In this section, we feature a few Company Spotlights – either new ideas recently added to our portfolios, or updates on some existing holdings.

We hope these features help you understand how our analysts and portfolio managers recommend stocks to purchase. Each quarter, we'll post several in-depth spotlights here for your review. Portfolio holdings are subject to change, and for specific information about portfolio composition as of the most recent quarter-end, please refer to the specific Fund or Product you are interested in.

Baxter International develops and manufactures a diversified line of healthcare products. The company was founded in 1931 as the first manufacturer of IV solutions. Since then, the company has expanded into biotechnology and created multiple new life-saving and sustaining technologies. The company aims to be the global leader in critical therapies for people with life-threatening conditions. All three of its units—BioScience, Medication Delivery and Renal—focus on this goal.

Strong Competitive Position
Baxter maintains market leadership in most of its offerings. Its patients often use its products for a lifetime. Moreover, there is tremendous customer loyalty because patients become comfortable with these products and because complications can occur when therapies are changed. In addition, the company has a global presence and infrastructure which many distributors and the national group purchasing organizations (GPOs) strongly favor. Finally, Baxter runs lean and mean, driving its hefty free cash flow into research and development, which continually maintains its leadership advantage.

High Innovative Products and Services
Baxter pioneered several key healthcare products, such as the first dialysis machine, the first IV solutions in glass, and the first plastic container for administering IV solutions. Under Chief Executive Officer Robert Parkinson, Jr., research and development efforts have focused tightly on its most promising efforts and R&D spending has increased nearly 75% since 2004 to just under $1 billion. Currently, the company is in clinical trials for several market-changing products, ranging from Alzheimer’s disease to renal dialysis products. Additionally, the company has a full pipeline of products that could be approved into the marketplace over the next several years.

Compelling Valuation
While Baxter International is a premier franchise company within the healthcare sector, it has been a recent market laggard. Since early last year, investors have raised concerns regarding short-term issues within the BioScience division (namely pricing pressures and supply/demand stability). Although the demand for Intravenous Immune Globulin (IVIG), which treats immune deficiency and neurological conditions, has weakened over the past few quarters, the market is growing longer-term and pricing among manufacturers remains rational. We believe demand will increase as the patient population expands, new chronic indications are approved, and the global reach grows. Secondly, although significant progress has been made in reforming healthcare within the United States, the final details remain unknown.

Wall Street fears uncertainty. We do not believe we have a crystal ball into how the final combined House and Senate bill will look, but we do believe more patient lives will be covered within the United States and know the global population is aging. There will probably be pricing concessions by many healthcare providers and manufacturers, but we strongly believe any volumes will offset any discounting. As of December 31, 2009, shares traded at $58.68, a 22% discount to our private market value of $75.59.

Baxter International Inc. (NYSE: BAX)
One Baxter Parkway
Deerfield, IL 60015
847-948-2000
baxter.com

The International Business Machines Corp. (IBM) is a global information technology company operating in three primary segments: services, software, and hardware. The business has evolved from a hardware manufacturer to a company where 80% of its profitability comes from services and software. The shift in the company’s core business has improved the consistency of its revenue streams and allowed it to side-step the commoditization of the company’s legacy mainframe and PC businesses. IBM has grown into an organization that provides customized enterprise solutions across consulting, outsourcing, software, hardware, and financing operations.

Company Strengths
IBM differentiates itself from its competition by using its global scale and blue chip client list. Its competitive advantages result from superior product scale and scope, industry-leading research and development capabilities, and a deep, high-quality management team. Clients need more vendor accountability, so entire projects consolidate to one single service provider. This means fewer competitors can meet customer needs. Therefore, a key competitive advantage is the ability to offer a broad range of services with end-to-end solutions deployable around the globe.

The company’s world-class R&D effort is at the forefront of technological innovation. In 2009, the company spent a staggering $6 billion on research and development to maintain its innovation edge. Also, 2009 marked the 17th consecutive year whereby IBM was awarded more patents than any other company in the U.S. The company currently earns $1 billion annually in intellectual property and custom development income. Last year, the company received over 4,900 patents, more than Microsoft and Hewlett-Packard combined. IBM’s management has distinguished itself in their ability to take a rational look at its market positioning and industry outlook and make tough decisions. Company leadership exited nearly $15 billion of annual revenue in commodity-like legacy businesses including hard disk drives in 2002, PCs in 2005, and printers in 2007, shifting its focus to better areas.

Finally, IBM remains one of the most disciplined capital allocators in the industry. It has grown through a targeted, value-creating acquisition strategy to strengthen its branded middleware and business analytics efforts. Management has served as an excellent steward of shareholder capital, returning much of the company’s prodigious free cash flow through share buybacks and dividends while maintaining a solid balance sheet and strong financial profile.

Recent Results & Opportunities
Over the last ten years, IBM has doubled its EPS, growing at an 8% compounded annual growth rate, but is trading at the same share price it did in 2000. The primary knock on IBM centers on its ability to keep growing given its large size. We believe with the company’s improved market positioning, massive global presence and efficient capital allocation, IBM offers moderate but sustained growth. Plus, the investment community has under-appreciated the franchise’s consistency and stability in what remains a cyclical growth industry. IBM had a great 2009, gaining share from its major competitors in a tough recessionary environment. Despite the brutal operating conditions, the company had strong margin improvement on weak revenue trends through major cost actions. IBM is on track to realize $3.5 billion of cost and expense savings in 2009 yet still sees a multi-year opportunity to push margins up further. IBM also has new market opportunities such as business analytics, green computing, and cloud computing initiatives that will help top-line growth for years to come. IBM has beaten estimates for ten straight quarters while raising guidance repeatedly. Yet the stock remains very cheap. As of December 31, 2009, shares traded at $130.90, a 7% discount to our private market value of $141.00.

International Business Machines Corp. (NYSE: IBM)
1 New Orchard Road
Armonk, New York 10504
914-499-1900
ibm.com

The global leader in spices, herbs and seasonings, McCormick & Co. makes the world’s food taste better. In grocery stores, McCormick’s brands dominate the shelves, and the company is also the leading producer of store brand spices. The company goes well beyond just basil and oregano, specializing in unique spice blends, pepper grinders, soup mixes and more. Outside home kitchens, McCormick provides flavors to restaurants and food manufacturers, with a marquee list of clients including Frito Lay®, McDonald’s®, KFC® and others. After acquiring Lawry’s in 2008, the company now features a leading line of marinades, as well as Lawry’s iconic seasoning blends. Finally, McCormick is not only an American story; the company is growing in international markets, especially emerging countries where consumers can increasingly afford inexpensive goods that were until recently out of reach.

Spicing it up
Over several decades, McCormick has grown its entire lineup through innovation and marketing. Its products are one of the most indispensible yet inexpensive parts of any meal. Parents preparing dinner for their families can make meals far more delicious for just pennies. McCormick’s marinades, spice blends, and recipes simplify meals while making them taste better. Even when consumers eat outside of the home, they are still enjoying the company’s wares because restaurants use them too.

Bringing Innovation Home
During recessions, advertising spending declines as McCormick’s commitment to innovation increasingly strengthens its relationship with consumers while improving the company’s economics. Recently the company introduced Recipe Inspirations, a single product holding pre-measured spice packets, complete with directions for creating a home-cooked dish. Such original products provide better operating margins for investors. Moreover, as the economy recovers, these slightly more costly—yet very reasonable—items become more attractive to consumers.

A Tasty Opportunity
Ariel has owned McCormick’s stock in the past, and we have been closely monitoring its shares ever since. In October 2009, we got another chance to build a position in this industry leader at a bargain price. As consumers readjusted their spending in the Great Recession, McCormick was well-positioned. More consumers were eating at home, but had become accustomed to the complex flavors found in restaurant meals and bought McCormick spices to replicate those tastes. Investors, however, became concerned consumers would bypass McCormick’s branded offerings and go straight to generic store brands. While McCormick actually produces many of these store brand spices, they do so at much lower margins. Investors were also concerned Wal-Mart would reduce the presence of branded spices in its stores. In our opinion, Wall Street’s overblown pessimism created a buying opportunity.

As such, short-term market fears have enabled us to purchase a household name with a strong market position. As of December 31, 2009, shares traded at $36.13, a 21% discount to our private market value
of $45.93.

McCormick & Company, Incorporated (NYSE: MKC)
18 Loveton Circle
Sparks, MD  21152
410-771-7301
mccormickcorporation.com