Money was never a big motivation for me, except as a way to keep score. The real excitement is playing the game.”
– Donald J. Trump, Trump: The Art of the Deal
Love him or loathe him, I think all of us can agree that President Trump relishes deal-making. The HUUUGER, the better, and boy oh boy can he chase the biggest of deals from his perch in the Oval Office. Forget picking up Mar-a-Lago for pennies on the dollar or securing air rights to build Trump Tower. That’s chump change, private sector stuff. His “gameboard” today spans far beyond real estate and media to some of the biggest public policy issues of our time, including international trade, healthcare, taxation, and nuclear weapons.
Since the Dealmaker-in-Chief took office, our clients regularly inquire about political risk in their portfolios. They ask me what I think Trump’s unorthodox style and seemingly manic drive to unilaterally do deals means for financial markets and the global economy itself. Will he push too far with the unfinished deals on his bucket list and lead us into a prolonged, global trade war or, God forbid, a nuclear conflict?
System-wide checks and balances both here and abroad, admittedly facing more stress than they have in decades, remain robust enough to keep my base case for the Trump wild card less dire. But let’s face it: Trying to predict how far the President will go to “win” big public policy deals is like trying to predict the path of a tornado. If I’ve learned anything in Trump’s first 500 days, it’s to expect the unexpected. And with most financial markets seemingly baking in a “more bark than bite” set of outcomes for trade and nukes, anything less benign could quickly reverse the positive mood in today’s markets.
I write this piece mid-June, just a day after the over-hyped Singapore summit with North Korean leader Kim Jong-Un came and went with little fanfare for financial markets. Post-summit, as the delegations packed up and as former Pistons Bad-Boy Dennis Rodman’s expert witness gig was complete (how strange was that?!), global financial markets quickly returned to the business of the day.
Here in the U.S., at least, that business is looking pretty good overall. If there are fears that our President will sabotage the economy or damage relationships with our allies merely to get a mega-deal done, markets and businesses are doing a good job of hiding them. U.S. stock markets continue to march toward new highs, and global merger and acquisition activity is on track to post its largest year ever. Large businesses aren’t the only ones feeling confident. In fact, according to the National Federation of Independent Business, small businesses, which account for roughly half the American economy, are as optimistic as they’ve been in 35 years (see figure). These businesses are reporting solid earnings, planning expansions like never before, and raising wages.
Our team at the FIM Group remains constructive, given the current positive backdrop, while staying guarded against future possibilities. Not only are we cautious toward the possibility of the country’s experiencing a major policy mistake, but we are also closely monitoring the demographic, debt, and disruptive technological forces that will surely shape corporate profits, money flows, and investor sentiment far beyond President Trump’s tenure in D.C. As such, we continue to be largely focused on maintaining good balance in our core investment strategies. We are also spending most of our analytical time at the portfolio-holding level. We believe that days spent rigorously assessing each of our current and prospective investment holdings for the quality and valuation factors that will determine our long-term portfolio performance are generally more productive than time spent trying to handicap public-policy maneuvering.
Part of our investment holding-level assessment process, of course, is getting out and kicking the tires of our holdings. To that end, as this newsletter goes to print, I should be on the final stretch of a two-week research trip to Vancouver, Hong Kong, and Japan. There, I will meet the management teams of two dozen or so current or potential portfolio companies and learn more about their businesses. I’m sure that I’ll also hear from some about how they are characterizing and managing the risks they perceive with the Trump Presidency. I look forward to sharing highlights of this trip with you in a client webinar later this summer.
In closing, and staying on the theme of deal-making, I’ll summarize below two transactions recently announced by FIM Group portfolio holdings. One of our jobs as investment managers is to analyze these deals as they are announced, consider any share-price response to the news, and take appropriate portfolio action. With global corporate deal activity as hot as it is, I expect to analyze quite a few more transactions in the months ahead.
The Deal: MPW to sell a 50% stake in its German post-acute hospital portfolio to a European wealth management company for cash proceeds of EUR1.14 billion.
Background/Rationale: Over the last few years, MPW, a real estate investment trust that owns hospital properties here and in Europe, assembled a portfolio of 71 hospitals in Germany. As market valuations improved and institutional investor interest grew, MPW management had an opportunity to realize a significant (EUR500m) partial gain on its investment. As part of the deal, MPW will continue to manage the facilities and earn ongoing fees.
The Impact: This deal is the second partial divestment announced by MPW in the last few weeks. Management will take proceeds from both and deleverage (pay down debt) and then will make new hospital acquisitions at more attractive prices. Depending on the timing of new investments, the deals may lead to a short-term decline in cash earnings. Longer-term, MPW’s healthier post-deal balance sheet and demonstration of significant embedded value in the portfolio should boost investor sentiment toward the stock.
The Deal: Philips (see the Investment Team Spotlight) to buy EPD Solutions, a company that develops image-guided cardiac arrhythmia treatment products, for $293m upfront and an additional $246m on completion of certain milestones.
Background/Rationale: After a series of divestments, Philips has transformed itself into a health technology company with a strategy to grow both organically and through targeted acquisitions. EPD has developed an innovative imaging and navigation system for use in heart rhythm disorder procedures. EPD’s solution provides real-time detailed images of the heart anatomy, which helps pinpoint the location and orientation of catheters during diagnostic and therapeutic heart procedures. It fills a gap in the existing Philips portfolio of interventional imaging systems and will strengthen its offering in the multi-billion-dollar market for image-guided treatment of cardiac arrhythmias.
The Impact: EPD Solutions only recently won approval for use in Europe and is still under review by the FDA in the U.S., so the near-term impact of this deal will be minor for Philips. Longer-term, the addition of EPD will help Philips grow its EUR 7 billion diagnosis and treatment business, which the company expects to expand significantly in the years ahead.
A recent study of financial abuse estimates that scammers steal from the elderly at a rate of $37 billion per year…yes, billion, not million. That’s tough for most to comprehend. The study also estimates that almost 5 million senior citizens in America are victims of elder abuse each year. In New York State alone, financial abuse of the elderly exceeds $1.5 billion a year. While the exact nature of financial abuse may be difficult to notice for seniors with cognitive impairments, the legal definition perpetuated in the Older Americans Act of 2006 criminalizes “the fraudulent or otherwise illegal, unauthorized, or improper act or process of an individual…that uses the resources of an older individual for monetary or personal benefit, profit, or gain, or that results in depriving the older individual of their use or rightful access to benefits, resources, belongings, or assets” (Gallivan & Gallivan).
Just this month, Bloomberg Businessweek reported a sad and unfortunate portrait of elder abuse in the case of an 82-year-old woman who received an anonymous call stating she had won money in a sweepstakes. According to the caller, this woman, who was legally blind and lived alone, was told she would need to pay the “taxes and fees” on her winnings before the release of funds. After she wired the money to the anonymous caller, more stipulations and conditions became attached and the woman continued to send money until she depleted her entire savings. She also took out a reverse mortgage on her home and cashed out a life insurance policy. Instead of reaching out to her family for help, this ashamed and embarrassed woman killed herself. Some would say she was just plain foolish…after all, who would fall for a story like that? Similar stories are popping up daily, and the scammers around the globe are becoming more creative and effective at getting innocent seniors to believe in them.
By definition, Financial Fraud is defined as:
“An intentional act of deception involving financial transactions for purpose of personal gain. Fraud is a crime, and is also a civil law violation. Many fraud cases involve complicated financial transactions conducted by ‘white collar criminals’ such as business professionals with specialized knowledge and criminal intent” (see www.bnm.gov.my).
Financial abuse is a form of elder abuse and illegal in all 50 states; however, most of these crimes go unreported. According to New York State’s Office of Children and Family Services, for every case of reported elder abuse there are an astonishing estimated 44 cases that go unreported. The primary reasons for these unreported crimes are threefold. First, the crime is often committed by a member of one’s own family, and many elderly Americans are reluctant to turn in a family member. Second, because the perpetrator of financial abuse is typically a caretaker, many elderly Americans fear that their independence is at risk unless they cooperate and that they will either end up in a nursing home or be separated from their former life. Finally, the cognitive impairment that makes them vulnerable to predators can keep them from realizing the abuse or reporting it to authorities.
Elder abuse – including, but not limited to, financial abuse of the elderly – is a “public health crisis” in the United States and costs billions of dollars each year. If you have been contacted and/or you suspect a loved one is being taken advantage of, please report it to:
Internet Crime Complaint Center (IC3) | Home: https://www.ic3.gov
The IC3 accepts online Internet crime complaints from either the victim or a third party to the complainant. The center can best process a complaint if it receives accurate and complete information from the victim or a third-party individual.
If you have concerns or questions regarding contact from a person or agency that you suspect may be carrying out an act of financial fraud or elder abuse, please feel free to reach out to us at the FIM Group or to the custodian of your investment account. Also, be sure to take advantage of security opportunities (some of them free) offered to protect assets, and know that it’s recommended that passwords be changed frequently, or at least two to three times per year.
Draysen Wilson grew up on the luscious slopes of Haleakala in a little country town called Ulapalakula. He then moved to his family’s Kona coffee farm on the Big Island until he left for college on the “mainland.” Dray attended the University of San Diego and got a BBA in Business Administration and Supply Chain Management. After moving back to Maui, he joined the FIM Group Ohana as a Client Services Representative.
As a member of the Kihei-Wailea Rotary, Dray enjoys actively participating in community-based organizations. He is an avid surfer and enjoys growing his own food, including over 30 varieties of vegetables and tropical fruits. As a skilled chef, Dray enjoys transforming these fresh ingredients into a variety of cuisines from the 17 countries he has experienced.
Keeston Sutherland recently graduated summa cum laude from Western Michigan University with a degree in Finance. While in college he was a member of the mergers and acquisition competition team, the financial services club, and the student-managed investment fund and competed in various simulated portfolio competitions. He has joined FIM Group to help the investment team with company and market research.
In his free time, when not reading a book or a form 10-K annual report, Keeston enjoys playing basketball, biking, and hiking the trails that surround Traverse City. Now home, he hopes to get more involved in giving back to the Traverse area community.
Ticker: PHG / PHIA NA
Share Price | Market Capitalization (06/14/2018): $42.95 / 39.95 | $40.821B / 35.124B
Amsterdam, Netherlands–based Royal Philips has roughly 74,000 employees spread over 75 countries; in 2017 Philips generated nearly 18B in sales and 1.9B of net income against 1.8B in research and development spending.
The Philips story begins in 1891 when Gerard and Frederik Philips started to manufacture incandescent lamps and other electrical products. By 1927 Philips was the world’s largest manufacturer of radios and radio tubes. Known for their rotary electric shaver introduced in 1939 (under the Norelco brand in the U.S.A.), Philips also introduced the Compact Audio Cassette, later teaming with Sony to bring the Compact Disc to market (as well as the DVD).
Innovation did not stop there, as Philips is a global leader in many of their core competencies.
Philips operates with three business segments: Personal Health (Health and Wellness, Sleep and Respiratory Care, Personal Care, and Domestic Appliances), Diagnosis and Treatment (Diagnostic Imaging, Ultrasound, and Image-guided Therapy), and Connected Care & Health Informatics (Patient Care & Monitoring Solutions, Healthcare Informatics Solutions and Services, and Population Health Management).
This all means that Philips is active in an enormous variety of fields and products: power toothbrushes, mother and child care, home ventilation, CPAP, respiratory masks, male grooming, skin care, air purification, small kitchen appliances, computed tomography, magnetic resonance, X-rays, ultrasound scanners, patient monitors, hospital ventilators, defibrillators, healthcare IT, clinical and imaging informatics, home monitoring, and remote cardiac monitoring, among others.
Over the years, Philips has streamlined its business, spinning off divisions – primarily in electronics and semiconductors (and their manufacturing) – and focusing instead on health and personal care. Most recently they split their lighting division into a separate entity, a stake in which they’ve been selling down.
Investment Thesis: Philips is headed in a direction that we expect will increase their economic robustness; we believe their focus on healthcare has demographic tailwinds and the ability to smooth out the peaks and troughs of economic cycles. With nearly two-thirds of the company’s revenues derived from businesses in which they are in the top three globally, we like their “self-help” strategy, which is designed to increase shareholder value over time.
To accomplish this, Philips is focusing on areas where it has historically been strong, bolt-ons (a.k.a. tuck-in acquisitions) where its science/engineering/scale can prove synergistic, and ubiquitous healthcare systems – that is, this “connected society”, and the innovations needed in healthcare to move us forward.
Philips’s general areas of focus bring unique strengths that together make for a formidable company.
Philips’s Medtech unit – equipment and supplies – inherently has solid margins when compared to, say, pharmaceuticals/biotechnology as outcomes are more easily measured (e.g. a scanner either gives you a clearer picture or not) and cycles understood. Research timelines aren’t as stretched, and the market has a handful of large entities surrounded by dozens of smaller companies focused on narrow fields. Simply put, slow and stable core growth, with great potential for accretive mergers and acquisitions.
Philips’s Healthcare IT & Consulting unit is future oriented, with potentially tremendous growth; we surmise a bonus in this segment to be a rather “sticky” business, which means that having first-mover status and a solid offering could lead to a serious moat (economic and competitive advantage). This is also where we expect the greatest potential disruption. Philips’s proactive approach here places them in a strong position.
Philips’s Consumer Health unit is composed of a semiprofessional level of goods and services for which consumers are willing to pay a premium. These brands command pricing power while increased engagement (i.e., personalization) is blurring lines and shifting how services are rendered, naturally growing the opportunity.
An entity able to engage both individual consumers as well as large entities (trying to deliver better outcomes in an efficient manner) – now, that excites us! Efficiency and effectiveness are always a winning combination.
As a side note, healthcare also interests us, since (external) disruptive innovation has a longer lead time; this is because technological and regulatory hurdles slow innovation down and provide a greater level of visibility. Healthcare companies can be disruptive innovators, should they choose to be; hence, our preference for companies doing the work, deploying capital, and asking the tough questions – all of which amount to helping humanity make progress.
This being healthcare, stakeholders are equally if not more important through the cycle; part of our due diligence at FIM Group has been our consideration of corporate culture and ultimately weighing how Philips does business, because we believe that over the long-term this can have an outsized impact on shareholder value.
We see Philips’s innovative portfolio of products and solutions as evidence of a company that is willing to put end-user needs at the core of their business model. The balance between diagnosis, treatment, and preventative care (as well as monitoring) strikes us as a clear indication of their intentions.
This all sounds great. But is innovation truly a part of the Philips corporate culture? We believe so, considering that the words “innovation” and “innovate” are mentioned roughly 140 times in their 2017 annual report. Taken on its own, this data point might just indicate that they have a crafty public/media/investor relations team; so, when we see their 62,000 patents, 37,600 trademarks, 47,800 design rights, 3,000 domain names, and 1,200 new patents in 2017 alone, we truly believe that, YES, Philips has innovation in their DNA.
In addition, its compensation, ownership, and long-term incentives seem reasonable to us and well aligned with shareholders. This reflects on both the board and management, so we are satisfied with what we’ve seen.
Philips checks our favorite boxes: corporate culture, moat-i-ness (having the ability to grow their moat), growth, prudence, balance sheet strength, cash generation, research and development, environmental, societal, governance, economic robustness, demographic trends, future aligned strategy, track record, and total shareholder value/return potential.
Overall, we see validation in the Philips strategy through the, unsurprisingly, simultaneous and similar tacks being taken at Siemens and General Electric. Looking at the competition, we see rational entities and ultimately ample opportunity such that Philips is not in a zero-sum reality (there can be more than one leader).
Ultimately, we expect to see solid growth in revenues as well as expansion of margins – two things that are straightforward and easily tested; in this case, we believe them not to be mutually inclusive (i.e., there is a degree of independence given where Philips sits relative to peers). This means we will need to be focused on the how aspect, as innovation and stakeholder equity will drive the company’s long-term story; the intangibles today – quantified tomorrow. Meaning, all the bits that can’t be seen in the balance sheet and profit statement today, will ultimately surface in the future; at Philips we especially hold this to be true.
In the near-term, as Philips transitions from the conglomerate/industrial company many know them to be, we discern a slight discount in their valuation, plus a level of skepticism in the general investor community that we don’t believe is warranted. When we value Philips by their constituent parts, we see value and potential and growth and robustness at a fair price, thus we are enthusiastic about incorporating Philips into your portfolios.
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