Exceptional Opportunities Arise From Market Volatility

4Q2022 New Holdings:

• Cogent Communications
• Danaher
• Hilton
• Transdigm Group
• Warner Music

COGENT COMMUNICATIONS: The low-cost, high value internet service provider

Today Cogent serves just two key customer segments using a highly efficient and scalable, 100% fiber internet network. With its enormous reach and operating efficiencies, Cogent is able to position itself as an independent, global Tier 1 alternative to traditional legacy telcos. A recent acquisition should enable the company to add a third customer segment with minimal new operating costs and high revenue potential. Pre-acquisition, the company serves the following two customer segments with its global network:

1. Corporate Segment – Cogent provides direct internet access and virtual private network (VPN) services to corporate customers located in large multi-tenant office buildings at the same or better price than competitors while providing industry-leading broadband speeds, latency, and turn-on times. Its Corporate business makes up approximately 57% of overall revenue, sees low customer churn and is a recognized service leader.

2. Netcentric Segment – Cogent provides global wholesale IP transit services, accessed through carrier-neutral data centers, servicing hyperscale internet companies, content companies and other global telecom companies. Cogent’s wholesale IP transit business carries roughly 23% of global internet traffic and runs at around 30% peak utilization. Its Netcentric business comprises about 43% of total revenue, is a price leader and grew its current market position from zero to 23%over the last fifteen years.

Access to a third customer segment, Wave Services, will come through its acquisition and integration of Sprint’s legacy wireline fiber assets purchased from T-Mobile. Wave services are dedicated point-to-point circuits used by large corporations and global hyperscale providers.

Over the next 5-7 years, Cogent management will focus on: 1) taking share from other wave service providers (just as it has in its Netcentric Segment for the past 15 years), 2) delivering the anticipated acquisition cost synergies, and 3) realizing normalized growth in its two existing business segments. If successful, we believe that shareholders of Cogent could see a high teens or better annualized total shareholder return over the next seven years comprised of its current 6% dividend yield and the mid-teens growth of free cash flow as revenue rises 2-3x, EBITDA increases 2.5-3.0x and net income is modestly offset by rising debt costs.

DANAHER: Providing investors access to the potential growth of biologics and gene/cell therapy

Danaher is a global science and technology innovator in the biopharma and diagnostics industries. Over the past several years, management has strategically transformed Danaher into a science and technology leader by shifting away from manufacturing and industrial end-markets towards healthcare/life sciences. 

The company is comprised of over 20 operating companies that will be organized under the following segments pro forma for the anticipated separation of the company’s Environmental & Applied Solutions business in Q4 2023:

•    Biotechnology and Life Sciences – Danaher offers a broad range of instruments and consumables used by its customers primarily to study genes, proteins, metabolites, and cells to understand the causes of disease, identify new therapies, and test and manufacture new drugs and vaccines. The company enjoys strong positions in important steps in bioprocessing: cell culture media, bioreactors, purification, filtration, and chromatography. The company is a market leader in high margin single-use technologies, which are taking market share in bioprocessing applications.
•    Diagnostics – Danaher provides clinical instruments, reagents, consumables, software, and services that hospitals, physicians’ offices, and reference laboratories use to diagnose disease and make treatment decisions. This industry is attractive as diagnostic testing represents a small percentage of healthcare system costs but has a meaningful impact on treatment and patient outcomes. There is also a high recurring revenue mix in diagnostics with reagents and test cartridge consumables and services representing more than 80% of diagnostic revenue for Danaher.

We believe Danaher is well positioned to benefit from the growth of biologics and gene and cell therapy. Danaher’s secular growth trends should allow for high single digit organic revenue growth in 2024 and beyond. In addition, based on the management team’s demonstrated track record of accretive acquisitions, there may be upside potential from future transactions.

HILTON: A high-quality, asset-light hotel chain

Hilton is a leading hotel chain with a family of brands covering a wide range of lodging price points. Well-known company brands include Hilton, Hampton Inn, Homewood Suites, DoubleTree, Embassy Suites, Waldorf Astoria, and Conrad, among others.

Hilton is primarily a franchisor, licensing its brand names, operating processes, and information technology and reservation systems to hotel operators. Importantly, Hilton’s Honors membership rewards program builds guest brand loyalty and cost-efficient traffic for hotel properties. In combination, these solutions provide hotel operators with a clear and compelling value proposition, enabling Hilton to earn very attractive economics and enjoy long duration, largely recurring revenue.

Hilton has roughly a high single-digit market share of global hotel rooms today, making it the second largest hotel company behind Marriott. However, Hilton enjoys a nearly 25% market share of new hotels in development, which sets up a visible and attractive growth profile.

Historically, room count at Hilton has grown about 5-6% per year and we expect this to continue for at least the next decade as emerging markets grow and increasingly adopt known hotel brands on their newly constructed properties. Overall, we anticipate revenue will grow 7-8% per annum over a full economic cycle. With modest margin expansion and an asset-light business model, we think Hilton can deliver mid-teens earnings per share growth for many years to come.

TRANSDIGM GROUP: Leader in highly engineered aerospace components

TransDigm is an aerospace component manufacturing company that produces “small pieces that go into big planes.” The company partners with commercial aircraft and large defense OEMs to develop, design, and produce components for the aerospace and defense industry. TransDigm initially sells components to the OEMs to be placed on the plane. Once a plane enters into service, certain parts are replaced in the aftermarket as part of the plane’s maintenance cycle which drives highly recurring revenue.

For approximately 75-80% of TransDigm’s revenue, the company is the sole source for that component, which provides strong pricing power. Further, government certification of new parts is a time-consuming and expensive process, resulting in much lower margins for competitors. From the airline’s perspective, switching to a new supplier also carries a high cost of failure.

During the height of the COVID-19 pandemic, TransDigm proved resilient by maintaining margins and continuing to produce cash. In economic downturns the number of miles flown by airlines does not change much. For example, during the great financial crisis from 2007 to 2009, miles flown in the US were down only 7% and TransDigm’s revenue was down even less.

As we look to 2023, we anticipate miles flown to return to the historical annual trendline growth of approximately 3-4% for the industry. TransDigm should be able to grow revenue organically at 6-8% through a full aerospace cycle. In addition, over the past 25 years, the company has been an aggressive acquirer of other aftermarket aerospace parts businesses and we anticipate that these purchases will continue.

WARNER MUSIC: Streaming apps providing profitable and growing revenue stream

Warner Music is one of three top music labels that combined control about 70% of the industry: Universal Music has about 31% market share, Sony 23%, and Warner 18%. Warner has rights to recorded music and published notes and words to the songs of thousands of bands and artists that span modern and classic music, including Bruno Mars, Lizzo, Red Hot Chili Peppers, Prince, AC/DC, and Aretha Franklin.

Warner has an asset light, royalty-based business model with high margins and, we believe, a long growth path ahead. Every time a Warner song is played on a paid streaming music app, in television commercials, movies, or at a concert, Warner receives a royalty payment—which is typically less than one cent per play—adding up to nearly $6 billion of revenue per year. About one-third of this revenue is paid out to artists and song writers, with about two-thirds remaining for Warner to promote existing music and artists, find and fund new talent, and administer its business.

We also believe Warner benefits from secular growth as streaming services such as Spotify, YouTube Music, Apple Music, and others have breathed new life into this industry and comprise a growing percentage of revenue. In addition, rapidly growing consumer services with music overlays including Peloton, TikTok, video games, and Facebook/Instagram Stories, provide additional tailwinds. There are about 600 million global paid streaming music subscribers today, and we believe that subscriber base will grow to exceed 1.2 billion over the next decade. 

With these tailwinds, we believe Warner will grow revenues at a 9-10% compound rate and earnings per share at a mid- to high-teens rate over the next decade.