Quarterly ORBIS. 30 September o r b i s mi s ORBIS/SM AUSTRALIA EQUITY

Transcription

1 Quarterly Re p o r t 30 September 2010 ORBIS o r b i s mi s ORBIS/SM AUSTRALIA EQUITY

2 ORBIS/SM AUSTRALIA EQUITY FUND Investment Objective The Investment Manager seeks long-term returns for investors that are higher than those of the S&P/ASX 300 Accumulation Index. Investment Approach The Investment Manager's basic investment philosophy is the belief that, while stockmarket prices are the best indicator of value for companies over very long periods of time, substantial deviations of those prices from their true value do occur over the short to medium term. Most businesses (and thus their underlying value) do not change much from one week to the next. Yet, their stock prices may be subject to large deviations, often for no particularly good reason. Accordingly, the Investment Manager's focus is to look for companies whose share price is much lower than what its underlying value suggests it should be, based on the Investment Manager's determination of each company's long-term business fundamentals. The Fund's portfolio is constructed using the "best" of such companies. The Investment Manager relies on the market eventually recognising a company's true value. When the Investment Manager believes this has occurred, it will replace that company with another company which it considers to be undervalued/underpriced by the market at that time. NOTICES Buy/Sell Spread. The Buy/Sell Spread is 0.35%. It represents the estimate of the cost of acquiring (Buy Spread) or disposing of securities (Sell Spread) in the Fund. Source. The source for the S&P/ASX 300 Accumulation Index is Standard & Poor's. ASX 300 is the trademark of ASX Operations Pty Limited ("ASXO"); "S&P/ASX300 TM " exists pursuant to an arrangement between ASXO and Standard & Poor's (S&P TM is a trademark of Standard & Poor's, a division of The McGraw-Hill Companies, Inc.). Returns. Fund returns are gross of all income, net of all expenses and fees, assume reinvestment of distributions and exclude any spreads that might be payable on some transactions, i.e. on a "mid-to-mid" basis. Risk Warnings. Past performance is not indicative of future performance. The Fund's unit price will fluctuate and the Fund's performance is not guaranteed. When making an investment in the Fund, an investor s capital is at risk. Other. Equity Trustees Limited AFSL No is the issuer of units in the Orbis/SM Australia Equity Fund (the "Fund") and Orbis Investment Management (Australia) Pty Limited AFSL No is the Fund's Investment Manager. The Fund's Product Disclosure Statement ("PDS") is available from or by contacting Orbis' Client Services Team at +61 (0) You should consider the PDS in deciding whether to acquire, or to continue to hold, units in the Fund. This report is not an offer to sell, or a solicitation to buy, units in the Fund. Where the report provides commentary on a particular security, it is done to demonstrate the reasons why we have or have not dealt in the particular security for the Fund. It is not intended to be, or should be construed as, financial product advice. This report is current as at its date of publication, is given in good faith and has been derived from sources believed to be reliable and accurate. It does not take into account your individual objectives, financial situation or needs. Any implied figures or estimates are subject to assumptions, risks and uncertainties. Actual figures may differ materially and you are cautioned not to place undue reliance on such information. Subject to applicable law, we do not provide any warranty of accuracy or reliability in relation to information in this report or accept any liability to any person who relies on it.

3 ORBIS/SM AUSTRALIA EQUITY FUND a t 30 Se p t e m b e r 2010 Total Rate of Return From Public Launch Latest Latest in Australian dollars on 4 May Years 1 Year Quarter % Annualised % Not Annualised Orbis/SM Australia 3.2 (4.9) (0.9) 10.1 S&P/ASX 300 Accumulation Index 1.6 (7.3) Relative Performance (1.6) 1.7 Most of the companies Orbis Australia invests in are pretty boring. This is certainly true for the Fund s three largest investments, Caltex Australia, SP AusNet and Hastings Diversified Utilities Fund. In all three cases, the main business is reasonably mature and unlikely to change or grow much in the next ten years. The biggest attractions of these investments are the high yields the businesses can continuously pay to investors, the confidence we have in the long-term sustainability of the income streams backing the distributions, and the excellent inflation protection characteristics of all three investments. No news will be good news for these shares as we will be getting 7-10% annualised income returns on our investment (a large percentage of which will be fully franked) with growth at least matching inflation over time. The benefits of 7% or more annualised real returns over time are substantial and have been commented on extensively in our past reports. One downside of these kinds of investments is that it s difficult to write interesting reports about them. Generating enthusiasm about a gas pipeline or electricity grid can be a daunting task. Absent a re-rating, the potential for capital gains is also limited, further reducing their appeal. But we do have a few stocks in the portfolio for which the expectation of very large long-term capital gains exists. The downside to these shares is that they offer little or no immediate income and more risk than the three stocks mentioned above. The stocks are also usually much smaller because they are early in their development, not well-covered by the analyst community, and largely ignored by investment managers. The stock we believe probably offers the best sustainable returns (relative to risk) in the portfolio at the moment is ImpediMed, a company for which we recently participated in a capital raising, resulting in a weighting of about 1% of the Fund. ImpediMed is a medical device company that diagnoses lymphedema, a condition that can result in permanently swollen and impaired limbs. First some medical background: If a person undergoes certain types of surgery or radiation therapy, especially for cancer, a disturbance of the lymph flow at the base of the arms or legs can occur. For example, in women undergoing surgery for breast cancer, the lymph nodes under the arms are usually removed by surgery or irradiated during radiation treatment as metastatic cancer cells often collect in these locations. This disturbance of the lymph vessels can result in a disruption of the flow of the lymphatic system studies have shown that this affects about 20% of women who undergo breast cancer treatment. The fluid in body tissues technically known as lymph does not drain out of the arm as it should, and gets trapped between the cells in the arms. If it is not removed quickly, fibrotic changes within the tissue can occur, making the condition permanent. Even at low levels of lymph accumulation, this can affect a person s fine motor skills (a real problem if you are a surgeon, typist or musician for example) and, if left untreated, lymph may continue to build and can lead to permanent disfigurement (see pictures below). Lymphedema Disfigurement Stage 0 Left Unilateral Arm Stage I Left Unilateral Arm Stage II Left Unilateral Arm Stage III Left Unilateral Arm Responsible Entity Investment Manager Custodian and Administrator Equity Trustees Limited Orbis Investment Management (Australia) Pty Limited State Street Australia Limited 1 Source: ImpediMed

4 ORBIS/SM AUSTRALIA EQUITY FUND a t 30 Se p t e m b e r 2010 The good news is that if lymphedema is diagnosed early, it is fairly easy to treat. The patient can wear a compression sleeve which pushes the fluid back into the bloodstream, and after a few weeks the arm should return to normal. The bad news is that if lymphedema is left for too long and fibrotic changes occur, the process becomes irreversible while the sufferer can stop or slow the progress of the lymphedema with constant treatment and by continually wearing a compression sleeve, there is no cure at this point. The real problem has been that, until now, there has been no reliable way to measure lymphedema until visible swelling of the arm occurs, at which point it is usually too late already. One method that doctors often try is comparing the sizes of the patient s arms by putting each arm into a bucket of water and measuring the difference in overflow. Not really high tech stuff, and very ineffective when you are looking for discrepancies of 1% or less. For example, the volume of a tennis player s one arm typically exceeds that of their other arm by more than the increase that doctors are trying to measure (in Roger Federer s case, the difference would be far more extreme). ImpediMed has discovered a simple test to indicate whether a patient is showing the early signs of lymphedema. It involves attaching electrodes to each arm and one leg, and taking a standardised bioimpedance spectroscopy reading. The process is quick and can be performed by a trained nurse in less than ten minutes. If the reading is positive, the patient wears a compression sleeve for a few weeks until the readings return to normal and the lymphedema has successfully been reversed. We are not relying on the company s word that the test works. There are numerous academic articles that back the device and a major study which was done (and paid for) by the National Institutes of Health in the US (an independent, government-funded body) which found the device to be highly effective. Based on these study results, the US Food and Drug Administration has granted ImpediMed clearance to sell the device in the US. It is currently the only FDA-cleared device designed to aid in the clinical assessment of lymphedema, and we have not been able to find another company with a rival product in development. The device and testing method are covered by patents, some lasting 10 to 15 years. The business model for ImpediMed is also interesting. The company gives the measuring device to doctors and charges them roughly US$45 for each test while the doctor typically receives US$100 for each test performed - a very profitable outcome for them, which is important as profitability is the second largest determinant of whether doctors will use a new device (after whether they are likely to get sued for using/not using it!). The technology is also interesting from a medical funder s perspective: unlike most new medical technologies, which purport to save insurance companies money in the future by spending more now, the ImpediMed device will save insurance companies money by spending less now. By testing cancer patients for lymphedema (at a cost of $400 per patient for four quarterly readings), the condition can be largely avoided. Each person who avoids getting lymphedema saves an insurance company around US$10,000 per annum for life. The state of North Carolina has recently passed a law mandating lymphedema coverage for any health insurer doing business in the state and a similar bill is in front of the US Congress. The company has recently been given a funding code by the American Medical Association, for use from 1 January 2011, which makes it much easier for doctors to get paid when they use the technology. The only hurdle left to clear is signing on the health funders in America (who rely on this code). This should not pose a problem as, in their first month since receiving their funding code, ImpediMed has signed up four managed care contracts, representing potential access to over 10 million people. Negotiations with key insurance companies are well advanced and likely to be concluded shortly given the unusual clinical benefits and economics of this device for the funders. 2 Source: ImpediMed

5 ORBIS/SM AUSTRALIA EQUITY FUND a t 30 Se p t e m b e r 2010 Once these pieces are in place, it is likely that most breast cancer patients in America will be regularly screened for lymphedema. There are currently around 2.5 million breast cancer survivors in the US with an estimated 1 million patients still in their first five years of care. There are also around 250,000 newly-diagnosed patients in the US with breast cancer every year. ImpediMed estimates that, in breast cancer treatment alone, the US market could generate US$150 million in revenues each year (this assumes that 75% of breast cancer patients undergo the test in their first five years of care), which should generate profits exceeding US$50 million. This is great value for a company with a current market capitalisation of A$100 million with enough cash in the bank, after its recent raising, to see it through to achieving its core commercialisation milestones. Growth prospects are also very good unfortunately, this is partly because breast cancer cases have been rapidly rising over the years. Also, with little effort, the company should be able to sell the same device in most other parts of the world increasing its market by a large multiple. The greatest upside is that the device will work equally well in lymphedema of the legs, a condition that is 3-4 times more common than that of the arms. For example in pelvic cancer, the treatment of which can cause lymphedema in the legs, the company estimates the market could generate a further US$400 million in revenues annually. ImpediMed has already filed its final application for use of its device on legs with the FDA and an answer is expected shortly. If the extension to legs is granted, the uplift is immediate, as the funder s code and funding agreements already cover all limbs. If those are not enough upsides, the technology may also be able to be used to diagnose venous insufficiency, a condition even more common than lymphedema. Greg Brown, the Chief Executive Officer of ImpediMed, is one of the best and most experienced CEOs in the Australian biotech industry. He and the other ImpediMed directors have regularly bought ImpediMed shares and together own a total of 8% of the company. We recognise that ImpediMed does not have a track record of making a profit and as such investing in the company carries some risk that the economics will fail. However, all our research shows there is every chance that their management will succeed in making the company as profitable as we think it can be. It may take a while for Australian investors to realise how much upside and potential it has, but should this happen, ImpediMed will add greatly to the Fund s returns despite its modest position size and the capital growth will complement the high income and steady capital growth of the major investments in our portfolio well. Yours sincerely, Simon C Marais Sydney, Australia 8 October

6 ORBIS/SM AUSTRALIA EQUITY FUND a t 30 Se p t e m b e r 2010 Sta t e m e n t of Ne t As s e t s (Un a u d i t e d) Market Value % of Security A$ 000 s Fund Caltex Australia 27,502 6 SP AusNet 26,160 5 Hastings Diversified Utilities Fund 24,264 5 APN News & Media 17,758 4 Sigma Pharmaceuticals 16,672 3 Australia and New Zealand Banking Group 15,805 3 Metcash 13,862 3 EDT Retail Trust 13,550 3 Roc Oil 13,477 3 National Australia Bank 13,106 3 Australand Property Group 12,899 3 PMP 12,678 3 ALE Property Group 12,101 3 Iluka Resources 11,361 2 Fisher & Paykel Appliances 11,125 2 PaperlinX 10,250 2 Nuplex Industries 9,983 2 Salmat 9,751 2 Acrux 9,717 2 Air New Zealand 9,314 2 Valad Property Group 8,934 2 Charter Hall Office REIT 8,691 2 Pharmaxis 8,318 2 Skilled Group 8,123 2 Tassal Group 8,117 2 Thakral Holdings 7,836 2 Sunland Group 7,214 1 Tower 7,214 1 Austal 6,808 1 Centro Retail Trust 6,502 1 Guinness Peat Group - CDI 5,252 1 ImpediMed - Common and Warrants 4,856 1 Positions less than 1% 70, Total Equity Exposure 449, Stock Index Futures Bought*: SPI / ,634 5 Net Current Assets 4,569 1 Net Assets 475, Net Asset Value per Unit A$ Total Assets Under Management for the Australian equity strategy (000 s)** A$ 1,779,920 * All stock index futures are fully backed by cash holdings. ** Orbis Investment Management (Australia) Pty Limited also manages several segregated accounts that have the same investment goals and restrictions as the Fund. 4

7 CHARACTERISTICS OF ORBIS/SM AUSTRALIA EQUITY FUND Investment objective The Fund seeks long-term returns for investors that are higher than the S&P/ASX 300 Accumulation Index ("Benchmark"). Investments Structure Who should invest? Minimum initial investment Minimum Redemption Dealing Days Dealing deadlines The Fund is designed to remain continuously invested in selected Australian equities. These equities are selected using extensive proprietary investment research undertaken by the Investment Manager. Registered Managed Investment Scheme aimed at Australian investors. Investors with a long-term horizon and able to withstand periods of disappointing performance. The Fund's portfolio may deviate meaningfully from its Benchmark in pursuit of superior returns. A$50,000. Subsequent minimum investments of A$10,000. A$10,000, subject to maintaining an investment balance of A$50,000. Weekly, normally each Thursday. Application forms must be received by 2:00 p.m. Sydney time (the "Deadline") on a Dealing Day for processing on that Dealing Day, provided sufficient cleared funds and all applicable customer identification documents have also been received by the Deadline. Redemption requests must be received by 2:00 p.m. Sydney time on a Dealing Day for processing on that Dealing Day. A Unitholder who submits a request for a Significant Redemption must make that request by 2:00 p.m. on the day that is 10 Business Days before the Dealing Day. Fees and expenses The Management Fees payable from the Fund have a fixed component (the "Base Fee") and a performance component (the "Performance Fee"). The Base Fee is 0.75% per annum of the Net Asset Value of the Fund. The Performance Fee is 20% of the extent to which the Fund outperforms its Benchmark once the Fund has reached a new High Water Mark. Other expenses such as stamp duty and GST will be deducted from the Fund as appropriate. 5

8 ORBIS ORBIS INVESTMENT MANAGEMENT (AUSTRALIA) PTY LIMITED (AFS Licence No ) LEVEL 2, CHALLIS HOUSE, 4-10 MARTIN PLACE, SYDNEY, AUSTRALIA NSW 2000 TELEPHONE: +61 (0) WEBSITE: