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.
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Founded in 1996, eBay is the world’s leading provider of online marketplaces for the sale of goods and services, as well as an eCommerce and telecommunications service provider. As the dominant Internet auctioneer, nearly $60 billion of goods and services were purchased last year within eBay’s marketplaces.
A Dominant Brand with a Global Reach
As our shareholders know, we typically avoid internet companies. However, eBay has all the qualities we traditionally seek in a long-term investment—a leading brand recognized globally, a strong competitive advantage with the largest network of buyers and sellers and a highly scalable business model. With these three key ingredients, we believe eBay is here to stay. Its business model produces steady, handsome earnings and cash flow growth. Finally, it is a bargain: the company has a market capitalization of $20.7 billion, no meaningful debt and a cash balance of $3.5 billion. That means that with roughly $2.5 billion in cash flow next year, it is now trading at only 6.7 times cash flow.
A Retailer without the Hassle
Think of eBay’s core business as a gargantuan store, but without the hassles. Retailing tends to be capital intensive. Shops cost a lot of money to build, buy or lease. Moreover, sales staff is expensive. There is also inventory risk with traditional retailing. For example, if a store stocks items that its customers do not want, its profitability sags. eBay does not have these costs or risks. Finally, eBay has dramatic economies of scale making expansion less costly than most retailing firms.
Skepticism on the Street
In the first quarter of 2005, the company’s growth rate downshifted from spectacular to merely great. This disappointed the crowd, which all-too-often extrapolates superior results into the distant future. At the same time, the company pursued its ongoing acquisition strategy to help expand its core business by bringing PayPal and Skype into its portfolio. The results were mixed. PayPal, an online payment merchant, was a natural product extension to its auction business and was a winner from the start. Skype, an online telecommunications provider, proved to be a more difficult fit. During this time, eBay faced additional challenges. Specifically, its online design and search capabilities began to suffer and lag behind its competitors. But perhaps the biggest hurdle for eBay is convincing users and investors of its non-auction fixed-price selling strategy.
Bright Future
At Ariel, we see things differently. We believe eBay’s efforts to build out its fixed-price channel will complement its well-known auction business and ultimately bear fruit. The company has also acknowledged and made good progress on refreshing its user interface with updated search capabilities, descriptive product listings and more detailed seller reviews. Finally, we believe the market often overlooks parts of a company that are less well-known like PayPal—thus ignoring significant value.
Many only see PayPal as a way for eBay buyers and sellers to exchange money for goods. However, more than half the payments processed through PayPal come from third party vendors such as Avon, iTunes, eHarmony.com and PETCO.com to name just a few. We expect this business to grow in a consistent and significant way.
As of September 30, 2008, shares traded at $22.38, a 39% discount to our estimate of its $36.68 private market value.
eBay, Inc. (NASDAQ: EBAY)
2145 Hamilton Avenue
San Jose, CA 95125
408-376-7400
www.ebay.com
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Jones Lang LaSalle is a leading global real estate services firm. Its roots are in representing the owners and occupiers in the leasing, buying, and selling of commercial real estate. In that business, it receives a commission when a property changes hands. It also manages commercial real estate, performing all the tasks necessary to run an office building or other business facility. Think of this as real estate management outsourcing. Finally, it is an asset manager, holding a portfolio of real estate investments on behalf of clients. The latter two are fee-based businesses, with typically steadier earnings streams.
Wall Street’s View
As the credit crisis grew in late 2007, shrinking access to loans meant fewer real estate transactions, which the market sees as critical to a company’s profitability and growth. Recently, there has been more bad news: unemployment is rising, office vacancies are up even in places like New York and economic woes are spreading globally. The street has locked in a dark and gloomy scenario for commercial real estate. Moreover, the financial community is discounting earnings from the investment management business which is much less cyclical and more stable.
An Ariel View
At Ariel, we focus on the long-term fundamental reality: large, multinational companies need space, and representation to buy and lease it, on a global basis. Few firms can service that need worldwide, and Jones Lang LaSalle is one of them. Moreover, companies increasingly realize outsourcing non-core functions eliminates hassles and boosts profits, so outsourcing will grow. Finally, we believe Wall Street is ignoring the value of the asset management business.
Seeing Jones Lang LaSalle’s future
Conventional wisdom says transaction-based business is shrinking, so the whole company is shrinking. We believe the three main business lines are dynamic as percentages of the overall enterprise. Some years the brokerage unit may be the hero, while other years the outsourcing business will be stronger. To us it is clear–outsourcing is growing dramatically, by nearly 30% year-over-year. Also, we believe real estate investing is here to stay, and will likely be increasingly important to pension plans and other institutional investors seeking diversification.
Solid Management
When tough times hit a company, it is critical to have a strong team of rational leaders running it. We have known this management team well for a long time and they are very knowledgeable, highly skilled and deeply prudent. We believe their caution shown by an avoidance of heavy debt, means their firm is not at risk in a downturn—while many others are. During the storm, they remain fixed on running the business for the long-term. For instance, this year Jones Lang LaSalle opportunistically added to their staff in Europe to enable future growth. More importantly, they recently acquired the Staubach Company. This move enhances the firm’s capabilities, as Staubach is a leading tenant representation firm in the United States. We think tenant representation should have defensive characteristics in a downturn, as falling rent prices give tenants better bargaining power.
As of September 30, 2008, shares traded at $43.48, a 53% discount to our estimate of its $91.95 private market value.
Jones Lang LaSalle Inc. (NYSE: JLL)
200 East Randolph Drive
Chicago, IL 60601
312-782-5800
www.joneslanglasalle.com
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Founded in 1903 by the du Pont family, Wilmington Trust is the leading bank in Delaware. Its three main businesses all share the common traits of high-quality and professional client service. The core is a regional bank, with an emphasis on serving high net-worth families and small businesses; it has more branches than any other bank in its home state. Its wealth advisory services group provides affluent families with asset management, tax planning, trust management and so forth. In its corporate client services area, it serves as a trustee, agent, asset manager or administrator in a variety of ways for corporations.
Low Key
Upper management at Wilmington sees banking as simple—provide credit to those who are likely to repay it and hold assets on behalf of those who need security. These basic tasks create modest, but ultimately dependable growth. While others expand into new territories and venture into increasingly exotic business lines, Wilmington’s leadership is content to stay home and serve their clients well. With a strong balance sheet, Wilmington delivers excellent long-term returns without taking undue risks.
Long Relationships Build Long-Term Value
Wilmington Trust has built its reputation on a higher level of service. It has served a number of families for five generations, and some of the wealth advisors have worked with the same clients for 35 years. Thus highly valued assets stay in place and grow. The bank’s focus on personal service and a true relationship does not stop with the affluent. Wilmington insists on interacting with all loan customers, while many of its peers use intermediaries. These practices organically mitigate risks and steer the bank clear of quick-money methods that have burned so many banks in the credit crisis.
Delaware: Small Wonder
Delaware is a great place to run a bank. Unlike the struggling rust belt and the boom and bust sun belt, this mid-Atlantic state is very stable, featuring low unemployment and a healthy number of retirees. While housing prices have plummeted elsewhere, they have fallen only marginally in Delaware and its neighboring states. That means fewer loan losses for banks, which drives slow and steady earnings growth. Because there are no state corporate income taxes, many companies file for incorporation there, creating an opportunity for Wilmington’s corporate client services business.
Getting Back to Basics
The complicated securities that led to the credit crisis underscore the importance of strong and trusted fiduciaries. Wilmington is a rare combination of world-class knowledge in trust services without the conflicts of interests posed by traditional investment banks. As a result, we believe the company is well-positioned to be a leader in corporate trust as the credit crisis changes the face of financial services.
As of September 30, 2008, shares traded at $28.83, a 33% discount to our estimate of its $43.07 private market value.
Wilmington Trust Corporation (NYSE: WL)
Rodney Square North
1100 North Market Street
Wilmington, Delaware 19890
302-651-1000
www.wilmingtontrust.com
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