Earnings season has officially started for Wall Street. Over a period of about six weeks, a majority of S&P500 companies will report their latest quarter operating results and provide insight into the health of the U.S. economy and consumers.
But earnings season is far from the only major data dump that investors know about every quarter.
On August 14, institutional investors with at least $100 million in assets under management were required to file Form 13F with the Securities and Exchange Commission. This valuable documentation allows investors to see what Wall Street’s smartest money managers bought and sold last quarter.
To be transparent, 13Fs are not perfect. When filed, they may be 45 days old, meaning they present outdated information for active hedge funds. Still, the 13Fs provide insight into which stocks, sectors, sectors and trends are capturing the interest of Wall Street’s leading asset managers.
The quarter ending in June was a particularly active period for billionaire Seth Klarman, the CEO and portfolio manager of Baupost Group. The value-oriented Klarman, who modeled his investment philosophy on Benjamin Graham, oversees $3.6 billion in invested assets across nearly two dozen holding companies.
Perhaps Klarman’s most notable move in the second quarter was meaningfully downgrading the cheapest of all the “Magnificent Seven” stocks, Google’s parent company said. Alphabet (NASDAQ: GOOGL)(NASDAQ: GOOG). At the same time, Klarman willingly poured into a stock of drugs that were under-the-radar but historically cheap.
Klarman’s Baupost has jettisoned a significant part of its stake in Alphabet
Baupost first initiated a position in Alphabet’s Class C shares (GOOG) in the first quarter of 2020 (i.e. during the COVID-19 crash). As of March 31, Klarman’s fund held more than 2.9 million shares. But over the course of three months ending June 30, Baupost investment leaders, including Klarman, sent 1,888,064 shares of Alphabet to the chopping block, representing a 64% reduction.
While profit-taking is a viable reason for Seth Klarman and his team to reduce their fund’s stake in Google, YouTube and Waymo parent Alphabet by almost two-thirds, I think there are four other possible explanations.
For starters, Klarman and his team may be concerned that the stock market is historically pricey. The S&P 500’s Shiller price-to-earnings (P/E) ratio, commonly called the cyclically adjusted price-to-earnings (CAPE) ratio, hit a yearly high of 37.70 earlier this week. and has more than doubled the average value of 17.16, dating from January 1871. Although Alphabet’s price-to-earnings ratio is a fairly low price-to-earnings ratio of 19, the company’s shares would undoubtedly come under pressure if the broad market indexes were to roll over.
Alphabet’s valuation could be a new turning point for Baupost’s chief. Despite Alphabet’s stock trading below its average price-to-earnings ratio over the past five years, it is more expensive than its average book value over the past five years, and is no longer the bargain it once was relative to cash flow. Klarman tends to focus heavily on these traditional fundamental value measures.
A third possibility behind this aggressive selling activity in Alphabet’s Class C shares is that the US could enter a recession. The first notable decline in the M2 money supply since the Great Depression, along with the longest yield curve inversion in history, indicate that the US economy may stumble in the coming quarters. Because Alphabet generated 76% of its net revenue from advertising in the quarter ending in June, it would be vulnerable to weakness if economic growth were to slow or turn in a reverse direction.
Finally, the Baupost Group’s brightest investment minds have anticipated possible legal trouble for Alphabet. Specifically, the U.S. Department of Justice could seek a breakup of Alphabet due to its total dominance in Internet search. Uncertainty is often the enemy of investors.
For what it’s worth, I believe this is a decision that Klarman will ultimately regret. But since the stock market is historically pricey and Klarman is an avid value investor, this selling activity makes sense.
Klarman is snapping up shares of a stunningly cheap pharmaceutical stock
On the other end of the spectrum, Klarman and his team expanded nine of Baupost Group’s existing positions in the second quarter. Arguably, none of these purchases stands out more than the drug developer Jazz pharmaceuticals (NASDAQ: JAZZ).
During the quarter ended in June, Klarman oversaw the addition of 440,552 shares of Jazz, increasing his fund’s stake in the company by 53% to 1,274,248 shares. By mid-2024, Jazz Pharmaceuticals was Baupost’s ninth largest holding, valued at $136 million.
Jazz’s oxybate franchise, which consists of Xyrem and Xywav (two therapies aimed at treating sleep disorders), are what drives the company. Xyrem was Jazz’s successful narcolepsy treatment, while Xywav is the next generation of sleep disorder therapy. Xywav contains 92% less sodium than Xyrem, making it an ideal sleep disorder therapy for people with cardiovascular problems. Based on sales in the first half of 2024, Jazz’s oxybate franchise has current year sales of $1.6 billion.
Jazz is also looking for its cannabidiol (CBD)-based therapy, Epidiolex (known abroad as Epidyolex), to eventually reach blockbuster status. Epidiolex was the crown jewel of Jazz’s $7.2 billion acquisition of GW Pharmaceuticals in May 2021. It treats rare forms of epilepsy and has limited competition, which has paved the way for steady double-digit sales growth. Epidiolex appears to be on track to generate nearly $900 million in annual revenue by 2024.
Additionally, Jazz’s oncology segment reached $1 billion in sales for the first time in 2023. Much of this growth was fueled by the injectable therapy Rylaze, a treatment for acute lymphoblastic leukemia and lymphoblastic lymphoma. Improved cancer screening diagnostics and substantial pricing power should lift the oncology segment’s revenue to at least $1.1 billion this year.
Despite steady long-term growth across all three facets of the company’s drug portfolio, there are concerns about this Avadel pharmaceutical products could challenge Jazz’s dominance in sleep disorders. Avadel commercially launched Lumryz in the US five months ago, a therapy that competes directly with Jazz’s oxybate franchise for certain indications.
However, a strong argument can be made that these competitive concerns are already fully ingrained. Jazz’s shares are valued at just over five times Wall Street’s consensus estimate for 2025 earnings per share (EPS). This represents a 32% discount to the company’s earnings per share. average forward price-earnings ratio over the past five years.
Additionally, Jazz Pharmaceuticals has a robust pipeline that currently includes more than 30 clinical trials. While there are a handful of label expansion opportunities for Epidiolex, the company’s future revolves around its oncology pipeline, which includes small cell lung cancer, breast cancer and acute myeloid leukemia. Just a few wins in these 30+ trials could be huge for Jazz.
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Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. Sean Williams has positions at Alphabet. The Motley Fool holds positions in and recommends Alphabet. The Motley Fool has a disclosure policy.
Billionaire Seth Klarman sold 64% of Baupost’s stake in Alphabet and is diving into this historically cheap and under-the-radar drug manufacturer. originally published by The Motley Fool
