We took a stake in Schwab, the largest publicly held brokerage business in the country, after it came under significant pressure in late 2018 and early 2019 as customers began shifting their cash balances into higher-yielding products. This trend put pressure on the company’s asset growth and revenue. In early October, the pressure accelerated when Schwab announced it would cut online stock trading commission to zero, creating a clear short-term headwind to revenue and profits.
However, shares rallied on news that Schwab was acquiring competitor TD Ameritrade Holding Corporation (AMTD) in an all-stock deal. The transaction is expected to boost earnings by 15% to 20% over three years, as Schwab should be able to reduce Ameritrade’s cost structure by 60% to 65%.
Going forward, we except earnings growth to resume, driven by continued market share gains in Schwab’s brokerage and advisor-services businesses as well as accretion from the Ameritrade transaction.
The portfolio’s Health Care names were among the top performers on an absolute basis and the group contained a key contributor, Triple-S Management Corporation (GTS).
Triple-S is a managed care company in Puerto Rico that operates under the Blue Cross name. The company also has a property and casualty insurance unit that is not core to its overall business strategy. During the summer, a negative research report was released that suggested the company lacked adequate reserves to meet a potential surge in property and casualty claims stemming from 2017’s Hurricane Maria.
When the report was published, we once again revisited our investment thesis, delving into the potential impact a significant increase in new claims filed would have on earnings and balance sheet strength. Additionally, we dug into the assumptions used in the bear case to determine whether the scenario suggested by the authors was likely to play out. At the conclusion of our review, we remained confident that Triple-S offered an attractive risk-reward profile.
In the months following the report, the flood of claims predicted by the authors has yet to materialize, and shares have recovered. Longer term, we view Triple-S as a compelling opportunity due to its potential to increase market share, recently approved rate increases and continued progress on cost cutting.
No deal. Following a string of strong gains during the past several quarters, the Real Estate sector lagged the broader market to close out the year, and the portfolio’s holdings in the space contained a key detractor. CyrusOne Inc. (CONE), one of five publicly traded datacenter real estate investment trusts (REITs) in the U.S., sold off after management announced that the business was not pursuing a sale to a competitor or private equity, as had previously been rumored.
We originally took a position in CyrusOne in early 2019 after shares had fallen out of favor with investors who were concerned about recent softness in margins and cash flow. The weakness stemmed from company efforts to expand in Europe. At the time, we believed management had set the stage for strong growth relative to peers once the overseas initiatives began to produce results.
Soon after we initiated a position in CyrusOne, the company began showing progress in boosting earnings per share. However, as merger rumors began to heat up, CyrusOne shares approached our estimates of fair value and we began trimming the strategy’s exposure to the name.
As shares sold off once it became clear there were no efforts to find an acquirer, we began increasing our stake at what we believe are compelling valuations.