Elan Corporation, plc (ADR) (ELN), Actavis Inc (ACT): Billionaire James Dinan Liked Pharmaceuticals Last Quarter

Several weeks after the end of each quarter, hedge funds and other major investors are required to file 13Fs with the SEC to disclose many of their long equity positions as of the end of the quarter (so the most recent round reports positions as of the end of June). We track 13Fs for a variety of purposes. For one, we have found that the most popular small cap stocks among hedge funds generate an average excess return of 18 percentage points per year (see the details here) and have adapted this strategy into a real-time portfolio which outperformed the S&P 500 by 33 percentage points in the last 11 months. It’s also useful to look at how top managers have been trading the markets- not necessarily to blindly follow them, but to use their filings as a source of free initial investment ideas. We have compared billionaire James Dinan’s York Capital Management’s most recent 13F to the fund’s previous filings (see a history of Dinan’s trading activity) and here are some things which we noticed:

Drugmakers. Two of the largest new positions in York’s portfolio were a stake of 17 million shares in Elan Corporation, plc (ADR) (NYSE:ELN) and a sizable position in Actavis Inc (NYSE:ACT). These two drug companies, interestingly, are playing opposite roles in two similar acquisitions. Elan Corporation, plc (ADR) (NYSE:ELN), based in Ireland, is a biotech company being acquired by U.S. pharmaceutical company Perrigo Company (NYSE:PRGO), which tends to focus more on generic drugs. Actavis Inc (NYSE:ACT) is itself an American drug company specializing in generics, which is currently in the process of acquiring branded and generic drug developer and manufacturer Warner Chilcott Plc (NASDAQ:WCRX). Both Actavis Inc (NYSE:ACT) and Perrigo Company (NYSE:PRGO) will move their headquarters to Ireland, a lower tax jurisdiction, upon completing their respective transactions. Merger arbitrage is a popular investment strategy, explaining the fund’s interest in Elan Corporation, plc (ADR) (NYSE:ELN) (learn more about merger arbitrage strategies), but the investment in Actavis Inc (NYSE:ACT) suggests that Dinan and his team may believe that these types of deals will create shareholder value.

Sprint. Between April and June, Dinan increased the size of his position in Sprint Corporation (NYSE:S) to a total of about 79 million shares making the communications company his largest 13F holding by market value. Sprint Corporation (NYSE:S) was another merger arbitrage play at the time, but following the acquisition of a majority stake by SoftBank a minority stake in the company remains publicly traded as Sprint Corporation. As part of the deal Sprint also received billions in cash from Softbank which may help it cover current operating losses (Sprint Corporation (NYSE:S) had consistently been losing money prior to the deal) and strengthen its competitive position. The stock is up moderately since the transaction.

Selling top picks in financials. According to the filing, the fund sold about 40% of its holdings of Realogy Holdings Corp (NYSE:RLGY), the $6.2 billion market cap real estate broker which owns Century 21 and Coldwell Banker, and also sold nearly 4 million shares of American International Group Inc (NYSE:AIG). A number of other billionaires had been cutting their stakes in American International Group Inc (NYSE:AIG) last quarter, yet it still made our list of the most popular stocks among hedge funds for Q2 (check out the full top ten list). Wall Street analysts are calling the stock a good value, with a forward earnings multiple of 11, and in fact American International Group Inc (NYSE:AIG) does trade at a significant discount to the book value of its equity.

Realogy Holdings Corp (NYSE:RLGY) went public last October, and is up 23% from its levels shortly following its IPO. In the second quarter of 2013, revenue grew by 17% versus a year earlier driving the company into profitability. The sell-side, likely looking for continued strength in the housing market, is forecasting $2.71 in EPS for 2014 which places the current valuation at 16 times forward earnings estimates. We’d note that this projection is based on very large percentage increases in earnings per share.

As a result, while we are impressed with Realogy Holdings Corp (NYSE:RLGY)’s recent growth we would hold off on buying the stock for now. AIG, however, is at least a possible value prospect given the discount to book (though we wouldn’t count on the P/B ratio rising all the way to 1 in the near future). We’re not very familiar with the details of the pharmaceutical companies’ products, and so wouldn’t be comfortable recommending those names in terms of their fundamentals; if an investor did buy Elan or Warner Chilcott Plc (NASDAQ:WCRX) it would probably be because of an attractive merger arbitrage situation.

Disclosure: I own no shares of any stocks mentioned in this article.