
May 6, 2015 11:00 AM ET

RISKS
The Longleaf Partners funds are subject to stock market risk, meaning stocks in the Fund
may fluctuate in response to developments at individual companies or due to general
market and economic conditions. Also, because the Funds generally invest in 15 to 25
companies, share value could fluctuate more than if a greater number of securities were
held. Mid-cap stocks held may be more volatile than those of larger companies. As it
relates to the Small-Cap Fund, smaller company stocks may be more volatile with less
financial resources than those of larger companies. As it relates to the International and
Global Funds, investing in non-U.S. securities may entail risk due to non-US economic
and political developments, exposure to non-US currencies, and different accounting and
financial standards. These risks may be higher when investing in emerging markets.
Funds distributed by ALPS Distributors, Inc. Southeastern Asset Management serves as
advisor to the Longleaf Partners Fund. Southeastern Asset Management and ALPS
Distributors are unaffiliated.
Fund holdings are subject to change and holding discussions are not recommendations to
buy or sell any security. Current and future holdings are subject to risk.
The Top 10 holdings of each Fund as of March 31, 2015 are as follows:
Partners Fund: Level (3) Communications, 10.6%; CK Hutchinson, 10.1% Loews, 8.2%;
Philips, 6.6%; Vivendi, 5.5%, CNH Industrial, 5.0%, McDonalds, 4.9%, CONSOL
Energy, 4.9%; Scripps Networks, 4.5%; Wynn Resorts, 4.5%.
Small-Cap Fund: Level (3) Communications, 9.7%; Graham Holdings, 9.6%;
DreamWorks, 7.2%; Everest Re, 5.4%; Vail Resorts, 5.1%; Consol Energy, 5.1%; OCI,
4.4%; Rayonier, 4.4%; Viasat, 4.4%; Hopewell, 4.4%.
International Fund: CK Hutchinson, 9.5%; EXOR, 7.6%; Lafarge, 7.3%; Melco
International, 6.9%; Adidas, 6.5%; K Wah International, 5.5%; OCI, 5.4%; Vivendi,
5.0%; BR Properties, 4.9%; Philips, 4.8%.
Global Fund: Level (3) Communications, 9.0%; CK Hutchinson, 8.8%; Loews, 6.5%;
Adidas, 5.6%; Melco International, 5.5%; EXOR, 5.0%; McDonalds, 4.9%; Vivendi,
4.9%; Philips, 4.8%; Everest Re, 4.8%.
P/V (price to value) is a calculation that compares the prices of the stocks in a portfolio
to Southeasterns appraisal of their intrinsic values. The ratio represents a single data
point about a Fund and should not be construed as something more. P/V does not
guarantee future results, and we caution investors not to give this calculation undue
weight.

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Southeastern Asset Management

Webcast Transcript
May 6, 2015 11:00 AM ET

The S&P 500 Index is an index of 500 stocks chosen for market size, liquidity and
industry grouping, among other factors. The S&P is designed to be a leading indicator of
U.S. equities and is meant to reflect the risk/return characteristics of the large cap
universe. An index cannot be invested in directly.
The Russell 2000 Index measures the performance of the 2,000 smallest companies in the
Russell 3,000 Index, which represents approximately 10% of the total market
capitalization of the Russell 3000 Index. An index cannot be invested in directly.
MSCI EAFE Index (Europe, Australasia, Far East) is a broad based, unmanaged equity
market index designed to measure the equity market performance of 22 developed
markets, excluding the US & Canada. An index cannot be invested in directly.
MSCI World Index is a broad-based, unmanaged equity market index designed to
measure the equity market performance of 24 developed markets, including the United
States. An index cannot be invested in directly.
Definitions for terms used include:
Free Cash Flow (FCF) is a measure of a companys ability to generate the cash flow
necessary to maintain operations. Generally, it is calculated as operating cash flow minus
capital expenditures.
EV/EBITDA is a ratio comparing a companys enterprise value and its earnings before
interest, taxes, depreciation and amortization. Enterprise Value (EV) is the measure of
the aggregate value for a company. It measures the theoretical price an investor would
have to pay to acquire a particular company.
Earnings Per Share is the portion of a company's profit allocated to each outstanding
share of stock.
P/E (Price Earnings) Ratio is the market price of a company's share divided by the
earnings per share of the company.
Price to Free Cash Flow compares a company's market price to its annual free cash flow.

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Southeastern Asset Management

Webcast Transcript
May 6, 2015 11:00 AM ET

Lee Harper:

Thank you, everyone, for joining us on the Southeastern Asset

Management and Longleaf Partners webcast today. Joined from
Southeastern, is our research team whos around the globe
participating.
Our format today will be that Mason Hawkins and Staley Cates
will each make some brief remarks, and then we'll spend most of
the time on question and answer. Many of you submitted
questions ahead of time, which we appreciate, and we will address
a number of those, but you can also submit questions during the
call, and we will provide instructions when we get to the Q&A of
how to do that, if you arent already aware.
As one disclaimer, just so everyone knows, since this is an open
format, this webcast is intended for our investment partners, and as
your managers and largest investors in the Longleaf funds, we'll try
to provide our perspective on the opportunity we see today. As a
bit of a disclaimer, to the extent that members of any media are
participating on the webcast, we want to make sure that you know
that all of our comments are meant for our clients, and are
therefore completely off the record for purposes of publication.
We'll start this webcast with Mason providing some context as to
where we are today.

Mason Hawkins:

Thank you Lee, hello everyone and welcome. This August, we

will celebrate Southeastern Asset Managements 40th anniversary.
Over our four decades of operations and through seven market
cycles, I think its fair to say, we've had our core investment tenets
tested and confirmed, and we've learned a great deal.
Investing is putting money out where you're assured of getting it
back with an adequate return. As Ben Graham said, everything else
is speculation. All of our capital commitments since we founded
Southeastern in 1975 have been premised on adhering to this
investing definition. Its our internal imperative. Buying
competitively entrenched, advantaged businesses, managed by
honorable and capable people, at prices significantly below
corporate intrinsic values gives you the best chance to compound
capital at above average rates with low risks, risks defined as the
probability of permanent capital loss.
While it is important to have a large margin of safety of value over
price to protect against unforeseen events, and/or analytical errors,
over time, the quality of the business and the quality of the
management matter more. FedEx and Fred Smith; Aon and Greg

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Southeastern Asset Management

Webcast Transcript
May 6, 2015 11:00 AM ET

Case; Level 3 and Jeff Storey; Vail and Rob Katz; and C. K.
Hutchison Holdings and Li Ka-Shing are exemplary combinations
within our four portfolio mandates of uniquely advantaged
businesses stewarded by most exceptional corporate leaders.
Because great investments are rare, you must be extremely
disciplined and patient until you find one. When you do, you must
trust your qualitative assessments and your appraisal, move with
alacrity, commit a material percentage of your portfolios assets,
and be willing to look stupid in the short run.
Most managers arent willing to look foolish because of the career
risk. As the largest owners of the Longleaf Funds, we see our boss
and worst critic each morning in the mirror when we shave.
Equity investment success depends upon the price one pays for a
business future free cash flow generation. You need to be
approximately right on the latter, and parsimonious with regard to
the future.
Because we're concentrated, convicted, long term fundamental
investors focused on absolute returns, our portfolios will never
resemble an index, and our returns can vary materially from
market benchmarks. Right now, our Longleaf Partners Small Cap
Fund is leading the performance race in its universe, and many
believe Southeastern has magic ability in that arena. Yet, some
think we are ineffective in managing our large U.S., international
and global strategies. That is interesting, because the same team
that is being lauded for brilliantly executing its small cap is the
same one applying identical investment disciplines and decisionmaking in our other mandates.
We are highly confident our large U.S., international, and global
portfolios relative returns should look as stellar as small caps.
Headwinds - the soaring dollar, collapsing energy prices and the
resetting of goals from Macau - that have pressured our relative
returns in U.S. large cap, international and global will weaken or
reverse.
Most market participants almost always want to put their money in
what has most recently worked. In fact, a number of pre-submitted
questions for todays call asked us to open the Small Cap Fund.
We wont. Indexing, after a six year bull market, is working as
more dollars are forced into those securities that have gone up the
most. The last time we saw this much passive momentum chasing
was in the late 1990s. It ended very badly. In fact, its taken

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Southeastern Asset Management

Webcast Transcript
May 6, 2015 11:00 AM ET

almost 16 years and a significant change in its composition for the

NASDAQ index to get back to even.
Speculative juices are flowing again. Over the last year, as in
1999, some 80 percent of the IPOs (Initial Public Offerings) that
have come public were underwritings of unprofitable companies.
Its critical to remember, the speculator is most optimistic when
prices are the highest, and most despondent when they are lowest,
and that the number of good investment opportunities is inversely
related to speculator psychology.
We think the proper focus for investors is not what has worked, but
what will work going forward. We have recently invested
significant capital in our active, engaged, non-small cap strategies
because we believe they will significantly outperform their passive
benchmarks and because it is where we see terrific, absolute return
opportunity.
Our recent quarterly letter clearly delineates why we think our
beliefs are valid. Staley will highlight the reasons for our large
excess return expectations; then we'll go to Q&A. Staley?
Staley Cates:

Thanks, everybody. Frequently asked questions about the funds

other than small cap include when and how we will start posting
better relative returns, and how can we feel good about future
returns when price to value ratios are higher than normal? I'll start
with price to value ratios and then discuss our relative return
outlook.
Price to value ratios today range between 70 to 79 percent across
our four mandates. While these are higher than historical averages,
they offer two forms of upside which arent normally present. The
first is that, since those values are predicated on 9 percent discount
rates, if the large majority of the developed world remains in this
low interest rate period for a long time, then our appraisals are too
low, and our companys underlying intrinsic values will prove to
be higher than we are carrying now.
Secondly, when our management partners take advantage of these
ridiculously low interest rates by selling things at multiples higher
than we use to appraise their assets, our appraisals rise, and it is
usually a catalyst for stock prices to also rise accordingly. This has
been the story of the Small Cap Fund, where price to value went
over 80 percent in April of 2013. Despite that starting point of an
80 percent plus P to V, small cap had terrific absolute and relative
performance since then, because names like Texas Industries and

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Southeastern Asset Management

Webcast Transcript
May 6, 2015 11:00 AM ET

TW Telecom announced full company sales and Graham Holdings

sold off assets, all at values higher than appraisals, driving
significant stock price appreciation.
In incredible contrast to those stock price outcomes, in the other
funds, there were also high levels of brilliant sale and divestiture
activity that enhanced value, especially at Chesapeake, Murphy,
Vivendi, Philips, and CONSOL. Yet every one of those names has
a stock price that is down in dollar terms over this period, mostly
because of previously discussed weakness in energy and in foreign
currencies. We believe that eventually the value building activity
of our management partners will be rewarded throughout our
holdings as it has been in small cap most recently.
Turning to relative performance expectations, I dont want to
repeat all of the detail of our quarterly report here, but I will refer
you to it for a longer discussion of future return expectations. In a
nutshell, what we have attempted to do in that report is get even
simpler than our normal price to value discussions. When we
calculate the values in our price to value ratio, we take todays
normal free cash flow of a company and layer onto that some
critical assumptions about future growth rates and the proper
multiples to use in determining terminal value. However, today we
will simply look at the current multiple of price to free cash flow,
which you can also think of as a cash earnings P/E ratio.
Price to free cash flow is extremely instructive, and in some ways
cleaner than P to V because it removes any assumptions about the
future. In fact, some legendary value investors, and some of the
greatest investment authors have successfully made this simple
metric their main guiding light. Internally at Southeastern, we
have always discussed the price to free cash flow multiple in great
detail and paid very close attention to it, even though most of our
external communication has been around price to value ratios.
For most of our history, our portfolios featured price to free cash
flow multiples of around 10 times, while usually the broad market
would sell for around 17 to 18 times. As we look in this metric
today, we are paying 11 times free cash flow on average for our
portfolio companies. This is slightly higher than that historical 10
times, but it is extremely attractive in relative terms. Thats
because the market sells for over 20 times, far higher than normal,
and in line with past market peaks. If you invert our 11 times
multiple, our 9 percent free cash flow yield also compares much
more favorably to current interest rates than our more typical 10

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Southeastern Asset Management

Webcast Transcript
May 6, 2015 11:00 AM ET

percent free cash flow yield has usually contrasted to rates at any
given time.
Lets now look at the other variables to move us from the simple
price to free cash flow multiple to total return expectations for us,
and for the broad market as defined by the S&P and the U.S.
Inverting these multiples to turn them into yields, we start the race
against the market with a 9 percent free cash flow yield, while the
market starts with less than a 5 percent free cash flow yield.
When you then try to determine the future organic growth rate of
these yields, theres another important point of distinction between
our investees and the broad markets. We have large weightings in
names like Level 3, FedEx, Exor, C&H, Adidas, and Philips,
which, for various reasons, are earning subpar margins, but are
raising them as we speak. So, by definition, those companies in
our portfolios will feature earnings rising faster than revenues, but
for the broader market, margins are at such high levels that we
think they can only decline. That would mean earnings growth
lower than revenue growth.
Our portfolios, therefore, have a 9 percent going in free cash flow
yield, positioned to grow much faster than Mr. Markets 5 percent
peaky free cash flow yield. Additionally, the reinvestment of that
free cash flow yield and other capital provides another advantage
for our portfolios versus the indices. Our companies are doing
very shrewd things overall with their capital allocation to boost the
future expected return even more. While many businesses in the
indices are primarily buying back their own stock at historically
high multiples or paying huge multiples for acquisitions. High
priced stock buy backs and high multiple acquisitions within the
indices should end up as low return choices. This is especially true
in the U.S. within the S&P 500.
The total expected cash return is mostly under the control of our
management teams and impacted most directly by the quality of
the businesses we own. Other factors which will impact eventual
total return will include the downside of any bad surprises at our
companies, the upside of closing the price to value gap and returns
on all other capital allocation activities beyond just the coupon of
the business.
So, to summarizefor Longleaf, we expect 9 percent from our
aggregate free cash flow coupon plus earnings growth greater than
organic revenue growth, plus high returns from capital allocation.
Price to value gaps closing should hopefully at least offset negative

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Southeastern Asset Management

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May 6, 2015 11:00 AM ET

surprises. This is another way we get to our long stated goal of

inflation plus 10. For the S&P 500, we expect less than 5 percent
from the coupon plus barely any earnings growth on a few percent
revenue growth as margins drop, with a neutral or even negative
contribution from low return capital allocation and a higher than
normal risk of some multiple drop from todays level, which is
over 20 times, because that has never been sustained for long
periods.
This is why the S&P looks risky to us right at the moment that it is
considered to be the mindlessly safe way to invest in equities.
These various contrasts are why we think our portfolios are
unusually advantaged in relative terms, so with that, I'll send it
back to Lee, and we'll open up to Q&A.
Lee Harper:

Okay, great. We're going to take questions now. Just so you

know, our global research team is on the line. Besides Mason and
Staley, who you've heard from, we have Ross Glotzbach, Jim
Thompson, Lowry Howell, and Brandon Arrindell in the U.S.
Theres Scott Cobb and Josh Shores in London, and then we have
Ken Siazon and Manish Sharma out of Singapore.
For those who want to e-mail in a question and its not obvious on
your screen, you can click on the orange arrow up in the upper
right hand corner of the screen, and a box will appear where you
can type in your question and hit send.
We'll start with a few questions that we received ahead of time.
Are you still finding more investment opportunities outside the
U.S. than within the U.S.? If so, why are the Partners Fund and
Small Cap portfolios not at maximum foreign holdings permitted?
Can you comment on the broad geographic opportunities, and how
have sustained low interest rates impacted those opportunities?
Staley, you want to start?

Staley Cates:

I will start, and then I will toss it over to Scott and Ken. We are
still seeing more opportunities non-U.S. versus the U.S., and
actually, to the question, we are at basically the maximum
allowable percentage in the Partners Fund of non-U.S. holdings,
and that limit is about 30 percent.
The Small Cap Fund, we have not quite the full, maximal,
allowable amount, but we have more non-U.S. exposure than
we've had at any time since the Asian crisis, actually.

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Southeastern Asset Management

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May 6, 2015 11:00 AM ET

As far as the opportunity difference in the U.S., its a function of

really low interest rates and low volatility, meaning multiples that
are very high, as we've already talked about. In contrast to Asia
and Europe where problems are easier to see and they're more
easily articulated, but thats also led to better discounting, and
among some of that fear, some names that are way cheaper than
what we see here.
Ken, why dont you weigh in on Asia and then Scott, talk about
Europe?
Ken Siazon:

Sure, so in Asia, we're probably seeing the most opportunity,

which is probably why Asia is the percentage of your portfolio that
has generally been increasing in recent years. I guess, as Staley
mentioned, even in the domestic small cap and large cap programs,
you will see Asian names, and C. K. Hutchison Holdings, in
particular, is among the largest positions in the Partners Fund.
I think the anti-corruption campaign in China, as well as fears of a
China slowdown have created opportunity in Hong Kong and
Macau as well as in the luxury and mass retail sectors.
Furthermore, weakness in energy and commodity prices have also
opened up opportunity in Asia. This macro headwind has enabled
us to buy high quality operators whose share prices are falling in
line with the underlying commodity price, but it makes money
based on volume of work produced. So, companies like ALS and
Mineral Resources share these characteristics. We think that we'll
do better in this environment as commodity production volumes
go, and therefore, their revenues will grow.
In Japan, we've also identified opportunities there and we're
encouraged by the increased focus on capital allocation, return on
equity, and corporate governance. Id say that in the past, the
pressure for better capital allocation came primarily from key
foreign and local shareholders, and in some cases, the Japanese
government actually helped shield Japanese corporates from
foreign activist pressure. I think today, the pressure for better
governance and capital efficiency is actually coming more from
the Japanese government and other domestic institutions.
So, for all those reasons, you know, Japan is becoming more
interesting as capital efficiencies become more of a key focus for
Japanese corporations.
Among the private sector companies in Asia, as they transition
from the older generation to the typically Western educated second

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Southeastern Asset Management

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generation, we see a lot of change happening, significant changes

in capital allocation when that younger set of management who are
typically schooled in the West take over, so Cheung Kong or C. K.
Hutchison and their massive restructuring spin off announcement
that they just approved last month, its just one example of what
happens when a younger, Western educated leader like Victor Li
takes over the leadership of an old style Asian conglomerate.
Asia still has a number of undervalued conglomerates that are
cheap, that are misunderstood and suffer from holding company
discount. So, we think that this opportunity set of younger
generation managers that enter a leadership position will open up
opportunities where these guys will seek to more actively realize
shareholder value. Scott?
Scott Cobb:

Thanks, Ken. You know, in Europe, were obviously, as Staley

said, seeing more opportunities here than in the U.S. I would say
its not as cheap as Asia on an absolute basis today, so the
opportunity set is maybe a little better in Asia than in Europe, but
we're still finding a number of great businesses with great partners
selling at a big discount, so something like an Adidas, which we
were able to buy late last year, we think highlights that trend.
But its notin Europe, its not like what we saw back in 2011
where you had broad based cheapness and multiple opportunities
across the entire region. Today, as you would expect, its what I
would call just a more normalized environment where you've got
to do some work and some digging and turn over a number of
rocks to find compelling opportunities, and they are out there. But
its not broad based cheapness across the entire region, but its
specific opportunities that we see, like an Adidas that has
temporary short term headwinds that the market overreacts to.
So I think its a unique opportunity where things are relatively
most companies are relatively fairly valued, but there are a number
of opportunities for structural reasons, things like Philips that still
exist in a conglomerate structure thats being addressed, where you
can find some hidden gems, and when those companies are
managed by brilliant owners and capital allocators, you can have a
fantastic outcome.
So I would say, you know, we're finding a number of interesting
opportunities and have a number of things that we're surfing today,
so I would say its a pretty exciting time to invest in Europe.

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Southeastern Asset Management

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Lee Harper:

Great. The Partners and International Funds have

underperformed over the past 5 and 10 years. Has anything
changed in the market that has made it more difficult for active
managers to match or exceed returns available in index funds?
Could you please explain the underperformance and why the funds
will outperform going forward?
Staley touched a little on this, obviously, in his comments, but
Staley, do you want to elaborate on the underperformance?

Staley Cates:

Sure. Taking this joyful topic last part first, the reasons for
underperformance in those two funds for the 5 and 10, we talked
about it in the last call, and we've hopefully articulated clearly in
the written communications as well, but basically, in the Partners
Fund, there are some external factors, there are some self-inflicted
mistakes, and theres some endpoint stuff.
The biggest endpoint points of interest, I guess, are this last year of
energy, which we've talked about quite a bit, and we'll talk about
more today, has seriously put the hurt on the one year number,
which is a poor way to finish the endpoint. And then, at the
beginning, we came out of the best relative time we've actually
ever had, from 00 to 03. Within that period, the biggest selfinflicted mistake would've been Dell, which was a large enough
weighting to really hurt us on the 5 year, and even hurt on the 10
year. We've also talked about why that kind of mistake is not
going to replicate.
And then, in the international fund, its been a bit of the same story
in that the one year number thats been such a tough final endpoint
has been a huge function of some of the Macau and China stuff
that Ken alluded to, which we are actually still very long term
optimistic about. And then on the self-inflicted part within that
range, HRT would've been the worst. Again, we've tried to talk at
length about why that is one of those mistakes that is not
replicated.
For the bigger picture of, is it harder for active managersits very
interesting to us that this is almost like a repeating cycle in that this
happens about every decade where you're in the late stages of a
bull market, so an active manager actually gets more careful, not
less, but some of the stuff going on thats crazy gets crazier and
then works, and wed point to the health care sector as Exhibit A of
that, which has also been one of the underperforming sectors of us
versus the market. That is all the more reason to not pursue that,
even though thats bringing in fresh money by the day.

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Southeastern Asset Management

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May 6, 2015 11:00 AM ET

Another part of this whole active versus passive bubble is that this
stuff, of course, feeds on itself for a little while, as we were in one
of those years in 2014 where passive wins, and its low cost, and
Bogle wins and Vanguard wins and all the other headlines you see
as well as anecdotal and statistical flow evidencestrength begets
strength, and even more money comes into these funds, although,
for reasons we tried to lay out, that doesnt go on forever.
Another factor feeding that passive spiral is share repurchase
activity itself. Its not a small number that company flows into the
same S&P 500 names has looked a whole lot like mutual fund
investor flows into those names, and again, that can feed it short
term, but that does not win out in long term value.
Mason Hawkins:

Id like to addthis is Masonit really does depend a whole lot

on your beginning and ending time periods. As you know, on
October the 7th, 2008, we held a very important phone call to talk
about how we had provided liquidity four different ways to own
the companies in, for example, the Partners Fund. If you measure
what we've accomplished from the subsequent lows in November,
November the 20th for the Partners Fund, the Partners Fund has
compounded at 22 percent since then, or twice the 11 percent of
our absolute inflation plus 10 bogey.
So, it really depends a lot on your perspective. I might also add it
outperformed the S&P 500 for that period of time. So it really
does matter what your beginning point of time is, your ending
point of time, and whether you're comparing against your main
bogey of absolute returns or you're hung up on relative
performance.

Lee Harper:

All right. One of the things that Staley touched on was energy,
where we are with energy now.
What impact has the decline in energy prices had on our
companies and the portfolios? Whats the opportunity for them
going forward? How has the recent decline impacted how we
think about investing in commodity based businesses, and about
how much of the portfolio we're willing to have in those types of
businesses?
Ross, do you want to start on the

Ross Glotzbach:

Sure, I'll talk about some of the specific companies, and Staley can
talk about the portfolio parts.

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Southeastern Asset Management

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Commodity prices have come down versus this time last year. We
have to face that reality and consider that impact on our values, so
this has not been a positive for values, but I will say, this is largely
something thats outside of our companies control, and the things
where they do have control over, they are delivering very strongly.
We can talk about CONSOL, that is buying back shares, thats
doing two IPOs this year at solid values for some of their assets,
both highlighting and realizing value. We can talk about Murphy,
who sold their minority interest in their Malaysian assets at a very
good price, at a very good time, and now has a very good balance
sheet. We can talk about Chesapeake, who sold their assets in kind
of the Southern Marcellus and Utica play for a very good price to
Southwestern, and was almost half their market cap for 10 percent
of their production at the time they sold that, to get that company
in a better, financially flexible position.
So we didn't panic in the early part of this year when other
participants were panicking in the oil and gas markets. We
actually have added to some of our holdings, theres new ones in
the Small Cap Fund that have performed well so far. We've got
Holly, California Resources and two other smaller ones that all are,
again, going on offense based on what they can control and will
emerge from this downturn stronger than they entered into it.
Staley can talk about the portfolio stuff.
Staley Cates:

Yeah, from a portfolio management perspective, I think one thing

to point out is, when you combine high visibility of the
Chesapeake corporate governance drama that played out over a
couple years, and then this one year where energy names have hurt
us, it leads to an impression that we're more commodity weighted
than we've actually ever preferred to be, or than we are now. If
you actually go name by name, kind of without regard to the
visibility of those names, you'll see what you normally see, and
that is, well over 50 percent of our names have pricing power,
which is something we deeply care about.
I would divide that into actually several different categories. You
have things like FedEx that just straight up raise prices. They do it
in the form of a plain price increase as well as a fuel surcharge.
You also have companies like building materials, cement and ags
companies that we've had a lot of success with, or CNH where they
have pricing power even in terrible down unit volume periods, so
they may be cyclical and kind of volatile, but they definitely have
pricing power that gets back to a Porter model strength. And then
you have the type like Aon, which is more of a gross profit royalty

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than a flat out price increase, but its the same kind of beneficial
economics.
So these things are the quality that we usually demand, and at any
given time, the straight up commodity names are going to be a
small percentage of the portfolio, and then last thing on this, when
we do have those, we have to have such a low cost provider status
and such a physical advantage as we have at something like a
Chesapeake, and we have to have great people managing those, as
we have at all three of the names in the Partners Funds that we've
talked about, and some of the small cap ones to be named later.
Lee Harper:

Okay. The other name that we touched on in talking about the

International Fund recently is the Macau pressure, so we got
questions saying, Describe your investment thesis on Macau
casino stocks and the impact weakness there has had on your
values. Does government or regulatory risk make you rethink the
positions, their size in the portfolio, or other companies you own
with large China exposure? And then, more generally, how do we
think about regulatory risk in general and industries?
So, Manish or Ken, does one of you want to start on the investment
thesis itself?

Ken Siazon:

Okay. This is Ken, and I'll start and maybe hand it off to Manish if
he has something to add.
So, the investment thesis on Macau is really unchanged in that we
continue to believe that Macau will be the only place where
gambling is allowed in China, and as the economy grows, as more
infrastructure gets put into place, that enables more Chinese to visit
Macau, and the gaming business will continue to grow over the
long term. Hotels are at very high occupancy rates. The average
stay of an overnight guest is only two days, and shortage of rooms
will be alleviated by over 12,000 new hotel rooms to open in
Macau by 2018, which is going to increase room capacity by
almost 50 percent.
However, the impact of the anti-corruption campaign of the
Chinese government has been significant, and conspicuous
consumption, whether gaming or sales of luxury watches or
fashion items has been deeply affected in China. VIP as well as
premium mass gross gaming volumes in Macau have been
negatively affected, and industry gross gaming revenues are down
about 40 percent in April year to date this year versus last year.
With most of that decline coming from the VIP segment, this

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accounts for about 60 percent of industry gross gaming revenues,

but only about 26 percent of industry EBITDA.
We believe that a large part of this VIP segment will not come
back. However, we also believe that the mass business, which
accounts for more than three quarters of industry EBITDA and
more than 80 percent of EBITDA at Melco Crown, will continue to
grow in line with the growth of the Chinese economy, wealth
creation, and investment in infrastructure.
So, the weakness in gaming volumes has resulted in values coming
down, but prices have come down more than values have. I guess,
to give you an idea of how attractive Melco International looks
today, please consider these valuation metrics.
So, today, Melco Internationals 34 percent stake in NASDAQ
listed Melco Crown is worth about 40 percent more than the
market cap and enterprise value of Melco International. If we
exclude about $2.5 billion of work in progress, which is Studio
City, and the stake in City of Dreams Manila, Melco International
is today trading at a look through low teens free cash flow yield, to
enterprise value. So we find that very attractive for a company that
we believe will grow high single digits in the long term, and this is
a company thats actually net cash.
So we think Melco International is worth probably, you know, in
the mid-20s per share, and the shares are deeply discounted, and
the sectors hated in the capital market, and by the sell-side
research community.
So, while the near term looks bleak and uncertain, we havent lost
faith in the mid to long term attractiveness of this investment. In
the last 12 months, both Melco International and Melco Crown
have repurchased shares. CEO Lawrence Ho has also purchased
shares personally, and while its too early to call a bottom, its
interesting to note that for the last few months, gross gaming
revenues have been more or less steady at 19 or 20 billion pataca a
month.
At some point, we will get to a bottom, and growth and mass will
overcome declines in VIP business, and Melco Crown is well
placed to benefit from that mass business, and makes over 80
percent of EBITDA from non-VIP. The Studio City, which is a
mass focused project, will come online in the fourth quarter, and
today, market is giving zero value for this property.

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With regard to regulatory risk, we think our appraisals are

conservative as they account for potential regulatory risk. For
example, we built in an extra value ding in our appraisals to
account for any potential payments that might be associated with
concession renewals, which could be happening as early as 2020.
We've also purposely partnered with a local, CEO Lawrence Ho,
who is (1) a member of a national committee of the Chinese
peoples political, consultative conference. His family has had
close ties to Macau for decades, yet Lawrence is a forwardlooking, Western educated CEO focused on value creation. So,
while partnering with locals is not a magic bullet to protect us from
regulatory risk, we feel much better after having interacted with
Lawrence Ho since late 2011. To have a CEO like him that can
navigate regulatory uncertainty more skillfully than others in
Macau, just by being better integrated into society in Hong Kong,
Macau, and PRC.
We initially started this investment in Melco International with a
2.5 percent position in 2011, and Melco International had an entry
price of around $6HKper share, as a way to test managements
position, as we got more comfortable in Macau and Melco
International, our size and portfolio has increased over time.
I guess, finally, we're comforted by the fact that gaming related
taxes account for more than 85 percent of total government
revenue in Macau, and that casinos are actually the largest
employers in Macau, employing around one-third of the labor
force. So its not really in the governments interest to destroy this
industry, or to push Chinese gamblers to spend their money in
other, competing countries.
So, although painful, we think that this anti-corruption program is
good for the long term, both for the Chinese economy, and for
Macau. Manish, did you want to add anything?
Manish Sharma:

Yeah, not much. I guess just one quick thing is, we couldnt stress
enough the importance of new infrastructure thats going to come
through in the next few years. I mean, any way you look at the
Macau market, its highly underpenetrated. I mean, the mainland
visitation penetration rate of Macau is still less than 2 percent. So,
as the new hotel rooms come through, as the Hong Kong-ZhuhaiMacau Bridge comes through and the railway network and the
light rail and the ferry it will make it a lot more accessible for
mainland Chinese to visit Macau, and that should really drive the
mass market. Thats what we are betting on. VIP has been always

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a black box to us. We never assigned much value to it. Where we

really see growth is the mass side, and thats why we play with
Melco, because Melco is whereMelco has the highest exposure
to mass business, about the highest exposure to mass business.
Staley Cates:

And this is StaleyId wrap that up by echoing the very last thing
Manish just said, which is, of all the things you heard, if I could
leave you with one, it would be that emphasis on mass, the stuff
you read about Macau and all the most terrifying parts of bad
stories about Macau happens within VIP as opposed to mass. And,
as Ken mentioned, mass is 80 percent of profits at Melco. This is a
bet on the long term growth of mass rather than a bet that the
corruption crackdown either lessens or that the VIPs come back, or
that there is some healing on that side of it. We can justthats
what gives us the opportunity to buy the stock cheaply, but thats
not a bet we have to make, and so its all about the long term
growth of mass.

Lee Harper:

Great. Another question, a couple of other questions have come in

related to Level 3. Given the large holding that we have in Level
3 Communications across the funds, can we share our three to five
year expectations for the company and stock, and also, how do we
think about the weighting of that stock in our portfolios?

Mason Hawkins:

This is Mason
Its early investment days for Level 3. As many of you know, their
global network carries and protects critical data that enables
computing in the cloud, the Internet of Things (i.e., big data), more
streaming and the worldwide proliferation of mobile devices. The
companys costs are predominantly fixed, and their growing
revenues have high contribution margins. The operating profit
leverage is huge, and Level 3s free cash flow generation is
exploding.
Furthermore, on top of the value that we ascribe to the future free
cash flow production, the company has two most valuable nonearning assets: a significant excess inventory of dark fiber, and 10
unused underground fiber-optic conduits. These assets are unique
and becoming much more important as bandwidth capacity
shrinks. Our three to five year expectation for the stock at Level 3
is, I guess, best summarized as saying high,; and, we are very
thankful that we have this large weighting in our portfolios.

Lee Harper:

Okay. The question: About how our appraisalshow do our

appraisals account for shifts in currency rates when we invest in

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overseas businesses? How has the strong dollar impacted our

portfolios, and have we re-thought our position on hedging, or
rather the fact that we dont hedge currencies? Staley, do you
want to
Staley Cates:

I will start that, and anybody, especially Ken and Scott, that went
to jump in, please do.
So, for the first part of that, on FX rates, that is, as they change
daily, we do mark those real time. I mean, that is what it is. That
does not involve projecting them out, that is just redoing our
appraisals every time there is new information. That would
include how FX changes, which has obviously been volatile
recently.
On a longer term FX look, this really gets back to inflation
differentials, which you can see in short term interest rates and the
cost of hedging, and thats what really is instructive as we do our
discount rates in different geographies to try to incorporate an
inflation differential through a high discount rate, all of which is
kind of clued by FX expected differentials.
The strong dollarso, the part of the question about the strong
dollar, we've listed that in some of our MD&A, but that has been a
huge headwind for us, both in calendar 2014 and year to date 15,
especially in the International and Global Funds, but even in the
Partners Fund.
The last part of the question, though, that is then begged by the
damage thats been done by the strong dollar is, does that make us
re-evaluate the hedging or look at that differently. We do try to
look at everything with a fresh piece of paper all the time, but
where we continue to come out on this is that we dont bring value
to the currency equation. I mean, we can all look at purchasing
power, and we would all have our hunches, but not enough to act
on them.
And whats especially different now than when we started the
International Fund with hedging is that it is so easy for our
shareholders to hedge on their own, and that was really not the
case when we started this fund. We're also a concentrated manager
with low turnover, so our shareholders usually have a pretty good
idea on what those currency exposures are, and since everybody in
our shareholder base can feel pretty differently about this topic, we
think its another reason not to hedge, that shareholders can do it
themselves to the extent that theyd like.

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We end up kind of where John Templeton started, which is that

these things do come out in the wash over a long period of time,
especially when we have multi-national blue chips in there where
they have a basket of currencies that do tend to kind of come out.
So, every once in a while, we will do things of note with currency,
like in Hong Kong, you'll see in the disclosure that we have bought
some putsnot a hedge, but just puts on that currency. Those are
super cheap because everybody extrapolates the peg, and there we
feel like, if the peg does remain, we're in great shape, if the peg
came off and it rose, we would obviously win, but if the peg came
off and their currency declined, thats where wed be protected by
the puts.
So, if they're one-off situations, we think that makes sense, we'll do
those, but basically, we stay with the unhedged.
Lee Harper:

Okay.

Mason Hawkins:

I might also add that the cost to hedge is a very big consideration
over the long term.

Lee Harper:

Could you discuss your view on current valuations of Orkla and

Philips, and what steps are current managements taking to realize
your estimate of future value?
Obviously, Josh and Scott cover those. Josh, do you want to start
on Orkla?

Josh Shores:

Sure. Thanks, Lee. So, Orkla is a Norway-based, historically

conglomerate thats in the process of a transformation to a focused
BCG branded consumer goods company, and its controlled by
Stein Erik Hagen, who owns 24 percent of the company and sits as
the chairman of the board and a close associate of him, Peter
Ruzicka, is, as of last year, the CEO of the company.
So, this transformation process isnt something thats just
happening kind of by happenstance. Its a very deliberate,
intentional process with a guy that we have a lot of respect for and
are happy to partner with. So, its been a successful transformation
and the market has recognized it over the last 12 months with
pretty good performance in local currency, but theres still a decent
ways to go.
So, over the last two years, they've IPOd Grnges, which is the
aluminum rolling products business. They put the other part of the
aluminum business, which is extruded products, into a joint

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venture with Sapa, called Sapa with Norsk Hydro, and they still
have some real estate and some various other non-core assets that
we trust they'll sell in a disciplined fashion at the right time. And
the key here is, you've got the right partners allocating capital, and
guys that we know have an excellent track record and a strong
vested interest in going and getting and realizing that value.
So, from todays level, if you strip out that non-core stuff, you're
still seeing core BCG, strong local brands trading at about 13 times
free cash flow, 13 times net incomebasically, the same there
and eventually you're going to get there, because you're partnering
with the right guys. And, under certain strategic scenarios, that 13
times while, on an organic basis, is worth high teens could be
worth substantially more than that.
So, we like that one, and we like the guys that we're partnered
with. Most importantly, back to Masons original comments on
what makes a good investment, we see permanent capital loss is
difficult with these kinds of brands. We still see good upsides
when we really like who we're partnered with there. So we're very
appreciative of what Mr. Hagen and his team have done,
particularly over the last 12 months, but also before that, seem to
think that theres more room for them to go, and we look forward
to seeing that happen. Scott?
Scott Cobb:

Yeah, so for Philips, I mean, its somewhat of a similar situation in

that Philips is a historical European conglomerate, and today,
within that conglomerate structure, you've got a health care
business which is essentially big medical devices; a lighting
business, which is a legacy business with the company; and a
consumer business where you have things like the Sonicare
toothbrushes and electric razors and rice cookers in China. So, a
good consumer business which is really an emerging market
business rather than a European consumer business.
So, within that structure stepped Franz van Houten in 2011, and
when he became CEO, he had two mandates, and that was to raise
the profitability of all three segments and then look to get the
market to recognize the inherent value of those segments outside
the conglomerate structure. That has now culminated after a
couple years of progressive margin improvement within the
segments, with the decision to split or separate lighting from health
care and consumer and so that the remaining Philips will become
something that they're calling HealthTech, which is health care
combined with some of the consumer subsegments, and lighting
will be a standalone company.

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So we think hes done a tremendous job on the operating metrics,

and now, within the next 10 to 12 months, we'll have two pieces of
paper that we think, when this conglomerate structure is removed,
the market will then be able to better appreciate the franchise, the
health care and consumer franchise, which today, on a look
through basis, is trading for aroundthe health care part is trading
for around 10 times free cash flow for a business that should at
least be mid-teens, if not higher.
And while we're waiting on that separation to take place, the
company is actively repurchasing its shares, management has
bought shares personally, so we feel like we've got good operators,
vested owners who are actively taking steps to remove the gap
between price and value.
Lee Harper:

Great, thanks. Several of the questions coming in are, as one

would expect, about some of our individual holdings, and we'll get
to some of those. A couple of names that people have asked about
in our U.S. portfolio, McDonalds and Googlethose are ones
where we are not yet willing to talk on the record about things
going on and about our case, but we do want to let you know that
we are getting the questions, so stay tuned on those.
And then questions around one of our largest holdings across the
shop, and its in the Partners Fund or the U.S. portfolios as well is
our international and global accounts. And we've touched on it
already, but its Cheung Kong and C. K. Hutch. Can we talk about
our Hong Kong property exposure and companies that we like?
That would be the largest, obviously. Any concerns about the
property market or a rise in interest rates there, and how do we
view the real estate piece versus the remaining businesses once that
split happens that was referenced earlier?
Ken, you want to talk about that?

Ken Siazon:

Sure. So, we have a number of investments in the Hong Kong

properties space. C. K. Hutchison Holdings is one and K Wah is
another. We hold them because the prices of real estate implied in
the stock price are much lower than the prices that the physical
land bank can sell for, or transact at, and their managements have a
demonstrated track record of growing value per share and
unlocking value.
So, while we are worried about a downturn in the Hong Kong
property market and a rise in interest rate, I think these things are
all priced into the stock price.

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There are some companies in the Hong Kong property space who
are taking advantage of this arbitrage between high physical
property prices and low prices in capital markets, but basically
selling land bank at 3 to 4 percent cap rates and reinvesting the
proceeds in high cap rate property stocks. If you follow this
industry, you'll notice that insider buying has also remained pretty
elevated in the Hong Kong real estate industry even today.
With regards to C. K. Hutchison, which is one of our largest
positions in both the International Fund as well as the U.S.
domestic fund, we think the property business accounts for roughly
a third of the value of C. K. Hutchison. So, even though they are
the single largest component of the Hang Seng Property Index at
24 to 25 percent, actually only a third of the value is actually
coming out of the property business. We think that the shares are
worth north of 200, and the property business will be spun off on
June 3rd.
So, there was an independent appraiser recently as part of this
restructuring exercise who recently valued C. K. Hutchison at 241
a share, of which the property value was around 98 a share. We
think C. K. Hutchison will continue to spin off and IPO divisions
at the right time. I think their retail arm, Watsons, is a good
candidate for an IPO in the next few years, and at some point, it
will also make sense for them to monetize their European mobile
telecom business in the next few years.
Lee Harper:

Okay.

Staley Cates:

This is Staley. I would just add that, as Ken talked about on those
numbers, Cheung Kong falls in the category of perceived as the
property developer in Hong Kong and China, but their true
economic value is so much bigger than that. This is, to us, a
Berkshire Hathaway looking thing. This is an incredible CEO,
incredible family ownership, amazing capital allocation and yet
they're some of the best sellers of assets that we've ever seen.
But the most encouraging thing about this restructuring is, we
would've thought that a great way to unlock value would've been
for them to just spin off or not continue to control publicly traded
Hutch, and they did one better than that by first taking in all of
Hutch and then taking the property that was in both of those
entities, and spinning that into the standalone property company
that Ken was talking about, they really isolated the whole level of
cheapness. I mean, its a fantastic thing, the stock price has

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responded, but their worldwide status and just kind of overall

global blue chip economic value as opposed to being strictly a
Hong Kong company is why we have made that a large position in
the Partners Fund as well as just the International Fund.
Lee Harper:

Taking it to higher, broader macro questions that we were getting,

one of them touches on specifically, if interest rates increase, how
will that affect the valuations of the companies we own? And
then, more broadly, how do we, in general, consider macro
possibilities, whether its Greek exit from Eurozone; we talked a
little bit about the Chinese economic slowdown; quantitative
easing, which that specific interest rate question is around; OPEC
(Organization of the Petroleum Exporting Countries) moves, et
cetera. How do you think about those macro possibilities in terms
of how we do our appraisals or manage our portfolios?

Mason Hawkins:

Wow. You all, I think, understand and appreciate our lack of

insight on macro events. But, we have some observations, I think,
that are worthwhile.
Theres no precedent in economic history for negative nominal
interest rates, even during the Great Depression in the United
States. No time, that I am aware of, has anybody paid to put
money under mattresses. We are in uncharted waters, and we've
spoken today about some of the risks of that changing. We are
clearly aware that this is unprecedented.

Staley Cates:

I think, as far as the interest rate effect, thats just so company by

company. Its just very hard to get into. Theres some companies
that immediately can benefit, like an Aon with the float on their
fiduciary funds or Bank of New York Mellon, which would benefit
if spreads widen. Then there are other companies where, if rates
do go up, that may have to do with inflation going up and the
pricing power at those companies would be kind of the indirect
offset.
So, I think its so case by case. Our analysts are definitely on top
of this with each of the names they follow. Every name we look
at, every analysis we do is done with the goggles of, What
happens to this appraisal, or to this companys earnings if rates go
up?so, no easy answer.

Lee Harper:

One other thing you referenced in your comments, too, was that
part of our insulation, at least on our appraisals is that we have,
we're using such higher discount rates than the current rates would
warrant.

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Staley Cates:

Right.

Mason Hawkins:

One of our questions that we've received recently, and more than
once, was, were we worried about regulations as it relates to health
care and utilities? And our response was, we were worried about
valuations, not regulations. And the valuation concerns are, that
free money and zero interest rates in many cases are driving some
of that speculative fervor and pushing prices to levels that we think
offer very low return and risk adjusted rates.
So anyway, again, we're reminded that you're not forced to do
anything in this world unless it makes sense and it falls within your
circle of abilities, and within the disciplines that you think are
important.

Lee Harper:

Okay. On another specific stock question, whats the investment

thesis for Scripps? Ross, do you want to talk about that?

Ross Glotzbach:

Sure. I'll also do business, people, price. On the business, Scripps

owns the vast majority of its video content. It has real brands in
HGTV and Food Network. These brands resonate strongly, with a
very specific, good demographic of largely upscale women thats
often ignored by people on Wall Street. You can see the strength
in their ratings today versus their peers, especially at HGTV, and
we also think that they're really early days in monetizing their
international opportunity.
Then on the people, we've got CEO Ken Lo, who has been at this
company for over 20 years now. Hes instrumental in founding
HGTV and doing the wonderfully successful Food Network deal,
and then spinning it off from Scripps other broadcast TV and
newspaper holdings, which gets into talking about the extended
Scripps family. We think that they're pretty unique among media
families in terms of being willing to both grow and then realize
value per share in often unconventional ways, like you've seen
recently at their other company, E. W. Scripps.
Then it gets down to price. You know, Scripps Networks is
lumped in with all these other media companies today that have
much worse ratings on TV that dont own as much of their content,
that have already gone international, and have much worse
controlling owners, so maybe Scripps trades sometimes as a slight
premium to those. We think it deserves a big premium. We also
think that that premium is also often capitalizing Scripps
international losses, and theres a few other unique accounting
quirks that we think are missed in the price.

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So, its undervalued, its a good business, and they're good people.
Lee Harper:

Great, thanks. Well, we're sort of closing in on an hour, which was

kind of our projected time for this, soand we've touched on a lot
of other questions that have come in, we've touched on them in our
comments already.
There will be a replay of this available, probably innot today or
not tomorrow, but within a week or so, once we get it all cleaned
up and out there on the web. And then, in closing, Mason, did you
want to make any final comments?

Mason Hawkins:

Yeah, wed like to close with the following. We believe that you
wont find a more committed, more engaged, and more equitably
aligned manager with more capital invested alongside our partners
than at any point in our history because we believe we'll produce
good returns with minimal risk, and that our disciplines and 40
years of applying them give us a substantial edge against our peers.
We thank you for your co-investment.

LLP000309
11/30/15

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