Alger Spectra Seeks Leaders With Positive Transitions

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The $2.4 billion Alger Spectra Fund is a skilled marathoner.

Its performance ranks in the top 24%, 6% and 1% of its large-cap growth rivals tracked by Morningstar Inc. over three, five and 10 years.

Patrick Kelly, 37 years old, has run the fund since Sept. 24, 2004.

He looks for growth companies that are undergoing positive dynamic change. Kelly discussed his approach with IBD from his office in Manhattan.

IBD: You look for two types of good businesses getting better, right?

Kelly: Yes, we have two buckets of companies. One is high unit-volume growers. These coming-of-age companies have market dominance and are taking market share. They benefit from growing demand. They're in good growth markets. They have lots of free cash flow.

The other bucket holds lifecycle change companies. These are more established companies. Their change comes through having a new product or new management, new regulations or an acquisition. They're looking for earnings acceleration and multiple expansion.

IBD: And naturally you hope not everyone spots the change as early as you?

Kelly: When we find that, we're more likely to find a differentiated view from the consensus view. We try to be disciplined on valuation.

IBD: Are you finding more opportunities in any particular area of the economy?

Kelly: The Internet is creating significant changes. E-commerce growth has been accelerating, creating a lot of demand for Internet companies but also traditional retailers. Companies likeAmazon ( AMZN ) andeBay ( EBAY ) benefit from this. Other companies suffer significantly from that change.

The Internet is also changing the way we consume media. It has driven change in how companies allocate advertising dollars. We've seen a rapid increase in Internet advertising, which has benefited companies likeGoogle ( GOOG ) but has been the demise of other companies like traditional newspapers.

IBD: EBay has more than one moving part. Tell me more about your thesis, please. You added to your stake in at least your Nov. 30 and Oct. 31 disclosures.

Kelly: There's that benefit from the secular growth of e-commerce. The company benefits from scale and network effects.

From 2007 to 2010 eBay was lagging e-commerce's overall growth. But starting in 2011 it started to grow in line with e-commerce and is now growing faster.

In its Marketplaces (e-commerce) business, continued innovation should drive future growth.

Its PayPal unit is directly leveraged to growth in e-commerce and global trade.

EBay's valuation is attractive relative to its growth rate.

IBD: Are Google's revenues and earnings still growing fast enough for you?

Kelly: Yes, they continue to grow at a strong clip. They're a dominant player in a rapidly growing online advertising market.

They're well positioned for the shift to mobile advertising. They have over 85% market share in mobile search.

And they have a large growth opportunity in online video through YouTube.

We believe Google's core search revenue can accelerate this year with the introduction of their Enhanced Campaigns, which will integrate campaigns for desktop and mobile. (Enhanced Campaigns requires advertisers to use the same keyword advertising campaign across multiple devices.) That will result in improved costs per click.

IBD: You've added to yourPVH ( PVH ) stake in your two most recent monthly disclosures. Their recent Warnaco acquisition lets them unify different parts of the Calvin Klein brand they have rights to, correct?

Kelly: They've got strong management. And they're well positioned to benefit from the expansion of the Calvin Klein and Tommy Hilfiger premium brands. And that Warnaco acquisition will be accretive to earnings.

IBD: Why did you open a stake inHCA Holdings ( HCA ) in your October disclosure?

Kelly: Hospitals are well positioned to benefit from the health care reform and the Affordable Care Act.

We think HCA has one of the best hospital management teams. They generate a lot of free cash flow. And we think the company can generate shareholder value through deleveraging and other deployments of cash.

IBD: You trimmedUniversal Health Services (UHS) between your September and October reports. Earnings per share grew 8% and 7% the past two quarters after falling 2% in the prior stanza. What's your take?

Kelly: They operate hospitals and health centers. It's the same kind of thesis as HCA.

IBD: What dynamic change do you associate withLinkedIn (LNKD), another new addition to the fund?

Kelly: It's another market dominating company, benefiting from increased Internet usage.

We think they're taking significant share in the professional recruiting market.

This is another business that benefits from network effects. We think they have an enormous market opportunity in front of them. That should give them the ability to expand margins significantly.

IBD: What is the catalyst forEastman Chemical (EMN)? Their earnings per share grew 25% and 53% the past two quarters after declining the prior two quarters.

Kelly: The change is their recent acquisition of Solutia, which will drive earnings accretion.

It improves the margin profile of the company. And it reduces the cyclicality of their revenue stream.

In addition, we see upside to management's synergy targets for the acquisition. And Solutia makes five of the eight key raw materials Eastman uses in its business.

IBD: Affiliated Managers (AMG) gives their acquisitions access to its global distribution network. And acquired firms' owners are able to monetize their equity. Any other special sauces?

Kelly: They have a unique affiliate asset management model, with a very strong brand that attracts smaller managers as partners. The company has a strong record of adding affiliates, attracting new organic client flows and performance has been very strong.

IBD: You've got a number of financials --JPMorgan Chase (JPM),Blackstone (BX) andCarlyle Group (CG). Do they have the same dynamic driver?

Kelly: Blackstone and Carlyle are leading alternative asset managers. And alternative asset managers are seeing increased allocations from investors.

Blackstone has a strong brand name. We expect them to rapidly grow assets under management in the next several years.

IBD: And what do you like about JPMorgan?

Kelly: We've taken a more positive stance on financials. We think home prices will surprise on the upside. And an improved housing sector is a key driver for financials.

We think JPMorgan is a dominant franchise with a strong management team, and its valuation is attractive relative to their long-term earnings potential.

IBD: What's your thesis onMorgan Stanley (MS), in which you've been building a stake?

Kelly: They're going through significant change. They're a good franchise, trading at a fairly significant discount to book value.

They are improving the profitability of their wealth management business and reducing their exposure to the fixed-income business. Reducing exposure to the fixed-income business will free up excess capital, which can be returned to shareholders. Improving the profitability of the wealth management business and reducing the fixed-income business will lead to a change in their business mix. We think that will translate into a higher multiple.

IBD: Why do you think they will succeed?

Kelly: Their pretax margin was 9% in 2010. We expect them to exceed 20% in 2015. Their earnings mix will change a lot. We think that will lead to a multiple expansion and revaluation higher.

IBD: What's your thesis for media holdings likeCBS (CBS) and News Corp. (NWSA)?

Kelly: We think CBS is well positioned to further monetize their industry-leading content. They continue to return significant value to shareholders through stock buybacks. In addition, they're planning to sell their international outdoor (advertising) business. And they're converting their domestic outdoor (billboard advertising) business to a REIT, which will have tax advantages. And they will lead to accelerated share buybacks.

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

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

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