This shareholder letter is part of the Bretton Fund 2014 Annual Report (pdf).
February 24, 2015
Dear Fellow Shareholders:
The Bretton Fund’s net asset value per share (NAV) as of December 31, 2014, was $25.72, and the total return for the fund for the fourth quarter was 6.91% compared to 4.93% for the S&P 500 Index. For the year, the fund returned 9.79% compared to the S&P 500’s 13.69%.
The fund’s cash balance muted returns again, but the volatility in the fourth quarter allowed us to put more of our cash to work by adding, what we believe, are three great businesses whose stock prices went on sale: Discovery Communications, Flowserve, and IPC Healthcare. We discuss these in more detail below.
Total Returns as of December 31, 2014
| 4th Quarter | 1 Year | Annualized 3 Years | Annualized Since Inception (A) | |
| Bretton Fund | 6.91% | 9.79% | 17.21% | 15.42% |
| S&P 500 Index (B) | 4.93% | 13.69% | 20.41% | 17.35% |
Calendar Year Total Returns
| Bretton Fund | S&P 500 Index (B) | |
| 2014 | 9.79% | 13.69% |
| 2013 | 26.53% | 32.39% |
| 2012 | 15.66% | 16.00% |
| 2011 | 7.90% | 2.11% |
| 9/30/10 – 12/31/10 | 6.13% | 10.76% |
| Cumulative Since Inception (A) | 84.01% | 97.46% |
(A) Since Inception returns include change in share prices and, in each case, include reinvestment of any dividends and capital gain distributions. The inception date of the Bretton Fund was September 30, 2010.
(B) The S&P 500 is a stock market index based on the market capitalizations of 500 leading companies publicly traded in the US stock market, as determined by Standard & Poor’s, and captures approximately 80% coverage of available market capitalization.
Performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be lower or higher than the performance data quoted. You may obtain performance data current to the most recent month-end here or by calling 800.231.2901.
All returns include change in share prices, reinvestment of any dividends, and capital gains distributions. Indices shown are broad-based, unmanaged indices commonly used to measure performance of US stocks. These indices do not incur expenses and are not available for investment. The fund’s expense ratio is 1.50%.The fund’s principal underwriter is Rafferty Capital Markets, LLC.
Note: In previous reports, we had shown the Wilshire 5000 Index in the above performance tables, with the goal of showing the broader market beyond the 500 largest companies that comprise the S&P 500 Index. But since those 500 companies dominate the market-capitalization-weighted Wilshire, the difference in those indices isn’t material. Going forward, we’ll just show the S&P 500.
4th Quarter
During the fourth quarter, the largest contributor to the fund’s performance was Ross Stores, adding 1.8%. Ross Stores, the company, continued to chug steadily along nicely during the year, selling even more discounted clothes and adding stores, and in our estimation, steadily increasing its value. ROST, the stock, on the other hand, saw wide swings in its perceived value by the market, starting the year at a value of $16 billion, hitting a low of $13 billion in July, then recovering to almost $20 billion by the end of the year. The business hardly changed.
Car-Mart also made a significant contribution of 1.6% in the fourth quarter. The company continues to open stores and managed to significantly improve its per car profitability, getting back to its historical average as the fierce competitive environment waned a bit.
Wells Fargo added 0.9% and CSX added 0.6%.
Contributors to Performance for 2014
For the full year, the main detractor from the fund was Coach. As predicted, its sales grew overseas quite nicely, but its appeal in the US deteriorated much more than expected, with sales per store declining 24% last quarter. We have since sold some shares as our assessment of its value wasn’t quite what we thought it was. This mistake cost the fund 2.4% in 2014. Fortunately, there were no other significant detractors from performance this year.
Wells Fargo and Ross had the biggest impact on the fund, adding 3.1% and 2.5%, respectively. The railroads continued to charge ahead, adding 4.1% to the fund as a group, with Union Pacific having the largest impact, 1.9%.
Taxes
The fund made a tax distribution to shareholders on December 23 for $0.01427 per share, representing 0.06% of the fund’s NAV at the time. While minimizing taxes isn’t the fund’s raison d’être, we strive to reduce the amount of taxable distributions to shareholders. The fund managed to avoid making a capital gain tax distribution during the year, and for the third year in a row, the fund avoided incurring any short-term capital gains, which are taxed at a higher rate than long-term gains.
Portfolio
| Security | % of Net Assets | Initial Purchase Date | IRR to Date (A) | Comparable S&P 500 IRR |
| Wells Fargo & Company | 13.5% | 10/3/11 | 27.9% | 20.3% |
| Ross Stores, Inc. | 8.6% | 10/4/10 | 37.3% | 16.3% |
| American Express Co. | 6.0% | 10/4/10 | 24.8% | 17.8% |
| Union Pacific Corp. | 5.2% | 10/4/10 | 35.4% | 19.2% |
| CSX Corp. | 4.8% | 10/22/10 | 19.4% | 17.7% |
| Armanino Foods of Distinction, Inc. | 4.7% | 1/2/13 | 53.9% | 20.5% |
| Bank of America Corp. | 4.6% | 10/15/13 | 21.3% | 18.7% |
| Norfolk Southern Corp. | 4.6% | 10/4/13 | 21.5% | 17.5% |
| JPMorgan Chase & Co. | 4.4% | 9/1/11 | 23.9% | 20.7% |
| Discovery Communications, Inc. (C) | 3.9% | 11/25/14 | NM | NM |
| Flowserve Corp. (C) | 3.9% | 12/8/14 | NM | NM |
| Aflac, Inc. | 3.8% | 10/4/10 | 6.2% | 16.4% |
| The Gap, Inc. | 3.2% | 6/21/11 | 50.5% | 14.8% |
| IPC Healthcare, Inc. (C) | 3.1% | 11/7/14 | NM | NM |
| Coach, Inc. | 2.8% | 2/12/13 | -14.1% | 19.1% |
| Carter’s, Inc. | 2.7% | 10/4/10 | 35.7% | 16.1% |
| New Resource Bank | 1.8% | 2/7/11 | 9.7% | 15.0% |
| America's Car-Mart, Inc. | 1.3% | 7/24/12 | 9.4% | 22.1% |
| Standard Financial Corp. | 1.2% | 12/2/10 | 12.2% | 15.0% |
| Cash* | 15.9% |
(A) IRR stands for internal rate of return, a method of calculating annualized returns.
(B) Comparable S&P 500 IRR is calculated for each investment by looking at the purchases and sales for each security transaction and how a comparable amount would have performed if invested in the S&P 500.
(C) The IRR figures for Discovery, Flowserve, and IPC are not meaningful (NM) given that they have been held for a very short time.
(D) Cash represents cash equivalents less liabilities in excess of other assets.
Each quarter, we disclose which investments had the largest impact on the fund’s performance for that quarter, and in the annual and semiannual reports, the attached financial statements contain gain-loss information for each security. This time, we thought we’d break out more detail on each investment to give you a sense of the companies we own and how they performed to date. To date, none of our investments has led to a net realized loss, and excluding the investments we made in the last weeks of the year, only Coach is in a net loss position. Including our fully exited investments, about two-thirds of our investments have outperformed the market.
Portfolio Discussion
Big Banks
Our three large banks, Wells Fargo, Bank of America, and JPMorgan Chase, comprise our largest position both individually, with Wells Fargo, and the fund as a whole. While each of these companies has distinct qualities, the common theme has been the tremendous resurgence in earning power of the banking sector. In 2009, Wells Fargo— broadly considered the best managed and most transparent of the large banks—earned $1.75 per share after writing down over $22 billion of assets, which, at the time, was not clear would be enough. Last year, earnings were up to $4.10 per share in an environment where ultra-low interest rates have materially depressed its interest income. We expect Wells to earn at least $4.20 per share next year, which, we believe, is a bargain compared to its $55 year-end share price.
Bank of America and JPMorgan have had slightly more complicated stories, thanks to crisis-era liabilities that have not been fully resolved. Bank of America made what, at least in hindsight, was an ill-advised acquisition of Countrywide and its problems during the subprime mortgage crisis, and it is still digging out. It also wildly overpaid for Merrill Lynch when it was at death’s door and failed to terminate its purchase contract in the face of a material adverse event: a worldwide financial crisis centered on these investment banks. Despite the circumstances, Merrill turned out to be a strong franchise and now represents close to half of Bank of America’s earnings. As its elevated legal and credit costs fade, the underlying earning power of Merrill Lynch’s wealth management operation and BofA’s enormous deposit and loan franchise will accrue to us as its partial owners. We estimate it can earn about $2 a share within a few years compared to its year-end share price of only $18.
JPMorgan has spent nearly $30 billion on legal settlements since the financial crisis—an amount that could buy Whole Foods and Safeway, with enough left over for E*TRADE— and it is unlikely that the regulators are finished with it. Yet, the bank earned nearly $22 billion just in 2014, an amount that’s likely to increase in the coming years with higher rates, increased loans, and lower legal costs. For all of the unwieldiness of the universal bank model, JPMorgan is, in an important sense, a combination of Wells Fargo, BlackRock, and Goldman Sachs, trading for a lower ratio of price to earnings. At current prices, we have an earnings yield slightly above 10%.
For the year, the total return for the stocks of Wells, BofA, and JPMorgan were 25%, 12%, and 10%, respectively.
Railroads
The railroads are, collectively, our second largest position, and represent the most effective means of transporting the industrial inputs that make up the core of our economy. At the time of our original investment, the risk was that the decline of coal in the American energy grid would hurt the railroads’ earnings. As it happened, coal has fallen faster than most estimates, helped more by the halving of natural gas prices than any environmental regulations, yet the railroads have more than replaced the volume, much of it by taking share from costlier trucking. Equally important, the railroads don’t face the prospect of facing off against a large field of tough railroad competitors—there are only two majors in each half of the US—giving them the ability to raise prices modestly every year.
Union Pacific has been the standout of the group. It has less exposure to coal, and the longer route distances of the western US enhance the value proposition of rail. The eastern rails have had to invest more in maintenance and upgrades to the fleet and, at current fuel prices, face more of a prospect of competition from truck transport.
Union Pacific, CSX, and Norfolk Southern returned 45%, 31%, and 23%, respectively.
Ross Stores
Ross continues to use its superior purchasing and logistics advantages to buy brand-name clothes at low prices from apparel makers, passing on those low prices to customers. Ross ended the year with about 1,400 stores, and it believes it can eventually have 2,500 in the US. The total return from the stock during 2014 was 28%, and management estimates earnings per share increased by 11%.
Apparel Retailers
Unlike the large banks, the apparel retailers have little in common with each other except a method of selling.
The Gap, Inc., is a multi-brand retailer of casual clothing. Beyond its namesake Gap brand, it operates a slightly more upmarket Banana Republic, a slightly more casual Old Navy, and Athleta, its answer to Lululemon. Of late, Banana Republic has struggled and is in the midst of a reinvigoration, Gap brand is treading water, and Old Navy and Athleta have performed exceptionally well. The markets have had an itchy trigger finger whenever one of the brands has an off month, and we have used this to pick up a few more shares during the year. Our core belief remains that the business generates a significant amount of free cash flow that management uses to return to shareholders and invest wisely, which provides it the breathing room to get the Gap brand back on track.
As mentioned above and in our third quarter report, Coach was a mistake. We underestimated the overall amount of fashion risk and the company’s reliance on outlet stores and discounting. The company changed its creative director and introduced a critically acclaimed holiday line, but it takes time and energy to reposition a major brand as big as Coach. Management spent a fair amount of time and energy—as well as money—acquiring the shoe brand Stuart Weitzman, which has broad appeal, but is not clear if it will revive Coach’s own brand or its earnings. We reduced our position.
People keep buying baby clothes. Carter’s continues to take advantage of its strengths, with its high margins and yet another year of over 15% earnings growth. The firm traces its history to Atlanta at the end of the Civil War, and when it finally went public in 2003, it had about $600 million of revenue and 40¢ per share in earnings. Our Carter’s of 2015 will generate more than $3 billion in revenue and earn nearly $4.50 per share next year.
Gap, Coach, and Carter’s returned 11%, -31%, and 22%, respectively.
American Express
American Express’s earnings per share continue to grow, increasing 14% last year, while the stock returned 5% for us. While earnings grew nicely from cost-cutting and greater efficiencies, the business had some challenges meeting its own revenue goals.
Reasons for the weaker than expected revenue growth: 1) The US dollar strengthened, which means spending by non-US AmEx cardholders translated into fewer US dollars for us. 2) Consumer spending across the world is still a bit weak. 3) The company is making a strong push in the US to sign up small merchants and is accepting lower fees to do so. 4) More of the company’s growth is shifting to its open-network payment business from its “closed-loop” charge card business, which has higher fees. If you use a traditional AmEx charge card, American Express is both the payment network and the bank that’s floating that transaction. In recent years, AmEx has shifted its model more toward the Visa-MasterCard model, whereby a third-party bank like Wells Fargo or Morgan Stanley issues an AmEx-branded credit card to its own customers. AmEx facilitates the payment processing for a fee, but the bank partner is responsible for paying the merchant and collecting payment from its own customer. In the long run, we believe this, along with broader merchant acceptance, will lead to stronger growth and a longer runway for American Express, but this shifting mix of business is holding back growth a bit in the short-term.
Armanino Foods of Distinction
Tiny Armanino continues to deliver. Our Northern California–based pesto-sauce maker is on pace to earn 20% more than it did the year before as it continues to find markets for its frozen pesto sauce, even developing a growing market overseas. Last year, the stock returned 10%, and it continues to pay out a healthy 3.5% dividend.
Aflac
Aflac dominates a small niche in the insurance market: supplemental health insurance. It’s neither traditional healthcare, since Aflac doesn’t pay doctors or manage health plans, nor is it like the more-familiar homeowners or life insurance. In exchange for monthly payments, Aflac will pay out cash to you if you incur a specified health event like cancer. It does a decent business in the US, but does extraordinarily well in Japan (where 70% of its revenue comes from), a much larger market due to the high out-of-pocket expenses Japanese face for their healthcare. (The Japanese government has a mostly nationalized healthcare system, whereby the government pays 70% of a patient’s expenses, leaving 30% the patient’s responsibility, which can add up with a major health event like cancer.)
Aflac makes money by writing policies that have a positive actuarial value; that is, policyholders send Aflac more in premiums than Aflac will pay out in claims. Aflac also makes money from the investment income it receives off the “float,” the capital generated by collecting premiums now and paying out claims years later. Unfortunately, most of this float is in Japan, and Aflac has struggled to find good avenues to deploy this capital. Japanese government bonds offer negligible yields, and Japanese equity markets have challenging corporate governance issues. From time to time, the pressure to stretch for yield has been overwhelming, and Aflac experienced material investment losses in 2011 chasing higher rates in poorly capitalized European banks.
What Aflac has done well is continue to grow policies and earnings. From 2010 to 2014, Aflac’s core Japanese operation grew by a little over 25% in local currency; unfortunately for American shareholders, the dollar-yen exchange rate from 2010 to today fell by more than 25%. Through its investment losses to the collapse of the yen over the past two years, we have held onto our investment on the belief that its fair value is worth significantly more than its current market value, which is only about nine times more than its annual earnings, a steep discount to the rest of the market, particularly for a solid business that excels in its niche. The total return from Aflac last year was –5%.
Small Banks
As they’ve appreciated, we’ve reduced our holdings of small banks and now own only two: New Resource Bank and Standard Financial, the latter of which was formerly a mutualized thrift (a bank that is technically owned by its depositors). Four years ago, regulatory changes caused several small, mutualized thrifts to convert to a conventional stock-ownership structure.
A thrift conversion is a funny thing. Pre-conversion, the bank has a capital base that represents its cumulative retained earnings. During the conversion, the bank sells shares to interested parties: its depositors, managers, employees, and, to the extent there is room, the general public. Post-conversion, the new shareholders collectively own the IPO proceeds they supplied and the retained earnings of the old depositors. Fidelity’s Peter Lynch noted that this is like buying a house, moving in, and then finding what you paid for the house waiting for you on the kitchen counter.
In addition, the cynic might note that one group is particularly impacted by the share price of the conversion: management. Pre-conversion, management owns no part of the company and receives a salary. During the conversion, management will have a chance to buy part of the company. Post-conversion, management’s equity incentives will be keyed off of the initial share price. Care to guess whether management wants a high or low conversion price?
These mis-pricings do not last long, and given our small size, we were able to pick up some shares in the open market while they lasted. From then on, the biggest risk we faced was that a management team would destroy the value it had just created by buying other banks for stock. The annualized gain (our internal rate of return) on our four investments since inception was: Kaiser Federal Financial 56%, People’s Federal Financial 16%, Standard Financial 12%, and SI Financial 6%. No prize for guessing which one decided to buy another bank. We exited SI Financial last quarter. The only one of our original four that we still hold, Standard Financial, returned 17% last year.
New Resource Bank, our San Francisco–based bank founded in 2006 and always a conventional stock company, is beginning to hit its stride. When we first invested in 2011, it was a turnaround situation: the bank had significant loan losses and had never been profitable. However, it had excess capital. Since our investment, the bank has grown its loans and deposits and achieved profitability, with its earnings through September 30 increasing by 53% over the prior year. The stock returned 13% in 2014 and still trades below 80% of its book value.
America’s Car-Mart
As we outlined in the 2012 third quarter shareholder letter, Car-Mart is one of the better operators in the subprime auto industry. It both sells the cars to its customers and makes them the loans necessary for those purchases, a model that puts significant strain on Car-Mart’s own finances—Car-Mart needs to carry both the vehicles in its showroom inventory and the vehicles in its fleet that are slowly paid off by customers. But it aligns Car-Mart’s incentives with those of its customers. A car is an economic lifeline for someone with subprime credit; it does neither Car-Mart nor the customer any favors to sell a lemon that the customer cannot service and will end up defaulting.
Much of the used-car world functions quite differently, with financing provided by third parties. When credit is tight, customers with damaged credit cannot buy a car. When credit is loose, typically a few years after a wave of defaults when finance companies have forgotten what happened the last time, it is open season to sell whatever car the dealer can get to whomever happens to walk in the door. The back half of 2013 and first half of 2014 were extremely loose.
Car-Mart management made the decision to sell fewer cars during this time period rather than chase poor deals. Earnings suffered. Cash flow increased, bringing down Car-Mart’s debt, and management took the opportunity to buy back 5% of its shares. When competition subsided in the summer, Car-Mart was able to regain its earnings pace. The stock returned 27% in 2014, and we took the opportunity to reduce a fair amount of our position.
Investments Initiated in 2014
Discovery Communications, Inc.
Flowserve Corp.
IPC Healthcare, Inc.
Investments Exited During 2014
Investment Internal Rate of Return
Apollo Group 0.4%
SI Financial 5.8%
Portfolio Additions
Discovery Communications
Discovery is the world’s largest collection of nonfiction media, operating 13 networks in the US, including its three flagship channels—Discovery, TLC, and Animal Planet—that reach substantially all pay-TV households in the nation. Discovery is not built around big-budget, dramatic television; the highest-rated program in its history, Deadliest Catch, is focused on the lives of Alaskan crab fisherman and poses no artistic threat to The Sopranos or Mad Men or The Wire.
What Discovery is built to do is create entertaining and informative video content about the real world in a low-cost way and distribute this content around the world. While most people associate Discovery with its main channels here in the US, it is the largest pay-TV programmer in the world. At last count, it had nearly three billion cumulative subscribers (defined by counting each channel in a household) across 48 channels, translated into 45 languages, distributed into 220 countries. While major US networks spend billions of dollars for the rights to highly perishable football content—content that is valuable precisely because it is so perishable and demands real-time viewing—Discovery is happy to rerun Gold Rush at odd hours. It turns out to be about as enjoyable in any culture.
The pay-TV ecosystem in the US has been wildly lucrative for over thirty years, guarded on one side by the natural monopoly of stringing coaxial cable to a living room, and on the other by intellectual property rights and federal program-carriage rules. Whenever there was conflict between distributors and content owners, it was solved by simply passing the cost to the end customer. Easy money attracts insurgents, and companies from Netflix and Amazon to Dish and Google are trying to change the status quo. We expect the domestic trend toward cord cutting (abandoning a pay-TV subscription for Internet-only) and unbundling (smaller channel packages) to continue. We also expect that there will continue to be a place for Discovery’s content and that, as these changes work through the US market, Discovery will continue to grow in overseas markets that don’t have enough local content to fill their rapidly expanding viewerships.
Since assembling its current portfolio of assets in 2008, Discovery has grown from $3.4 billion of revenue and 43¢ per share in earnings to what should be about $6.9 billion of revenue and $2.00 per share in earnings in 2015. The international nature of the business means that we are taking some foreign exchange risks translating earnings into dollars. The company has never paid a dividend, but instead has used its substantial free cash flow to expand its reach and buy back shares.
Flowserve
Flowserve is one of the global leaders in flow control. It makes pumps, valves, and seals—the products that move large volumes of liquid and gas. For those of us who think of a pump as something that inflates a bicycle tire, the scale and power of these industrial pumps are shocking. These are the devices that move some very unwieldy liquids along pipelines and through chemical facilities.
The sheer force applied to these pumps—let alone the nature of the fluids being pumped—means that, between the energy needed to operate the pump and the maintenance and retrofit needed to keep it going, the total cost of owning a pump is about nine times its original cost. Thoughtful customers tend to focus on the quality of the initial pump more than its sticker price; they will be investing in this tool for a long time.
Forty percent of Flowserve’s pumps are sold to the oil and gas industry, and the precipitous drop in the price of oil and, thusly, oil company spending budgets caused investors to sell Flowserve. We bought.
While investors may have been concerned that 40% of its revenue comes from the broader oil and gas industry, only about 8% of Flowserve’s revenue is from the upstream portion of the oil and gas industry—the actual removal of resources from the ground—the sector of the industry most at risk with low oil prices. Twelve percent comes from midstream—the moving and storing of oil and gas—and 20% comes from refining and other downstream activities.
Since the proximate cause of the oil price decline is too much oil, we don’t expect the world to move or refine any less of it. We certainly don’t expect much change to the half of revenue that comes from selling maintenance and repair parts to installed Flowserve pumps: it is the brave refinery manager who would risk his billion-dollar investment by saving a few dollars on a nonspecified replacement part.
IPC Healthcare
While the healthcare industry is nearly a fifth of the economy and home to tremendous innovation and progress, we have generally avoided investing in healthcare businesses. The ratio of prices to earnings are often high relative to their growth rates because of investors’ perception of safety, but healthcare companies have their own pronounced risks, notably technology risk.
The biotech, pharma, and medical device industries are littered with failed products, promising ideas that didn’t make it through some trial or other, or were pulled from the market, or just didn’t deliver much value. This isn’t surprising; the essence of innovation is a leap into the dark, and not all attempts will succeed. Each failed effort is accompanied by a suite of experts—executives, researchers, doctors, statisticians, investors—who had access to the best possible information and yet unsuccessfully bet millions of dollars and years of time. How could we hope to do better?
That said, we are happy to invest in healthcare when we find a business model that makes sense to us. IPC Healthcare is essentially a staffing agency for extremely talented staff: doctors.
Traditionally, a patient who found himself in a hospital was visited regularly by his primary care physician, who coordinated his care. Increasingly, this does not happen. Primary care physicians practice in their own offices, typically with busy schedules to compensate for limited reimbursement revenue per visit. Few have the time or incentive to drive to the hospital to check up on “their” patients who were admitted. So the patient sits in his hospital room, frustrated and confused, while specialist after specialist comes by and asks the same questions and orders the same tests before disappearing.
A hospitalist—a primary care doctor who practices in the hospital instead of a separate office—solves this problem by quarterbacking the patient’s recovery. The advantages to the patient are obvious: finally, there is someone to look out for you. The hospital also benefits: by eliminating duplicative work and expediting treatment, the hospitalist frees up space and lowers readmission rates. The payer (almost always insurance companies or the federal government via Medicare or Medicaid) benefits from reduced waste. And the doctor benefits from working for a hospitalist company by enjoying a steady income without any of the hassles of running a small business. Because of the clear benefits to all parties, hospitalists are now one of the fastest-growing segments in healthcare.
We were able to buy stock in IPC because of some short-term dislocations. The Justice Department is investigating a whistleblower complaint that IPC encouraged doctors to code visits inappropriately, essentially overbilling the government. Whistleblower lawsuits, lawsuits in which someone brings a complaint on behalf of the government and shares in any proceeds, have been a part of American law for 150 years, but until the mid-1990s were fairly rare, with perhaps 10 healthcare-related filed in a busy year. The government now pursues 400–500 cases a year, helped along by a cottage industry of law firms that identify disgruntled employees who can allege a billing error. There are 13,000 codes in the current Medicare system, soon to expand to 68,000, and many are distinguished by subjective measures. IPC’s case, for example, concerns whether some IPC doctors used code 99233 (evaluation and management, high level) when they should have used code 99232 (evaluation and management, medium level). IPC doctors have seven million patient encounters per year; we would be shocked if there were no coding errors. We expect the government to move slowly, but we believe the case will eventually be settled.
A long-term risk to IPC is that hospitals poach its doctors. It should be easy for a hospital to hire doctors: the doctors already show up to work in the hospital. In some cases, we expect that this is just what will happen. But hospitals have reacted to their own cost pressures by outsourcing functions, not absorbing them: they have found it’s more lucrative to run a mall and rent out space to vendors than it is to maintain a department store and try to own every sale. We believe that IPC and the other practice management businesses, such as Envision, Mednax, and Team Health, have a growing role to play in the modern hospital.
In 2008, IPC’s first year as a public company, it earned 87¢ per share on revenue of $251 million. We expect that next year IPC will earn $2.50 per share on revenue of $760 million.
Growing Team Bretton
I’m proud and elated to announce a wonderful addition to the Bretton Fund team. Later this year, Raphael de Balmann will be joining the firm as a portfolio manager. Raphael and I have been close friends for almost ten years, emailing or talking on an almost daily basis about finance, business, sports, and public policy. We’ve talked on and off for a long time about managing money together (he even came up with the Bretton name), and the timing’s finally right.
Raphael has spent his entire career in private equity, buying businesses for less than their underlying values and holding them for years, which is basically the Bretton Fund strategy. He joins us most recently from One Equity Partners, the former private equity arm of JPMorgan, one of the most successful bank-owned private equity firms. He was previously a principal at Paine & Partners/Fox Paine, and he worked in the private equity groups of Blackstone and Lazard in New York and London. No academic slouch, he has an MBA from Stanford and an undergraduate degree from Harvard. Raphael fills what has been the biggest hole for us so far: finding enough great investments to fill a diversified portfolio. He has extensive background in industrial businesses, manufacturing, and healthcare—sectors that have been outside my circle of competence.
Raphael and his family—as I and my family have done—will be contributing significant assets to the fund. He’ll also be buying a stake in the fund’s adviser, Bretton Capital Management, and in conjunction with this transaction, shareholders will be asked for approval through a formal proxy voting process in the coming weeks.
Schwab
Thanks to your requests, Bretton is now on the Schwab platform, the largest of the “fund supermarkets” and the back office for 7,000 registered independent advisers. The fund is also available on E*TRADE and Vanguard. If we are not on a platform that you use, please contact your representative at the platform to ask them to add us and email us at info@brettonfund.com so that we can follow up. Our back office partners at Premier Fund Solutions are able to connect with pretty much any willing brokerage platform, and it’s always possible to invest directly by going to our website and downloading the forms.
As always, thank you for investing.
Stephen J. Dodson
President
Bretton Capital Management