Alexion, Priceline, OpenTable: A Top Manager's View


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The transition is over. Henry Ellenbogen, who succeeded Jack Laporte at the helm of T. Rowe Price's $16.2 billion New Horizons Fund on March 1, 2010, has fine-tuned the portfolio into his own.

So far, so good. Under Laporte, the fund's average annual gain of 9.6% over more than 23 years ranked in the top 29% of its small-cap growth peer group. Ellenbogen has racked up a 22.97% average annual gain. That's in the top 1% of its direct rivals as tracked by Morningstar Inc.

Ellenbogen, 41 years old, talked about investment strategy with IBD from his Baltimore office.

IBD: Not all of your growth stocks are alike, are they, Henry?

Ellenbogen: We want to invest in small companies that can become big and use the power of compounding to work for our investors.

Underlying that, we hold two types of companies.

One, about 30% of the portfolio, is in early-stage companies that are often characterized by large market opportunities. They have a strong market position, although in immature business models. Their competitive barriers haven't formed yet.

The second type, about 60% of the portfolio, is in companies that have durable growth. They're typified by companies that do have strong competitive positions. They may have a business innovation. They may be in mundane areas of the economy but doing things differently, which gives them an advantage. They have strong management who understand how to continue to build a competitive advantage and reinvest cash flows and continue to drive strong growth.

IBD: Like Jack Laporte (who passed away in August 2013), do you let winners ride?

Ellenbogen: We take lessons from Jack Laporte and also from "Cub" Harvey (Curran Harvey Jr.), the former president of T. Rowe Price (1980-84), who also died late last year and was president and lead portfolio manager of New Horizons for several years (1969-74) and also CEO of T. Rowe Price (1981-84).

Like Jack, we still want small companies. We still share the view that compounding is (the) investors' friend.

I looked at rolling 10 years in New Horizons. What you see is 20 total stocks over 10 years that drove outperformance of the whole portfolio. Not 20 every year. Twenty over the entire 10 years.

I looked at a study of companies that start small but compound at an average of 20% a year for 10 straight years. What's stunning is that there is a total of 18 companies that do that. And it's only 11 unique companies, because some companies likeStarbucks ( SBUX ),Chipotle ( CMG ) orFlowers Foods ( FLO ) repeat on the list.

A lot of the time, the hardest thing is to not sell a company because it gets fairly valued or in the short term overvalued. It takes discipline. That lesson in compounding is a fundamental tenet we share with Jack.

IBD: You target private companies more than Laporte did, right?

Ellenbogen: By spending time on early-stage companies, we do better in early-stage companies but also in durable-growth investments. Our focus on that is more than our predecessor.

We've done five to seven private investments a year. It's a relatively small amount of capital. But over time we think it pays off for our shareholders. We were private investors inTwitter ( TWTR ),Zulily ( ZU ) (an online retailer for mothers) andGrubHub ( GRUB ) (an online and mobile food-ordering platform), just to name three.

IBD: And you have more appetite for global leaders than Laporte did, right?

Ellenbogen: That's correct. On the global side, the best companies are strong in multiple markets. Given a choice between a company dominant in one market or strong across multiple markets, I'll choose the second.

Also, as the world becomes smaller, innovation is not a monopoly of people in the United States.

IBD: Any plans to reopen the fund, which closed to new investors on Dec. 31?

Ellenbogen: We felt in the short cycle that small-cap valuations were stretched. For about a year before we closed, we looked at the 50-plus-year history of the fund. This is the oldest data set on small caps in the country, by the way. When we looked at relative valuation metrics, we were at significantly stretched valuations. Price-to-book, price-to-earnings, price-to-sales -- all were near all-time highs. With lower-quality companies coming to public markets (for IPOs) and the narrowness of what's going on, we felt it was not a good time to be taking additional cash flows. We have no plans to reopen at this point. Since we closed, small-cap growth has been the worst sector of the market.

IBD: Alexion Pharmaceuticals (ALXN) got clobbered in the biotech sell-off. Do you still like it?

Ellenbogen: It's rare for us to own a $30 billion market company. We bought it when it was a small cap. Alexion is best-in-class in management. They run the business well. We like continued prospects for them. That's what we're focused on.

IBD: Elaborate on Chipotle, please. In this broad market correction, Chipotle is among those selling off. Why do you like it?

Ellenbogen: This is almost a classic company that in the short cycle is relatively fairly valued. But what really underlies its strength is its business-model innovation (in quality ingredients, flexible menus, fast service and catering).

They combine efficiency in their stores to get best-in-class margins and combine empowering consumers to customize the mass dining experience. And in (co-CEOs Montgomery Moran and Steve Ells) you have a terrific team. One controls food and integrity of the dining experience. The other is good at operations. We see best-in-class returns and a strong runway for growth.

IBD: DoesPriceline (PCLN) epitomize the sort of innovator you like?

Ellenbogen: Actually, we inherited it. We were significant shareholders in Kayak. Priceline bought Kayak. Once we got Priceline, we decided it has a unique business model and growth in front of it.

Their asset benefits from global network effects. The more hotels you have in your network, especially because of the cross-border strength of travelers, that allows you to provide better monetization to your hotel partners and better supply to consumers.

They're superior at marketing, both from understandingGoogle (GOOGL) and understanding hotel reviews. Even though they've been following the same formula for almost 10 years, they still have a runway in front of them.

IBD: What's your view ofOpenTable (OPEN), which you've trimmed in recent disclosures?

Ellenbogen: Our sales (of the stock) reflected some of the risks. Some areas of the small-cap market are overextended, so we eliminated a number of Internet and consumer holdings. But OpenTable is one we want to hold.

Recently the company has done a good job of reinvigorating its product innovation. New product innovation can unlock areas of growth. Their new product is focused on better content. And they're investing in more customer acquisition. And they're working on allowing diners to pay in a seamless way. Basically, it would allow each consumer to have a tab at every restaurant he goes to.

The new product is a cloud offering, which will provide a better overall view of restaurants and the habits of their diners, helping to optimize the overall network.

IBD: What's the appeal ofManitowoc (MTW), a crane manufacturer?

Ellenbogen: There are two parts of the business. In their crane business, they're a blue chip. They not only have a cyclical recovery in front of them; they've also made improvements which the market does not give them credit for.

They also have a food equipment business, which is a solid asset. They've done some heavy lifting to make it better.

IBD: Why have you been building your stake inRexnord (RXN)?

Ellenbogen: There are two parts. The underlying assets are strong. One asset is Zurn, a very good plumbing supply business.

The stock market may not be giving it enough credit because we're at a bad point in the construction cycle. But they've done things to expand their scope and improve quality. They have good people and a capital acquisition culture that can continue to make smart acquisitions.

IBD: What's your outlook onPalo Alto Networks (PANW), which you trimmed recently?

Ellenbogen: Palo Alto is an early growth cycle company. They have a superior offering. We bought this when there was stress around it: its lawsuit withJuniper (Networks) (JNPR). What's going on with cyberterrorism creates demand (for Palo Alto's cybersecurity).

IBD: Harman International (HAR) has held up fairly well in the correction. What's your view?

Ellenbogen: They're basically the market leader in high quality audio and infotainment and navigation systems in cars.

Secularly, we see penetration of information systems in cars. They have been at the high end. But they've taken costs out, which lets them go into midsize cars.

Second, in general there was concern that they were competing with cell phones. We believe they complement cell phones.

Finally, they have many years of backlog, so the visibility of this business is high. Cash flow has gotten better, based on (the) efficiency and skill of management.

IBD: What's drivingSignature Bank (SBNY), which has four quarters of accelerating earnings per share growth?

Ellenbogen: They bring in the best-in-class (financial services) teams, marry them with best-in-class infrastructure and empower them better than their big competitors, which are large money center banks.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing Mutual Funds
Referenced Stocks: SBUX , CMG , FLO , ZU , GRUB

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