Recent Annual Report - Gabelli

• Second, we focus on companies whose public price is meaningfully less than our estimate of their
Private Market Value (PMV), or what an informed buyer would pay to own the entire enterprise. This
“margin of safety” provides us with significant upside potential and downside protection. Note that PMV
is not static; it should grow along with a company’s assets and cash flow potential. Whether a security’s
public price keeps pace with PMV growth can determine whether its margin of safety waxes or wanes.
• Finally, we attempt to articulate one or more catalysts that will narrow a company’s discount to PMV.
Catalysts can take many forms including mergers and acquisitions (M&A) activity, financial engineering
such as spinoffs and buybacks, change in management, evolution in regulation, completion of a major
project or introduction of a new product.
As portfolio managers our job is to balance the above considerations: a high quality company with a near
and certain catalyst could warrant a smaller margin of safety than the converse situation. Our aim is to
maximize returns while minimizing the potential to permanently impair capital. We seed the portfolio with a
diverse basket of ideas that can be harvested regularly at irregular intervals. Over time we have demonstrated
this is the best way to generate superior returns.
Deals, Deals, and More Deals
After accelerating into year-end, worldwide M&A activity rose 2% in 2012 to $2.6 trillion. Several Fund
holdings were subject to takeovers throughout the year. In May, Thomas & Betts was acquired by Swiss
industrial giant ABB for $72 per share in cash, giving ABB a greater presence in the low-voltage electrical
products market. In August, Robbins & Myers agreed to be taken over by National Oilwell Varco for $60 per
share. In December, Eaton Corp. (0.1% of net assets as of December 31, 2012) completed its acquisition of
Cooper Industries. Private label food manufacturer Ralcorp (0.2%) announced that it agreed to be acquired by
ConAgra Foods for $90 per share in November. In December, Intermec (0.1%) agreed to be acquired by
Honeywell (2.8%) for $10 per share.
As noted in prior commentaries, 2012 brought a continuation of the trend of “financial engineering,” as
companies surfaced value with spin-offs, split-offs, or the sale of a division. Ralcorp spun off Post Holdings, its
branded cereal business, in January. At the end of June, Sara Lee paid a $3.00 per share special dividend and
separated into two companies: Hillshire Brands (0.3%), a U.S. based producer and marketer of branded meat
products, and D.E MASTER BLENDERS 1753 (0.5%), a Netherlands based coffee and tea company. In
October, Kraft completed the spin-off of its North American retail business, Kraft Foods Group (0.2%), and
renamed itself Mondelez International (0.4%), focusing on its higher-growth global snacks business. That same
month, Tyco (0.5%) completed its business separation, with the “new” Tyco becoming a pure-play global fire
and commercial security firm following the spin-off of its residential and small business alarm monitoring
business ADT Corp. (0.5%) and the merger of its flow control business with Pentair Ltd. (0.1%), a global water
focused pump and valve maker. Gaylord Entertainment completed its sale of the Gaylord Hotels brand and
management company to Marriott International, and converted itself to a REIT structure, renaming itself Ryman
Hospitality Properties (1.0%). Others are still in process, including News Corp. (1.5%), which will separate its
extensive publishing operations from its faster-growing entertainment division. We believe many of these
companies – as well as those that underwent financial engineering in 2011, such as Beam (0.9%), Exelis
(0.3%), and Xylem (0.6%) – are potential takeover candidates.
While the future is always impossible to predict, we are encouraged by continued ample cash on
corporate balance sheets and financing availability at nearly unprecedented low interest rates. We believe that
with increased visibility on future tax rates and regulations, we will see a continuation of the “Fifth Wave” of
takeover activity in 2013 and beyond.
6