Activist Billionaire Barry Rosenstein’s Two New Picks: 2015 Q3 Investor Letter Highlights

As you already know, the third quarter was terrible for most smart money investors, who suffered significant losses amid the market turmoil caused by a slowdown of the global economy, weak commodity prices, and uncertainty regarding the next interest rate hike by the Fed. Activist Barry Rosenstein‘s JANA Partners was not spared, with its JANA Master Fund having posted losses of 8.2% in the third quarter, compared to a 6.4% decline for the S&P 500, according to a recent letter to investors. The investor decided to trim his long exposure in this environment amid the “macro backdrop”. Still, during the third quarter, JANA initiated stakes in Microsoft Corporation (NASDAQ:MSFT) and Baxter International Inc (NYSE:BAX). In this article we will take a closer look at JANA’s theses on its recent additions and see some other portfolio highlights.

Even though JANA Partners and other funds from our database have shown weak returns for the last quarter and overall year-to-date, they are still significantly ahead of the market over the long-term. JANA Partners has a total return of nearly 418% since inception, compared to 120.5% for the S&P 500. The focus on the long-term is what makes hedge funds the perfect investors to emulate. We have over 700 funds in our database and by identifying the stocks that they are collectively bullish on, we can obtain market-beating returns. The key is to follow their most popular small-cap picks, the top 15 of which have returned 102% since August 2012, beating the market by some 53 percentage points (see more details here).

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Microsoft Corporation (NASDAQ:MSFT) was added to JANA’s portfolio in the third quarter and we will see the size of the position once its 13F filing is out in the coming days. Rosenstein decided to take advantage of the lower share price amid the broader market decline to initiate a stake at 11-times Microsoft’s estimated 2016 free cash flow. The investor believes that Microsoft Corporation (NASDAQ:MSFT) has many opportunities to increase its profit and free cash flow per share over the next one-to-two years. Even though its operating margin has decreased over the last several years, Microsoft’s operating expenses are still pretty high and its management can continue the same trend by cutting operating expenses, driving profits higher.

“We expect dividends to continue to increase and for about $4.0 billion of cash to be directed towards share repurchases on a quarterly basis,” JANA added.

Among other things, JANA also praised Microsoft Corporation (NASDAQ:MSFT)’s transition towards the cloud and the transformation of its business model to an annual subscription-based service.

“Putting it all together, we see an asymmetric risk/reward profile in a large cap leader undergoing a significant transformation,” the letter also said.

Microsoft Corporation (NASDAQ:MSFT) currently has another activist fund on its board of directors, Jeff Ubben’s ValueAct Capital, which owns 75.27 million shares of Microsoft according to its latest 13F filing. Stephen Mandel of Lone Pine is also bullish on the company, disclosing it among its top picks in the firm’s own third quarter letter to investors.

Another new position in JANA’s portfolio is Baxter International Inc (NYSE:BAX). Rosenstein is following in the footsteps of another activist, Dan Loeb of Third Point, who initiated a stake in the stock in July and boosted it to 9.9% in the third quarter, along with obtaining two board seats. In the letter, JANA said it followed Baxter for several years before initiating a stake after the spin-off of Baxalta Inc (NYSE:BXLT). The 13% drop of Baxter International Inc (NYSE:BAX)’s stock between July and September, made Baxter International Inc (NYSE:BAX) more attractive for entry and JANA thinks that the company has good assets that will allow it to increase its margins considerably.

“Our experience informs us that our Baxter investment will require patience; the progression toward higher margins will require sharper attention to costs, a re-constitution of the portfolio and better execution,” JANA added.

On the following page, we will take a closer look at some other highlights from JANA’s letter, namely two other healthcare stocks, Allergan PLC (NYSE:AGN) and Walgreens Boots Alliance Inc (NASDAQ:WBA), and one tech pick, QUALCOMM, Inc. (NASDAQ:QCOM).

Allergan PLC (NYSE:AGN) represents one of JANA’s passive holdings, the fund owning 1.61 million shares as of the end of June. Rosenstein has been bullish on Allergan since 2013 (when it was called Actavis) and the company has made several important steps toward per-share value growth, such as the acquisition of Forest Laboratories and Allergan and the sale of its generics business to Teva Pharmaceutical Industries Ltd (ADR) (NYSE:TEVA). The investor believes that the company is on a path to become one of the leaders among branded pharma companies, which is why in September, JANA swapped its Valeant Pharmaceuticals Intl Inc (NYSE:VRX) stake for an increased position in Allergan. Many of Rosenstein’s peers seem to share the same view on Allergan PLC (NYSE:AGN), since the company ranked as the most popular among the funds we track, with 151 funds holding stakes as of the end of June. In the current round of 13F filings, Clifford Fox’s Columbus Circle Investors reported holding 836,352 shares of Allergan PLC (NYSE:AGN) as of September 30.

Walgreens Boots Alliance Inc (NASDAQ:WBA) is another healthcare pick of JANA Partners, in which it reported a position containing 13.75 million shares as of the end of June. In the letter, the investor praised Walgreens’ plans to acquire Rite Aid Corporation (NYSE:RAD), which will strengthen Walgreens Boots Alliance Inc (NASDAQ:WBA)’s position in the market and also carries some attractive financial metrics, with $1.0 billion in synergies. Barry Rosenstein also serves on Walgreens Boots Alliance Inc (NASDAQ:WBA)’s Board of Directors and will support the company’s management with its plans to increase shareholder value.

QUALCOMM, Inc. (NASDAQ:QCOM) ranked on the second spot in JANA’s 13F portfolio at the end of June, the fund holding 28.82 million shares of the company. Rosenstein believes that Qualcomm is much better positioned than its semiconductor peers, trading at less than 10-times earnings, excluding cash, below its industry peers. Therefore, the stock carries a significant intrinsic value and the Strategic Realignment Plan that is currently in process should further increase the value of the stock, bringing more profits to QUALCOMM, Inc. (NASDAQ:QCOM)’s shareholders. Aside from JANA Partners, eight other funds managed by or affiliated with billionaire investors held shares of QUALCOMM, Inc. (NASDAQ:QCOM) at the end of June.

Disclosure: None