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LOGO
BARON
FUNDS
1 BARON ASSET
FUND
PERFORMANCE........................................................1
INVESTMENT STRATEGY................................................2
WALL STREET '99....................................................3
PORTFOLIO UPDATE...................................................3
THE INTERNET.......................................................5
NEWS...............................................................7
OTHER DEVELOPMENTS.................................................9
2 BARON GROWTH
FUND
[Formerly Baron
Growth & Income Fund]
PERFORMANCE.......................................................11
PORTFOLIO HOLDING.................................................12
OTHER DEVELOPMENTS................................................15
3 BARON SMALL
CAP FUND
PERFORMANCE.......................................................16
PORTFOLIO
COMPOSITION.......................................................16
CORPORATE
DEVELOPMENT.......................................................17
INVESTMENT THEME..................................................17
www.baronfunds.com
767 Fifth Avenue
NY, NY 10153
212-583-2100
1-800-99-BARON
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THIS QUARTERLY REPORT CONTAINS
INFORMATION FOR THREE FUNDS
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BARON ASSET FUND
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QUARTERLY REPORT JUNE 30, 1999
DEAR BARON ASSET
FUND SHAREHOLDER:
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PERFORMANCE
Baron Asset Fund performed well in both the three months and six months ended
June 30, 1999. Baron Asset Fund's performance for the slightly more than twelve
years from the Fund's inception on June 12, 1987 through June 30, 1999, has
been nearly eight fold appreciation, 18.7% per year annualized. The Fund's
performance has been significantly better than that of the large cap S & P 500,
16.5% annualized, and the small cap Russell 2000, 10.8% annualized. Although
Baron Asset Fund invests principally in small and medium sized businesses, it
has not sold these investments when they have become BIGGER and successful,
e.g. Charles Schwab, Univision, NTL, Hispanic Broadcasting. As a result, Baron
Asset Fund now has a number of investments in larger businesses . . . that we
believe still have the potential to at least double in size during the next
three to five years.
Because of these large and mid cap stock holdings, some investment services as
of January 1st of this year have begun to classify Baron Asset Fund as a
"mid-cap" fund rather than a "small cap" fund. From the Fund's inception
through December 31, 1988, Baron Asset Fund was ranked by Lipper Analytical as
the number 2 of 53 small cap mutual funds. Baron Asset Fund continues to make
most of its new investments in smaller businesses with market capitalizations
of about $1 billion or less, virtually all of its new investments in market
capitalization businesses of less than $2.5 billion.
For the second consecutive July and August, Baron Asset Fund's performance has
been disappointing. The Fund's communications, media, entertainment and cable
businesses remain very strong stock market performers and represent about 20%
of our portfolio holdings. However, the stocks of our two largest investments,
Charles Schwab and Sotheby's, about 25% of our holdings, have fallen 30-45%
this summer, giving up a large portion
[GRAPHIC]
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PERFORMANCE PERFORMANCE PERFORMANCE
FOR THE 3 MONTHS ENDED FOR THE 6 MONTHS ENDED SINCE INCEPTION
JUNE 30, 1999 JUNE 30, 1999 JUNE 12, 1987 THROUGH
JUNE 30, 1999
BARON ASSET FUND 11.9% BARON ASSET FUND 20.0% BARON ASSET FUND 689%
S&P 500* 7.0% S&P 500* 12.3% S&P 500* 532%
RUSSELL 2000* 15.6% RUSSELL 2000* 9.3% RUSSELL 2000* 243%
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* THE S&P 500 AND RUSSELL 2000 ARE UNMANAGED INDEXES. THE S&P MEASURES THE
PERFORMANCE OF THE STOCK MARKET IN GENERAL; THE RUSSELL 2000 OF SMALL AND
MID-SIZED COMPANIES.
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B A R O N A S S E T F U N D
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of the gains achieved during the first six months. Our education, healthcare,
amusement and recreation, retail and other small cap investments have also
performed poorly during July and August. Many of these businesses have fallen
30-50% from their peaks during the last year and are now selling in the stock
market at their lowest earnings valuations in years . . . mostly 10-15X current
year earnings! And, for the most part, these businesses are larger than they
were earlier this year, and a lot larger than they were last year.
Baron Asset Fund's stated goal has long been to double our shareholders'
investments every four to five years by investing in businesses that double in
size every four or five years. Our goal has been to reach net asset value of
$100 per share before year end 2002. Although we have now had thirteen months
of very modest gains, we continue to believe that most of our investments have
the potential to at least double in size and value during the next nearly three
and a half years. Of course, there can obviously be no assurance we can achieve
this goal.
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INVESTMENT STRATEGY
"Some men see things as they are and ask "why?" . . . I dream things that never
were and ask "why not?" Senator Edward Kennedy eulogizing his brother Senator
Robert F. Kennedy in June 1968 quoting George Bernard Shaw.
George Bernard Shaw's phrase is applicable to investors as well as politicians.
Invest in what a business can become . . . not only what it is. That's pretty
close to our investment philosophy. Use our own research, not others', find a
business run by a great entrepeneur with a big dream and the opportunity to
fulfill it. Invest at a good price, a price that offers us the opportunity to
at least double our money every three to five years . . . keep learning about
the business so that you can judge if they're on track . . . and hang on . . .
And remember, a stock's price is like the weather . . . if you don't like it
today, come back tomorrow . . . it will certainly be different . . . and may be
a lot more favorable.
. . . and, keep it simple . . .
The dreams . . .
Charles Schwab . . . to reinvent full service brokerage, with an internet
backbone, of course . . . and to become the largest, most profitable financial
services firm in the United States. Vail Resorts . . . owner of the best ski
mountain in North America . . . which Vail's Category III expansion will make
even better . . . to improve, to redevelop, its Colorado towns, especially
Vail, own more Vail hotels, restaurants and retail, steadily raise prices for
lift tickets, and acquire more ski resorts and, perhaps, high end golf resorts.
Mirage Resorts . . . continue to develop, own and operate the best, themed
casino hotel resorts in the world . . . to "keep the promise" to build "houses
made of bricks, not straw or sticks." Industrie Natuzzi . . . to reinvent the
way home furnish-
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ings are distributed throughout Europe, South America and Asia and to remain the
most profitable furniture manufacturer in the world. ChoicePoint . . . to
provide businesses and government with the same, highly profitable services it
now offers insurance companies . . . to help its customers know more about the
individuals and businesses with whom they conduct commerce. Polo Ralph Lauren
. . . to continue to strengthen the Polo brand worldwide and to fully exploit
this lifestyle brand through the internet . . . to significantly increase Polo's
profitability beyond its base level of license fees as a more efficient merchant
using both physical and virtual stores. Sotheby's . . . to add millions of new,
younger online auction clients to its hundreds of thousands of existing live
auction clients . . . to use the internet and databases to better serve its
collector clients both at physical sites and through internet auctions . . . to
protect its 254 year old, highly regarded brand. The bottom line? Whether it's
NTL, CoreComm, Robert Half or virtually any and every one of our
entrepeneurially managed businesses, they've all got a dream . . . to get
bigger, more profitable and less vulnerable to competition.
Sustainable competitive advantage . . . for a business to be of interest to us,
it must have a sustainable competitive advantage, the ability to keep
competitors from usurping its business opportunities. We had long considered
capital constraints an important competitive barrier. But, the impact of the
long '90s bull market and cheap capital has made capital availability, access
to capital, less important. Many have been able to obtain capital . . . and
many have not used it wisely. This has had a huge impact on assisted living
facilities, gaming casinos, hotels, apartments and internet businesses, among
others . . . there's now too many of them. Surplus businesses, of course, will
consign their owners to earn lower returns on assets than could have been
achieved only a few years ago . . .
Predictable, recurring and increasing annual income streams . . . brand
franchise fees, license fees, royalty fees, rental income, management fees,
service income . . . accounting services . . . TV and radio station advertising
revenues . . . rental fees for content libraries . . . ancillary income
produced by sports teams franchises . . . license fees and value created for
adjoining properties . . . that's what we're looking for . . .
Growth . . . if a business isn't moving ahead, it's falling behind . . . to
paraphrase a late friend. We want to invest in growing businesses, businesses
that have a BIG idea as well as the financial resources and management to
execute their plans . . . We want any business in which we're a part owner to
be managed in such a way that in three or four or five years it will earn twice
as much as it does today . . . and that it will then have the prospect to
double its earnings again. We want to be sure current high business
profitability is not a "flash in the pan."
Steve Wynn, the Chairman, CEO and founder of Mirage Resorts, loves to say, "you
must 'keep the promise' you make to your customers . . . and to your employees
and shareholders and community . . . if you can't do it, don't promise you
can." That's
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B A R O N A S S E T F U N D
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why Steve overstaffs his resort properties when they first open. His help isn't
fully trained yet and Steve doesn't want his guests to be disappointed with
their experience. You get one shot with your customer, he thinks, don't blow
it, even if you don't make a profit the first time, they'll come back and
recommend you to their friends if they have a good time. Steve runs his
business planning and expecting to increase revenues and profits over the long
term. We invested in Mirage twelve years ago for that reason and recently
bought more.
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WALL STREET '99
1999 . . . the year of the day trader . . .
My family and I rented a beach house in East Hampton, Long Island during July.
The house came complete with a house manager. After we had been there just a
few days, the manager approached me. "I've begun to trade stocks myself. Could
you give me a little advice?" "Of course." "What do you think of covered calls
on Knight Securities? I've started to trade them at Merrill Lynch and I'm not
doing so well."
That evening we had dinner with one of my friends, Joe Zicherman, formerly one
of Morgan Stanley's top institutional brokers. Joe's 55 and sort of retired. He
spends the summers in his weekend home near the beach on a former farm in
Sagaponick, Long Island. Joe trades about $200 million for himself and a cadre
of wealthy clients from a home office wired with the most advanced
communications systems. When I relayed my house manager story, he responded
with a story of his own. His gardener recently knocked on his door. "Mr.
Zicherman, I've started to trade stocks myself. I was wondering if I could sit
in your office with you for a day. I think I could learn a lot."
Finally, in the June 21 issue of Fortune magazine is a story about another of
my friends, Todd Morgan. Todd, 51, and a former Goldman Sachs' senior partner,
is the Chairman and founder of Bel Aire Investment Advisors, a Beverly Hills'
money manager that manages money for the very wealthy, many of whom are
Hollywood notables. Among his most well known clients is Barbra Streisand,
which brings us to the Fortune article. Barbra, according to the article, has
her "serious" money managed by Todd, but she has also begun to trade for
herself. Where do her ideas come from? Following Peter Lynch's advice to invest
in what you know, she goes to Starbucks every day, so she buys Starbucks'
stock. Her husband mentioned American Online, so she bought it. She heard a
doctor friend discussing Viagra at a cocktail party, so she bought Pfizer. "I
don't pretend to be some maven, like the guy in Barron's last week who can
analyze all the companies and so forth . . ." So, how has she done? Better than
Todd! And, better than just about anyone else I know. After about five months
of intense trading Barbra has nearly doubled her money . . .
These anecdotes are reminiscent of a story we reported in a recent quarterly
shareholder letter about a traffic policeman who
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stopped Charles Schwab's Len Mayer to ask whether the officer should sell his
Dell stock to buy AOL. It's all eerily reminiscent of the story about the
shoeshine boy who reputedly began to give unsolicited stock tips to legendary
stock trader Bernard Baruch in the summer of 1929. The boy's advice made Baruch
so uneasy about speculative excesses that he began to sell all his stocks well
before the market crashed that fall . . .
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PORTFOLIO UPDATE
So, if speculation is rampant and stock prices are high, why aren't we more
worried?
It's because the speculation, the day trading, seems to us principally
concentrated in a group of highly valued and highly volatile technology and
internet businesses . . . businesses in which we have not invested. We
certainly believe our judgment that other people's stocks are overpriced, but
our's are cheap, is based upon substantive analysis. Especially since share
prices of many businesses in which we are investors are already substantially
below their peak prices achieved during the past eighteen months . . . 30-50%
below.
Stock prices don't always reflect current business results and prospects . . .
spelling investment opportunity for us.
Invest before the reasons you're doing so are obvious to others. During the
past year and a half we've been able to establish many new investments in small
and mid-sized businesses, as well as add to existing holdings, at what we
perceive are attractive prices due to investor focus elsewhere . . .
American Tower has the potential to more than double voice oriented
communications towers business with wireless data transmission, e.g. AOL,
everywhere, anywhere, anytime. It continues to build and buy more towers, add
more voice customers to existing towers as one-rate plans proliferate.
American Tower. American Tower's capable management led by Steve Dodge has
already made us a lot of money twice before. Several years ago we invested in a
Steve Dodge managed cable television business whose shares about tripled in two
years . . . during the past two years Dodge managed American Radio, which was
sold to CBS also about tripling our initial investment. We thought the
prospects for American Radio's tower business, the spinoff company, American
Tower, were exceptionally bright. One-rate wireless voice plans started by ATT
and joined in battle by MCI Worldcom are proliferating and causing burgeoning
demand for tower facilities. Our current expectation that the internet will be
accessed from wireless devices anywhere and everywhere and at any time, could
make the tower business much more than twice as profitable as we initially
expected. This only serves to confirm our theory that great, hardworking,
talented, fun-loving and generous managers like Steve seem to always get
"lucky." Although American Tower's share price has more than doubled from our
intial purchase price two years ago,
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it has recently fallen about a third for no readily explainable reason. As
American Tower continues to add communications towers to its portfolio and
customers to its towers, its cash flow will increase dramatically, as should
its stock price. Its latest deal . . . 2100 towers will be acquired from
Airtouch in Year 2000. American Tower owns, operates and manages more than 7000
communication towers, giving effect to pending transactions. There are
currently about 65,000 communications towers in the United States. Industry
experts forecast demand for 100,000 towers by 2002. American Tower is the
largest independent owner operator of communications towers in this country.
HCR Manor Care has potential to care for more acutely ill and potentially
significantly more profitable patients in its nursing homes. HCR is low cost,
high quality, healthcare provider.
HCR Manor Care. As has nearly every health care stock during the past two
years, HCR Manor Care's share price has been pummeled. During 1999, the
government changed the reimbursement schedule for skilled nursing facilties
from cost plus to prospective pay, PPS. PPS makes predetermined fixed payments
to nursing homes for specific patient disease states regardless of actual costs
incurred by a facility. This new government payment schedule has bankrupted
many leveraged nursing home facilities who relied for profits upon being able
to provide high cost, reimbursed services to its patients. Further, government
oversight of nursing facilities has dramatically increased during the past
year. Regulatory compliance, in many instances with details that to impartial
observers would seem barely relevant, have also added millions to costs. HCR's
strategy? To admit higher acuity, higher revenue-producing patients and to
provide them with high quality, intense treatment at lower costs than others
. . . and to increase occupancy in its facilities by 5 points. HCR Manor Care
has borne millions in extra expense to prepare its homes to accept higher
revenue-producing, sicker patients while foregoing revenues and income from
less profitable medicaid patients. If HCR can fill its empty beds with subacute
patients and improve its patient mix moderately, it could improve profits 50%
in existing facilities. More homes, and more intense services per home, will
boost profitability further. HCR Manor Care's share price has fallen more than
50% from its peak during the last year and a half. In a 32X earnings market for
7% growth, HCR Manor Care now sells for 7.5X its estimated $400 million '99
EBITDA and 13X estimated 1999 $1.50 after tax earnings per share. HCR's
earnings are currently subnormal and could jump 50% during the next two years.
Sotheby's establishes sothebys.amazon.com . . . joint venture collectibles
online auction site with Amazon.com. Amazon pays $45 million for one million
new Sotheby's shares and an option to purchase an additional million shares at
$100 each. Sotheby's stumbles with selection of manager to run this business.
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Sothebys.amazon.com expects to begin collectible auctions with Barry Halper's
fabulous baseball memorabilia collection on September 28. Don't miss it. Our
optimism for this venture is high. With Sotheby's 3500 affiliated worldwide
dealer network sourcing goods; Amazon.com providing technology, customer
traffic and analysis; and Sotheby's providing expertise and authentication,
this venture should be a big hit. In fact, the sothebys.amazon.com collectibles
auction site, when combined with the high quality Sotheby's art and antiques
online auction site, sothebys.com, slated to startup later this year, could
allow Sotheby's to be two to three times larger during the next decade than it
would have been otherwise. Since we expect Sotheby's auction profits to
quadruple during the next decade without online auctions, this is significant.
Sotheby's stumbled with its initial selection of a manager to run this
business. We expect that an ongoing search for a replacement will soon give us
a highly skilled, previously very successful, hardcharging and highly incented
executive capable of working independently of Sotheby's existing management
. . . but utilizing its expertise, authentication skills and independent dealer
network. Sotheby's share price has fallen about a third from its peak this
summer.
Education stocks fall as investors theorize that individuals can find jobs in a
full employment economy with no further education beyond high school, so why
waste the time and money to attend college?
The conventional wisdom on stocks of education businesses is, we guess, "why
does anyone need to go to college in a full employment economy if he or she can
get a high paying job today without a bachelors or associates degree?" Of
course, most individuals who do not graduate college are not likely to achieve
the success of Bill Gates, Tiger Woods and star Duke basketball players . . .
The private colleges in which we are part owners continue to open more schools,
add more students to existing schools, charge more tuition each year than the
year before and earn more money every quarter than they did a year ago. We
believe that in our high tech, knowledge-based economy, education wins.
Demographics is also helping. Echo boomers, also known as Gen Y, the children
of baby boomers, are a huge population segment and will increase demand for our
country's post secondary education resources for twenty years. There just
aren't enough schools. Since share prices of higher education businesses have
declined 30-50% while their businesses have continued to grow, we purchased
additional shares of DeVry . . . we've been an owner since 1991 and have
already earned more than ten times our money . . . as well as Education
Management and ITT Education. We have owned each of the last two businesses for
about two years. In addition, while we have followed Apollo for several years,
until now we have not had a chance to purchase its shares. We recently invested
in Apollo as well.
. . . the stock prices of many of our smaller businesses have been little
changed during the past year and a half . . .
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B A R O N A S S E T F U N D
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although most of these businesses are now larger and more profitable than at
the start of 1999 . . . and a lot larger and more profitable than at the start
of 1998 . . .
Choice Hotels, the second largest hotel franchisor in the United States,
continues to add more franchisees, improve the services it provides its
franchisees, aggressively repurchase its shares and increase its earnings per
share. Saga Communications, the big city quality radio broadcaster in smaller
communities, continues to dramatically improve results in its existing
stations, as it has every year for the more than six years we've been the
company's largest shareholder, while continuing to purchase additional stations
and radio networks at very attractive prices. Libbey Glass, the leading glass
tablewares supplier, continues to broaden its product line, improve its
distribution, lower its costs and improve its earnings. OM Group, a leading and
highly profitable and very fast growing specialty chemicals business, continues
to add new, and exciting products to its line, grow volume in its existing
products, make attractive, synergistic and accretive acquisitions and grow
. . . grow . . . grow. Industrie Natuzzi, the world's leading manufacturer of
leather couches, has recently introduced fabric covered upholstery as well, and
is now benefitting from the home building boom of the past several years, e.g.,
after you buy a house, you've got to buy furniture so you can live there.
Natuzzi, as we have described in past shareholder letters, is one of the two
most profitable furniture manufacturers in the world, and has an opportunity to
virtually revolutionize furniture distribution in Europe, South America and,
maybe even Asia. And, of course, its earnings are growing strongly.
When academics tell you about "efficient markets," ask them to explain why
these 15-20% annual growth, franchise businesses, are selling at 10-15X
earnings in a 32X S&P earnings market. And, why are Alexander's shares, as
described below, selling for a little more than 60% of current liquidation
value.
Alexander's demolished the existing building structure and has begun to move
dirt on its valuable full block site on 59th Street and Third Avenue in
Manhattan. The property, with development potential of 1.1 million square feet
of mixed use office, residential and hotel, could be sold before it is
redeveloped for perhaps $300 million, $60 per Alexander's share. Redevelopment
of the site could add $200 million value, net of building costs, to the dirt,
another $40 per Alexander's share, during the next two or three years.
Alexander's eight other owned properties in and around New York City have a
conservative value of $60-70 per share net of debt. After reaching $95 per
share in the spring of 1998, Alexander's share price currently languishes about
$20 below that level. This is despite the very strong New York City real estate
market and Alexander's opportunity to take advantage of these conditions. And,
as is the case for most of our investments, we just love this company's
management, Chairman Steve Roth and President and COO Mike Fascitelli.
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Inflation.
Babe Ruth, probably the best baseball player of all time, earned a salary of
$80,000 in 1929 . . . which happened to be more than the President of the
United States earned that year. "I had a better year than he did," the Babe
explained. The Brooklyn Dodgers' Sandy Koufax held out with fellow star pitcher
Don Drysdale in 1965 until they could each achieve annual salaries in excess of
$100,000. In 1965, Koufax was the best left handed pitcher in baseball. He just
may have been the best pitcher ever . . . from either side. Many baseball
players today earn salaries of $10 million per year and, Michael Jordan,
certainly the best basketball player of all time, in 1997 earned a salary in
excess of $30 million . . . not including endorsements. Home prices, salaries,
McDonald's fries, gas prices, clothes, couches, college tuition. They're all
higher than they were last year . . . and a lot higher than they were five,
ten, twenty, thirty and seventy years ago. Inflation. Don't believe government
statistics. In a democracy, inflation's not going to disappear. It's just
another hidden tax. Our rapid unit growth, branded, service businesses, but not
necessarily their stocks in the short term, benefit from moderate inflation
. . . they can readily pass on higher costs . . . as do our physical asset
businesses . . . nominal returns on their assets will increase and it will be
harder for competitors to build competing facilities. We think it unlikely that
the businesses we own will continue to increase in value, in profitability,
while their stock prices remain unchanged. Regardless, as our fast growing,
small and mid-sized companies become BIG, they'll be valued like the other big
guys anyway . . . and that's much higher.
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THE INTERNET . . .
. . . it's changing everything.
The internet . . . content, community and commerce . . . the opportunities are
vast for business to consumer transactions . . . and the opportunities for
business to business commerce are even larger. And, internet-related, huge and
exponentially increasing demand for data communications should benefit many of
the businesses in which we invest . . . from cable and telephony to
communications towers. But, what about barriers to potential competition?
Spectrum, licenses and huge capital required offer some protection for
communications businesses. But, for most so-called internet businesses, no such
barriers exist. So, how do you value these businesses?
Venture capital investors funding startup internet businesses that have been
accorded extraordinary valuations as public companies have been nearly deified
by the investment press this year. "Don't confuse genius with a bull market"
. . . I was advised early in my career when stock after stock I recommended
advanced in price . . . during a bull market.
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"First mover" advantage and the value of a customer.
"First mover advantage" . . . it's not all it's cracked up to be. Investment
bankers selling new companies to the public through initial public offerings,
often "businesses" that are not much more than an idea, never tire of
explaining to potential investors that the first to introduce a concept will
create a huge barrier to competitors, the "first mover advantage." This theory
is based upon customer inertia, i.e., once you get a customer, they're your's
for life, or at least for a long time. Don't believe it. A recent study of
United States' consumers indicates that 18% of our fellow citizens would switch
their telephone companies if a new company offered telephony service at the
same price as an existing provider. Offer a discount from the incumbent
telephony provider, and the trickle of disloyal customers becomes a flood.
Another 20% of customers surveyed would switch telephone companies for a 5%
discount; and 20% more would switch for a 10% discount. Many web businesses
have apparently built customer counts by offering price discounts to
established "bricks and mortar" business' customers. In our opinion, this is
neither much of a value proposition nor one that provides sustainable
competitive advantage. The web will make it easier than ever for customers to
switch from one service to another. For example, of the 15 top web sites in
1996 as measured by unique visitor traffic, only four remained in the top 15 in
1998. Not much sustainable value here, we think.
Costs to obtain a customer, costs to retain a customer, the likelihood that
customers will be retained and the present value of the lifetime revenue and
profit that can expected to be achieved from a customer . . . that's our focus.
Companies able to attract new customers for low cost; that can achieve
extraordinary customer persistency by providing great value, a unique and
valuable service and established brand, not just the lowest price; that are
able to obtain high and increasing revenues per customer; that have important
barriers in place to competition. That's what we're looking for.
Charles Schwab attracts and retains "baby boomer" customers and earns high
returns . . . offers its customers a great value proposition.
Schwab's stock market valuation on August 30, 1999, today's date, is about
$5100 per customer for each of its 6.2 million customers. Schwab currently
obtains about $700 annual, very profitable revenue per average customer. Its
average customer is 47 years old and holds nearly $100,000 assets at Schwab.
Merrill Lynch's average customer is 62 years old and holds $350,000 assets in
his or her Merrill account. The average account at Schwab, and, Schwab's
revenues per account, should continue to increase as its customers become older
and wealthier . . . if Schwab can retain these customers. Profits per Schwab
customer account, of course, should grow a lot faster than account assets due
to operating leverage. It doesn't cost much more to service an online account
with $200,000 or $300,000 in assets than it does for one with
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$100,000. Bigger accounts produce more revenue. Since 1992, when we first
invested in Charles Schwab, its average customer's account assets have about
tripled from $33,000 per account. Its number of customers have also more than
tripled from 2 million active accounts in 1992.
Schwab's cost to obtain a new account currently approximates $150-200. Its cost
to retain that customer can be measured by its $250-300 million per year
technology spending, an annual expense incurred to improve exisiting customer
services, to make its services more robust, and to add new services. This cost
is about $50 per account per year. Schwab's new Velocity service, announced
last week, is a good example of its efforts to further improve its electronic
offerings. Schwab's cost to attract and retain customers is dwarfed by its $700
annual revenues per customer . . . which, we believe, will continue to grow at
least as fast as same customer assets.
Schwab is currently experiencing about 6% annual customer attrition, a
remarkably low number. When Schwab segments its accounts by asset size and
provides enhanced services to its high end customers, e.g. Signature Services,
annual account attrition falls to 3%! By comparison, America Online, cable
television businesses and cellular telephone businesses usually experience
customer "churn," customer defections, of more than 2% per month; telephone
businesses, with their highly stable customer base, experience churn of 1% per
month (people move). In addition, Schwab's customers are currently growing by
about 200,000 net per quarter, about 15% per year. We assume Schwab's existing
customers will become wealthier as they become older; that these customers will
continue to increase their investments at Schwab; that Schwab will continue to
attract new customers; and, that more online, revenue producing services, e.g.,
banking, credit card and insurance referral fees, will be offered. As a result,
Schwab's customer assets could continue to increase 30-35% per year, its
revenues more than that and its profits, on average, even more for the next
several years.
Schwab's stock market valuation compares favorably to historic cable
television, cellular telephone valuation metrics . . .
When we began to invest in cable television businesses in the mid 1970's, we
invented, with a group of my then young friends whom some irreverently called
the "Wall Street media mafia," a metric to value these fast growing franchises.
Most cable businesses were then highly leveraged, had only modest revenues and
no profits. We initially valued cable businesses at $50 per home in a
franchised area, and later, when they obtained customers, at $600 per customer
(the then present value of their estimated future earnings) . . . several years
later these cable businesses were commonly acquired for $2000 per customer and
are currently changing hands for $5000 per customer. Cable customers now
produce an average $40 per month revenue with $1000 capital cost. Current cable
valuations are based upon expectations for
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significant revenue increases per customer as telephony and internet services
are added. Schwab's customers now produce about 40% more annual revenues than
an average cable cus tomer; Schwab's customer persistency, before the addition
of its enhanced Signature Services, is about four times greater; and Schwab's
capital costs per customer are a lot less!
When we began to invest in the late 1980's in leveraged, loss generating
cellular telephone businesses, we valued these fast growing, venture stage
businesses for $30-40 per "pop," per person in a franchised area (again, the
present value of our expectations for future earnings cash flow). The per "pop"
valuations were used since the startup cellular franchises then had few
customers and neither earnings nor cash flow. We assumed that a good percentage
of the population in a market would in time want to communicate wirelessly. We
made a lot of money (cellular franchises are now worth at least 10-12 times
cash flow, over $300 per "pop" despite a lot more competition) since we
thought, ten years ago, that a lot more people would use this service than most
others commonly assumed. In annual year end Barron's Roundtable discussions in
which I participated for seven years from 1988 through 1994, I regularly
projected that more than 20% of our population would use cellular phones. And,
even though our estimate was way too low, others were much lower. ATT forecast
in 1979 that cellular phone usage in New York City by 2000 would reach just
233,000 users. Donaldson Lufkin Jenrette, then the most bullish of the Wall
Street brokerage firms, projected in 1987 that cellular penetration would, over
time, reach 3%. There will be 4 million cellular users in New York City in
2002! By 2000, many countries will have 60% penetration! Italy will achieve
100% penetration! As legendary Mets' and Yankee manager Casey Stengle used to
say, "You could look it up."
In addition to Schwab being attractively valued relative to other customer
based valuation businesses, e.g., cable television, cellular telephone,
telephone companies and internet businesses, Schwab is attractively valued
compared to slow growth banks that commonly sell for 10-15% of customer
deposits. Schwab's shares now sell for about 5% of its rapidly growing customer
assets. Although we've made more than 40 times our original investment in
Schwab since 1992, we continue to believe we have a few more doubles in front
of us during the next decade.
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NEWS
Metro Networks, the radio traffic, news and sports service, acquired by
Westwood One for stock.
Westwood One provides radio programming to, and is controlled by, Infinity
Broadcasting. Westwood One also owns Shadow Traffic, which, although it's a lot
smaller business than Metro Networks', is Metro's largest competitor.
Westwood/Metro should be able to significantly reduce expenses and eliminate
certain competitive pricing practices. In addition, Metro will gain a large new
<PAGE>
market for the computerized news service it provides to radio stations . . .
Infinity's stations. "My wife wants me to be a billionaire," David Saperstein,
one of our speakers at last year's Baron Investment Conference, recently
confided to us, we assume only partly in jest. David's business was sold for a
little more than $900 million in Infinity stock. "Can't you just say it's for
about a billion?" David's wife teased the entrepeneurial former car salesman.
Baron Asset has been Metro Networks' largest outside shareholder for the entire
three years since that company's initial public offering in October 1996 . . .
and has so far about tripled its money. For David to personally reach $1
billion net worth, Westwood One, after its merger with Metro Networks, must
about double in value again. We don't underestimate David's motivation.
Hughes' Direct TV, General Motors and Clear Channel Communications invest $250
million in American Mobile Satellite's XM Radio subsidiary. American Mobile
then completes its own oversubscribed $125 million public secondary stock sale
significantly improving its balance sheet.
The chairman of American Mobile Satellite and XM Radio, Gary Parsons, is fast
becoming one of my heros. When we invested in American Mobile Satellite nearly
five years ago, we did so with the expectation that its proposed geostationary
satellite would meet widespread demand for its service, most importantly from
cellular telephone users in remote areas where there were no towers and no
likelihood towers would be built. Alas. The company's management, recruited
because of prior successes as managers of established businesses, had a
difficult time operating a startup venture. American Mobile Satellite started
with too much overhead and too much debt; its satellite launch was delayed a
few months and then lost capacity when it was improperly operated from the
ground; and, a lot more towers were built than we expected, sapping demand for
the satellite's roaming services. In 1996, Gary was recruited as the company's
new chief executive officer fresh from his role as second in command of a
startup communications venture that was sold to MCI for nearly $1 billion. The
competition to recruit Gary was vigorous. American Mobile prevailed, I think,
because although another venture offered greater consideration and perhaps more
assurance of success, he would have had to relocate. Gary lived a very short
distance from American Mobile's offices in northern Virginia.
Since Gary assumed control, he has dramatically reduced the company's
investment in inventories; replaced key managers with individuals he has known
to be successful; focused marketing efforts on institutional customers, e.g.
transportation companies, field service, and, raised additional capital, both
debt and equity. But, two developments stand out.
(1) American Mobile acquired Ardis, the powerful two way terrestrial wireless
network that perfectly complements the company's satellite communications
services. Ardis was purchased from
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Motorola for cash and stock, which, in the process, allowed Motorola to become
the company's third largest shareholder(Hughes is number one). This unique
satellite/terrestrial network is similar to that of Bell South, but our's is
more robust. American Mobile's network is a low cost, low latency . . . fast
two way response time . . . solution which allows intereactive two way paging.
Recent deals with Skytel, RIM confirm the value of network for two way paging.
Deal with UPS suggests field service value. Also of importance is telemetry
market, wireless polling of meters, Coke machines. There are clearly a number
of potential acquirors of this network . . . among them America OnLine, AOL
anytime, anywhere, MCI/Skytel, and the RBOCs.
(2) American Mobile acquired one of two digital audio radio licenses issued by
the FCC. As outlined above, General Motors, Hughes' Direct TV and Clear Channel
recently invested $250 million in American Mobile's subsidiary with the DARs
license, XM Radio. Baron Asset also invested $21 million in XM Radio. The
opportunity, we think, is many fold appreciation if this business is
successful. XM Radio's only competitor is CD Radio, another business in which
Baron Asset has successfully invested, that also still offers great
appreciation potential.
The lesson? Bet on great managers. Gary, thanks to our good fortune, is
certainly proving to be one of them.
Following Microsoft's $500 million equity investment in NTL earlier this year,
France Telecom invests $5.5 billion in NTL. NTL acquires U.K. Cable and Wireless
cable television/ telephony business. France Telecom now NTL's largest
shareholder.
Following NTL's acquisition of Cable and Wireless, the merged businesses will
reach more than 12 million households in the U.K. and Ireland, more than half
the available homes in that market. The company will be more than twice as
large as its closest competitor, Telewest. The transaction also increases the
likelihood that NTL will acquire Telewest as well. NTL has been the most
successful of the eight year old U.K. cable television/telephony businesses.
More than 43% of the homes NTL has "passed" so far have switched their
telephone service to NTL from British Telephone, the former monopoly telephony
provider. During the last twelve months, 66% of the incremental homes marketed
have taken the NTL telephone service, demonstrating strong additional
potential. We also think it's noteworthy that 40% of its telemarketing has been
inbound. Consumers are calling asking for the NTL service as soon as it's
available. Cable and Wireless has achieved 26% penetration, offering NTL
substantial upside as it rolls out its innovative services, e.g., digital
t.v.'s coming in September, and marketing programs that bundle services at
attractive prices. Following this acquisition, NTL's reach and, therefore,
program buying power, will be substantially enhanced. This offers NTL the
potential to improve its cable
<PAGE>
television operating margins significantly, from 40% to 50-55% of revenues, we
think. Finally, the explosive demand for bandwidth due to the internet . . .
data transmission in its markets has already increased seven fold in the past
two years . . . we think is just beginning. Bandwidth demand, so far driven by
e mail, will soon get a giant boost from images transmission, streaming video.
Anyway, NTL could increase its revenues 3-5 times in the next few years as it
increases its homes passed from 8 million to 12 million, increases penetration
of its potential customers, sells its customers more services for greater fees
and adds business customers.
So, how did George and Barclay find this investment in the first place? About
seven years ago, after George and Barclay had sold Cellular Communications of
Ohio to Pactel, now Airtouch, they were looking for a business in which to
invest for their small, Ohio microwave business, OCOM, the predecessor company
to NTL. George and Barclay had heard that the U.K. government was then trying
to foster competition for its monopoly telephone company, British Telephone. It
was offering regional franchises that could provide both cable television and
telephone service to their customers . . . and British Tel would be prohibited
from competing in video services until 2002. U.K. residents in 1992 received
just four television channels and their phone service was both expensive and,
to be charitable, not considered top notch.
A close associate of George's had obtained a provisional, regional U.K. cable
television/telephony franchise. But, the capital needed to retain this license
and build a system in the franchised area was beyond that executive's
capabilities. George thought the joint greenfields cable television/telephony
system sounded like a good idea, but felt the capital required could not be
easily justified. For the venture to be successful, a large portion of British
consumers' homes a cable television/telephone system passed would have to
switch their existing telephone service to an unknown, new company . . . or
sign up for monthly cable television charges instead of free over the air
television. Prior cable-only television systems in the U.K. had failed and News
Corporations' BskyB satellite programming service was rapidly becoming
entrenched with long term program contracts and attractive satellite dish
financing. George then was invited to a dinner by an ardent investment banker
seeking to interest George in the U.K. venture. George met a Comcast executive
at the dinner who operated another U.K. cable franchise. That executive bragged
25% of the homes passed by Comcast were initially subscribing to not only cable
t.v., but telephony as well. George was overwhelmed by this early evidence of
strong consumer demand and decided, virtually on the spot, that his friend's
franchise offered unique opportunity. The chance meeting and kernel of
information gained again confirms my theory of good luck that accrues to hard
working, honest and brilliant entrepeneurs. Then, in a chicken and egg
conundrum, George and Barclay figured out how to raise the required billions
for OCOM to finance construction, although
8
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the U.K. franchise license would not be granted to their company before it was
financially strong. Seven years ago Baron Funds became the company's largest
outside shareholder, which it remained until it was diluted by subsequent NTL
stock and convertible debt offerings at successively higher prices. We have
since earned more than eight times our original investment . . . and hope to
double its value again in the next three or four years.
Cellular Communications of Puerto Rico (CCPR), another business controlled by
George and Barclay, acquired by SBC Communications and Telephonos de Mexico.
This acquisition was consummated in late August. The consideration to CCPR's
shareholders was $29.50 cash. Another George and Barclay coup. Baron Asset Fund
was CCPR's second largest shareholder; the Fund owned 7.4% of CCPR's shares,
and has more than tripled its money during the past four years.
Spieker's rents just keep going up . . . and up . . . and up.
Spieker Properties continues to achieve very strong rent increases when its
existing suburban California office tenant leases expire and are renewed.
During the second quarter, Spieker's rent increases on new leases and renewals
averaged 27.8%. In addition, the company's $396.3 million office development
pipeline is now 54% preleased and is expected to provide an initial yield of at
least 11.1%. This is at the high end of office development opportunities. This
is further evidence of very strong demand for Spieker's properties . . . and of
little competitive space offerings.
Addenda: Libbey and Southern Union fail to acquire target companies; Smart &
Final and AMF Bowling complete rights offerings.
Leading glassware manufacturer Libbey terminated its unsolicited bid to acquire
leading flatware supplier Oneida. The distribution synergies in this
combination were terrific, but Oneida's mangement felt they would be better off
independent. This is despite the fact that Libbey's offer was at twice the
price Oneida's shares traded before Libbey's interest. Oneida's extraordinarily
high overhead expense as a percentage of sales probably offers a clue as to why
the lean and mean Libbey was considered an unsuitable acquiror. In a second
disappointment for us . . . Southern Union failed to acquire Southwest Gas
despite its significantly higher cash offer than Oneok. Our friend Mario
Gabelli was one of the few investors who stood up for his shareholders and
voted no! But the politics of this deal, as outlined in a recent Forbes
article, or something more nefarious, as charged by Southern Union, were too
much for Chairman George Lindemann. Smart & Final and AMF Bowling both
successfully completed rights offerings to improve their balance sheets. Both
businesses, following the addition of new managers, are doing much better.
<PAGE>
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OTHER DEVELOPMENTS
Eighth Annual Baron Investment Conference: October 15, Grand Hyatt, New York
City.
For the more than twelve years since Baron Asset Fund's inception on June 12,
1987, we have tried to provide our shareholders and prospective shareholders
with enough information to make an informed judgment about whether Baron Funds
is an appropriate investment for you and your family. Baron Funds' quarterly
report narratives regarding our investments and strategies, as well as the
financial information we provide, is what I would like to have if our roles
were reversed. We regard our annual Baron Investment Conferences as another
opportunity for you, our shareholders, to become more knowledgeable about your
investments in Baron Funds.
Each October since 1992 we have invited the chief executives of five businesses
in which Baron Funds has significant investments to speak with our shareholders
at our annual conference. The executives first describe the businesses they
lead and the prospects for those businesses in 30 minute formal presentations.
These are similar to the Wall Street "dog and pony" shows analysts regularly
attend to initially become acquainted with a company and its management. The
formal talks, usually, but not always, are accompanied by film clips and
slides. Each talk is followed by a 15 minute question and answer period with
our shareholders.
The presentations are often enlivened by footage like that Vail Resort's
chairman Adam Aron used two years ago of nuns from "The Sound of Music"
executing exciting snowboarding leaps from snow covered Colorado mountain tops.
Or a quiet talk without slides or notes last year by Polo Ralph Lauren's
chairman, Ralph Lauren, about his business' humble origins. Our shareholders
were totally charmed by Ralph and especially enjoyed his reparte when a
questioner from the audience began to reminisce with the Polo chairman about
teammates on their high school baseball team at DeWitt Clinton High School in
the Bronx. And we get the blowout presentations, too . . . like last year's
talk by NTL's chairman, George Blumenthal. George wowed the crowd with what
Morningstar. Net called his "breathtaking projections" for NTL's U.K. fibre
optic network's voice and data telephony, cable television and internet access
services . . . projections which a year later, actually look a little
conservative.
Immediately following the presentation by our luncheon speaker, who this year
will be Charles Schwab's co-CEO and President, David Pottruck, I will address
our shareholders. My talks, in the past, have focused on our investment
strategies and philosophy. After my talk, unlike our other speakers who answer
audience
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questions for a limited time, I will answer our shareholders' questions until
you tire of asking them. You can also ask Morty, Cliff, Matt and Mitch any
questions you'd like. No holds barred. Last year, shareholders questioned me for
nearly two hours before the last investors filed out to Billy Joel's "New York
State of Mind." Whew.
We would not think of investing in a business on behalf of our Fund's
shareholders, which include us as among the largest individual shareholders, of
course, before visiting and interviewing a business' management, speaking to
their competitors and carefully studying available financial information. We
call this our "kick the tires" research approach . . . and after we kick the
tires once, we keep kicking them regularly to make sure they're still o.k. We
offer our shareholders an opportunity to annually "kick the tires" of their
investments in Baron Funds, to judge for themselves whether the businesses in
which we've invested on their behalf are still appealing, have significant
growth prospects and are attractively valued. You also have the opportunity to
judge for yourselves whether the executives leading these businesses are people
who are forthright, capable and trustworthy. You have the opportunity to judge
the competency, not just of several business' managers, but also of your funds'
portfolio managers, me, in the case of Baron Asset, Cliff, in the case of Baron
Small Cap, and, in the case of Baron Growth, Mitch and Matt, who work with me
on that fund. Just ask us questions. We'll try to answer them.
Our conference begins at 8:00 AM for breakfast and ends following my speech
after lunch. Our first speaker after breakfast this year will be Sol Kerzner,
Chairman and CEO, Sun International Hotels, Ltd., the owner of the spectacular
lost continent oriented Atlantis Resort Hotel and Casino on Paradise Island,
Bahamas, manager of the Mohegan Sun in Connecticut, and developer of new resort
gaming projects in Atlantic City and Las Vegas (Sol is generally regarded as
one of the preeminent developers of themed casinos, and an important influence
on Steve Wynn, among others). Sol will be followed by Derek Smith, Chairman and
CEO, Choicepoint, the very profitable, fast growing manager of insurance
company databases that is extending its services to other businesses and
government; Michael Marks, Chairman and CEO, Flextronics, the lightning fast
growth electronics contract manufacturing company that counts the largest
consumer electronics and communications businesses as its customers; and,
Isadore Sharp, Chairman and CEO, Four Seasons Hotels and Resorts, the
franchiser and long term manager of the best five star hotels in the world. To
Izzy, long term management contracts have a different connotation than to
almost anyone else . . . eighty year contracts are the norm here. If others can
achieve decade long contracts, they're doing well. How does he do it? is
<PAGE>
an interesting question. Finally, following surprise Rock 'N Roll luncheon
entertainment, David Pottruck and I will give the last two presentations. David
is President and Co-CEO, Charles Schwab Corporation, the largest online
brokerage firm that is reinventing full service brokerage, with an internet
backbone. How Schwab will distinguish itself from would-be competitors will be
an interesting topic. Schwab has been Baron Asset Fund's largest holding for
years . . . due principally to that firm's outstanding business and stock
market performance.
Please RSVP at 1-800-99-BARON or 212-583-2100 or visit us at our web site
www.baronfunds.com to reserve a place so that we can be certain we will be able
to accommodate you. Space is limited. Last year more than 1300 guests attended
and we expect even more this year. Of course, as always, there will be no
charge to attend our conference. We have set aside rooms in four hotels to
accommodate our guests at "special rates." Unfortunately, this is New York City
and "special rates" here would not be so regarded in most of the rest of our
country. We hope to see you in October.
Thank you for investing in Baron Asset Fund.
We recognize it cannot be an easy task for most individuals when you choose to
invest in stocks through mutual funds. Your decision must be especially
difficult when you have to consider how to invest your hard earned savings to
pay for your children's education, a new home or your retirement. It is
especially daunting now since there are more mutual funds than there are stocks
. . . and well respected advisers often give conflicting opinions.
We hope our quarterly shareholder letters, interviews in the financial press,
investment adviser conference calls and annual investment conferences have made
it easier for you to determine if Baron Asset Fund is an appropriate investment
for you and your family.
We want to thank you again for joining us as fellow shareholders in Baron Asset
Fund. We will continue to work hard to justify your confidence.
Sincerely,
/s/ Ronald Baron
- ---------------------
Ronald Baron
Chairman and CEO
August 30, 1999
10
<PAGE>
LOGO
BARON
FUNDS
2 BARON GROWTH
FUND
[Formerly Baron
Growth & Income Fund]
PERFORMANCE........................................................11
PORTFOLIO HOLDINGS.................................................12
OTHER DEVELOPMENTS.................................................15
www.baronfunds.com
767 Fifth Avenue
NY, NY 10153
212-583-2100
1-800-99-BARON
<PAGE>
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BARON GROWTH FUND
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QUARTERLY REPORT JUNE 30, 1999
DEAR BARON GROWTH FUND
SHAREHOLDER:
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PERFORMANCE
Baron Growth Fund performed well in the three month period ended June 30, 1999,
both absolutely and relative to the small cap averages. The Fund gained 17.5%
in the June quarter while the Russell 2000, an index of small cap stocks,
gained 15.6% and the S&P 500 gained 7.0%. Since the Fund's inception on January
3, 1995, nearly five years ago, the Fund has also performed well, gaining
222.9% through June 30, 1999. For the same period, it significantly
outperformed the Russell 2000, which increased 95.0%, and kept pace with the
S&P 500, which gained 225.7%.
Investment Opportunities in Small Cap Companies.
The investment performance of smaller companies for the past several years when
com-pared to larger, more established and better-recognized companies has,
until recently, been disappointing. The Russell 2000 underperformed the S&P 500
by over 30 percentage points in calendar 1998, an unprecedented gap for a
single year. In fact, small cap stocks have underperformed larger companies for
most of the last 15 years. This relative underperformance of smaller companies
has resulted in relative valuations of smaller companies that are unusually
compelling. More importantly, we are identifying many investment opportunities
in what we believe are great businesses that are selling at very attractive
prices on an absolute basis as well as on a relative basis to larger cap
stocks. Although small cap stocks continued to perform poorly relative to
larger companies during the first quarter of 1999, this trend reversed during
the second quarter. While the S&P 500 beat the Russell 2000 by 10 percentage
points in the March quarter, it lagged the Russell 2000 by 8.6 percentage
points in the June quarter.
[GRAPHIC]
- ------------------------ ----------------------- ------------------------
PERFORMANCE PERFORMANCE PERFORMANCE
FOR THE 3 MONTHS ENDED FOR THE 6 MONTHS ENDED SINCE INCEPTION
JUNE 30, 1999 JUNE 30, 1999 JUNE 12, 1987 THROUGH
JUNE 30, 1999
BARON GROWTH FUND 17.5% BARON GROWTH FUND 26.3% BARON GROWTH FUND 223%
S&P 500* 7.0% S&P 500* 12.3% S&P 500* 226%
RUSSELL 2000* 15.6% RUSSELL 2000* 9.3% RUSSELL 2000* 95%
- ----------------------- ----------------------- -----------------------
* THE S&P 500 AND RUSSELL 2000 ARE UNMANAGED INDEXES. THE S&P MEASURES THE
PERFORMANCE OF THE STOCK MARKET IN GENERAL; THE RUSSELL 2000 OF SMALL AND
MID-SIZED COMPANIES.
<PAGE>
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Baron Growth Fund's performance boosted by long term investments.
The Fund's performance in the June quarter was favorably impacted by strong
gains in Choice Hotels, currently the Fund's largest position. The Fund was
also favorably impacted by Charles Schwab, which currently represents about
7.2% of the portfolio, and which was the Fund's largest holding for most of
1999. Schwab's share price gained 94% in the six months ending June, reflecting
very strong customer asset flows and strong current earnings. While Schwab's
stock price has retreated from its earlier highs, we remain optimistic
regarding Schwab's longer-term prospects. We believe Schwab can triple its
customer assets to $1.8 trillion and quintuple its earnings within the next
five years. Schwab's stock price has increased about forty fold since Baron
Asset Fund's initial purchases in 1992 and more than fifteen fold since Baron
Growth Fund's initial purchases five years ago.
The Fund was also favorably impacted in the quarter by its position in American
Mobile Satellite Corporation. During the quarter the company announced an
agreement with SkyTel to market that company's two-way paging technology
through the Ardis network the company purchased from Motorola two years ago.
Additionally, AMSC announced a strategic alliance with GM, Clear Channel and
Hughes Direct TV for the AMSC digital audio radio satellite service, XM Radio.
The company also completed a successful equity offering, which reduced its
leverage and will provide the necessary capital to support its growth
opportunities.
Baron Growth Fund was negatively impacted in the quarter by its education
related investments in Devry and Education Management. Baron Growth Fund's
performance was also negatively impacted by Robert Half, a long-term holding of
the Fund. Half, the temporary help company, fell in price 21% during the
quarter, as the company had difficulty hiring temps in the current full
employment environment. The company is developing new strategies to attract
potential employees to meet the high levels of demand that exist for their
services. We think Half is currently trading at very attractive levels,
ignoring the strong demand for the company's services.
Portfolio Changes - A New Mandate.
Consistent with the Fund's change in name and objective approved by
shareholders in a vote on May 19, 1999, Baron Growth Fund is focused solely on
small cap, growth investment opportunities. The Fund has continued to invest
all of its net flows this year in smaller businesses and to scale back its
investments in larger companies. The Fund's median market cap is currently
approximately $950 million and falling.
Baron Growth Fund, while it shares Baron Asset Fund's philosophy and approach
to investing, is much smaller than Baron Asset Fund. It can therefore take
advantage of smaller cap opportunities where the larger Baron Asset Fund may
have difficulty establishing positions of significance. During the June
quarter, the
<PAGE>
Fund sold its positions in three larger cap companies, American Tower, Mirage
Resorts and Spieker Properties. Additionally, the Fund reduced its position in
two other Baron Asset Fund core positions HCR Manor Care and Charles Schwab.
While these companies have significant growth opportunities and continue to
represent attractive investments for Baron Asset Fund, Baron Growth Fund is now
focused on smaller cap opportunities. Since March 31, new positions have been
established in sixteen small cap companies. Among these new investments are
Radio One, Citadel Communications, Electric Lightwave and Ethan Allen.
Please note: The preceding sections were written by Morty Schaja, Chief
Operating Officer and Vice President, Baron Funds.
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PORTFOLIO HOLDINGS
Amusement and Recreation.
Note written by Mitch Rubin, Vice President and Co-Portfolio Manager, Baron
Growth Fund.
Cruises. Recreational expenditures are growing at over twice the annual rate of
both GDP and personal consumption (over 6% v. approximately 3%). In addition to
our skiing and gaming investments, the cruise industry will also benefit from
these accelerating expenditures.
The cruise industry is among the fastest growing sectors of the travel and
leisure industry. Approximately 6.4 million North Americans cruised last year,
and the number of cruisers has increased at a 9% annual rate for the past 30
years. Still, only 2% of all vacationers currently cruise and 90% of the U.S.
population has never been on a cruise. People 50 years old and over make up the
majority of cruisers, and this is the fastest growing segment of our
population. To address this growth, over $10 billion of new ship construction
is planned in the next four years by the world's three largest cruise lines.
We recently initiated two investments that we believe will benefit from the
explosive growth in cruising: Steiner Leisure and American Classic Voyages.
Steiner Leisure. Steiner is the leading worldwide provider of spa services and
products on-board cruise ships. The company currently serves 99 ships
representing 26 different cruise lines. Steiner traces its origins to 1935,
when the company's founder began his career as England's Queen Mary's
hairdresser. The business evolved into a salon service provider in the 1950s
and, in 1967, Steiner received a contract to manage the spa and salon aboard
the world renowned QE2. Since 1967, Steiner has added nearly 100 ships to its
fleet and has bought its largest and only competitor. The company is currently
run by the founder's son-in-law CEO Clive Warshaw and daughter Executive Vice
President Michele Steiner Warshaw who own approximately 17% of the company's
stock.
12
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Steiner acts as an independent contractor to its fleet partners. The fleets are
building larger and more elaborate ships, which boast larger and more elaborate
spas as a means of enticing cruise industry customers to their cruise line.
Although the spa is an integral part of the customers' on-board experience,
managing and staffing a high-end spa is not a core competency of any of the
cruise lines. Spa staff turnover is high, quality training is critical, and
capacity utilization drives profitability. The average spa generates
approximately $35,000 per week revenue. This compares to nearly $3 million
revenue per week for an average 2,000 berth cruise ship. As a result, the
industry has almost universally elected to outsource its spa management to a
third party, Steiner, which currently has an over 80% market share of the on-
board cruise spa management business.
Steiner takes charge of marketing and selling its services to shipboard guests.
The company has a highly trained and motivated staff whose goal is to sell out
all spa services and treatment appointments before each ship sets sail for the
first night of a cruise. Steiner also focuses on introducing newer, more
elaborate treatments for its clients rather than attempting to raise prices.
Steiner shares the revenue generated from the spa with the ship owner and
guarantees the ship owner a minimum level of revenue (on average, approximately
40% of the on-board revenue is paid to the cruise line owner). Steiner
generally has no investment in the physical spa and no obligation for capital
expenditures to maintain or upgrade the area or equipment. Not surprisingly,
the company has both an extremely high return on equity and a high and
increasing level of annual free cash flow. Although Steiner's contracts are
relatively short in duration, 1 to 3 years, the company has never failed to
renew an important relationship that it wanted to keep. Moreover, although the
company has continued to provide higher guarantees and splits to its fleet
partners over the years, Steiner has steadily increased its operating profit
margins (from 4% in 1994 to 18% currently.)
Steiner is enjoying substantial growth from the addition of new ships (9 in
1999, 20 in the next 4-5 years), increased sales of its proprietary products
(Elemis and La Therapie) both on-board and direct to spas or customers
(including through the company's web site), increased productivity of the
ship-board staff, and strategic acquisition and expansion. Steiner recently
added its first significant land-based spa management contract at the Atlantis
on Paradise Island, the Bahamas with Sun International (a significant Baron
holding) and has recently acquired the leading spa vocational training school
in the U.S. in Florida. Both land-based spa management and vocational spa
training schools present exciting additional opportunities for Steiner in
coming years.
We expect Steiner to continue to grow its core shipboard revenues at a 15-20%
pace over the next several years with accelerating growth derived from
land-based spa management, vocational training and product sales. We expect
Steiner's earnings to grow at an even faster pace. In addition, the company
will also be generating a sizable horde of cash.
<PAGE>
American Classic Voyages. This is the largest operator of United States flagged
cruise ships (most of the large cruise lines are foreign flagged in order to
avoid U.S. taxation). American Classic operates the Delta Queen cruise line,
which operates high-end nostalgic, paddle wheel excursions on America's in-land
rivers. It also operates the Independence, the only sizable overnight cruising
vessel operating exclusively in Hawaii. Although a steady business currently,
several unique opportunities make the next several years exciting for American
Classic.
First is the company's dominance of the potentially strong Hawaiian cruise
market. In exchange for the commitment to build at least two new world class
cruise ships in U.S. shipyards in the next several years (a commitment of over
$1 billion of expenditure), American Classic has been granted (1) legislative
exclusivity to operate U.S. flagged cruise ships in Hawaii for the foreseeable
future and (2) the right to purchase and reflag a foreign cruise ship to be put
into service in Hawaii as a U.S. flagged ship immediately. In addition,
American Classic has been granted 87.5% financing for its new building program
in 25 year, non-recourse, U.S. guaranteed debt at interest rates only 100-125
basis points over U.S. treasury rates.
Hawaii is a proven destination travel market with over 7 million annual
visitors but almost no cruising due to legislation which restricts the right of
foreign flagged ships to dock solely in U.S. ports on a cruise. Currently, less
than 1% of all Hawaiian visitors cruise (as compared to 35% of visitors to
Alaska and 22% of visitors to the Caribbean). Nevertheless, the demand appears
to be substantial as American Classic currently generates over $325 in daily
average rates on its cruise ship (as compared to an average of approximately
$200 per day on Carnival or similar cruise lines in the Caribbean) and runs
over 100% occupancy despite serving the market with a small (867 berths), 40
year old cruise ship.
American Classic plans to attack the Hawaiian market first through the
introduction of the New Amsterdam, a 1,214 berth Carnival cruise ship that the
company will soon purchase for approximately $114.5 million. AMCV hopes to have
the New Amsterdam introduced to the Hawaii market under a new name by late next
year with a substantial marketing push to bring world class cruising to the
market. At the same time, AMCV will be constructing the first two new ships to
be built under its government exclusivity grant. These ships (1,900 berths
each) are under fixed price contracts to be built by Ingalls Shipyard, one of
the top U.S. defense department naval contractors. AMCV estimates the total
cost per ship to be approximately $500 million and the first ship is scheduled
for delivery in early 2003. Given the attractive financing, AMCV estimates that
the return on equity for the new construction will exceed 65%, assuming current
rates in the Hawaiian market (which will hopefully see some upward pressure as
the product quality increases dramatically). The company recently hired Rod
Macleod from Carnival Cruise Lines as its director of Hawaiian operations. Rod
is one of the most respected executives in the cruise industry.
13
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B A R O N G R O W T H F U N D
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In addition to its Hawaiian acquisition and construction plans, AMCV plans to
further expand its Delta Queen franchise, through the recent acquisition of a
vessel to be introduced in the Pacific Northwest in early 2000 and through a
new build program to introduce 3-5 coastal cruising vessels to serve the east
and west coasts. These coastal cruisers are less costly than the large,
Hawaiian construction projects, (with projected costs of approximately $37
million each), but with equally impressive 65%+ return on equity expectations.
AMCV expects to grow substantially over the next several years and catapult
itself into the upper echelons of the world's cruise lines. We expect AMCV to
grow from its current base of $192 million of revenue and $22 million of EBITDA
generated in 1998 to between $275 million and $300 million of EBITDA by 2005.
Moreover, we expect earnings per share, which are essentially break-even
currently, to top $3.50 per share by the end of the company's current new build
program.
Communications.
CoreComm. Note written by Matt Ervin, Vice President and Co-Portfolio Manager,
Baron Growth Fund.
Upstart telephone companies known as Competitive Local Exchange Carriers (CLEC)
have rewired many business centers with the same type of telecom architecture
used by the legacy Bell operating companies. Nonetheless, the new kids on the
block have enjoyed some advantages. (1) New networks are more reliable and
exhibit more capacity; (2) new networks are built to provide optimal service to
the most lucrative corporate customers; and, (3) construction and maintenance
of new networks is being performed by more efficient non-union staff. CoreComm
is one of the new kids on the block, a CLEC headquartered in Ohio with the
intent to focus on the Midwest. However, CEO Barclay Knapp plans to architect
CoreComm to reach other dimensions of competitive advantage.
Barclay Knapp has taken NTL from $25million of start-up capital and turned it
into one of the largest companies in the U.K., with a $30 billion enterprise
value only six years later. Along with Chairman George Blumenthal and other
senior management, Barclay intends "to duplicate the success of NTL in the
U.S." Barclay tells us that "CoreComm can benefit from marketing strategies
that have proven highly successful in the U.K." The management team feels they
can keep marketing costs to less than three months revenue, advertising through
mass media outlets and closing sales on the phone. CoreComm's focus groups
reveal that "people don't really know what they pay for right now," and the
opportunity is to give consumers more "perceived value." On the technology side
of the business, CoreComm plans to implement an advanced architecture, using
Internet Protocol (IP) to create an economical backbone for their Ohio-based
telephone company. The backbone is held together by data routers, devices which
reduce the company's reliance on central office switches. Central office
switches are behemoths costing from $4-8 million each, while routers can be set
up for less than $100K. CoreComm aims to implement its IP-backed architecture
for $250-400 per
<PAGE>
potential line in a city like Columbus, OH. This investment compares very
favorably to the sunk costs of the Regional Bell or even the first generation of
the CLECs, where sunk costs run up to $2000 per line. Each residential telephone
line sold generates $600 per year in revenue, and a local business line produces
$700 and up. CoreComm will often rent the "last mile" to the customer premise
from AmeriTech for a flat rate less than $13 per month, but even after taking
account this expense, the revenue stream from switched services should produce
high margins. CoreComm could report healthy returns on capital if the company
achieves 5-10% marketshare. At NTL, Barclay has achieved marketplace penetration
of 35-40% and growing. We are very optimistic about management's ability to
re-produce impressive results at CoreComm.
Hotels and Lodging.
Choice Hotels. Note written by Mitch Rubin, Vice President and Co-Portfolio
Manager, Baron Growth Fund
Choice's new management team, headed by Chuck Ledsinger, is building the
company's core franchising network while also aggressively pursuing exciting
internet initiatives.
Choice's core hotel franchising operations continue to exceed expectations.
Year to date, the total number of Choice hotels has grown 15% to 4,088,
Choice's royalty revenues have increased by 10% and the system-wide royalty
rate has grown to 3.63% from 3.50%. In addition, Choice franchisees have
enjoyed a domestic RevPAR increase of 3.3%, ahead of lodging industry averages.
Choice continues to sell new franchise contracts as well, with an additional
748 hotels in either design or under construction.
In addition to this strength in its core franchising business, Choice has taken
two significant steps to enhance its revenue potential through the Internet.
First, Choice introduced ChoiceBuys.com as a supply source for its franchisees.
Through ChoiceBuys, Choice is offering its franchisees the opportunity to
purchase all of the goods and services they use at their hotels (soap, pillows,
bed linens, carpet, light bulbs, etc.) in a convenient, integrated internet
site at a substantial discount to their normal product purchasing prices. By
establishing bulk purchasing contracts with preferred suppliers, Choice is able
to both get its franchisees substantial discounts, while also keeping a small
portion of the savings. Currently, over 25% of Choice's domestic franchisees
are registered users of ChoiceBuys.com which has nearly 3,000 products from
which to choose (Choice hopes to add an additional 5,000 products to the site
by the end of the year). Choice believes that in time, the system has the
potential to drive annual expenditures of $1.5 billion in goods and services by
Choice franchisees.
Secondly, Choice is aggressively pursuing opportunities to provide in-room
internet services to its guests. The goal is to allow Choice's guests to leave
their laptops at home (or dial in through a faster connection than the hotel
telephone) and still access the Internet through a Choice-hosted system that
offers a high-speed T-1 connection. Choice does not anticipate any charge to
guests
14
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B A R O N G R O W T H F U N D
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to simply be online. Instead, Choice anticipates that it will generate
advertising fees for its site as well as charge for the use of business
applications such as Microsoft's Word, Excel and PowerPoint. Choice will also
charge a fee to be connected to an "After-Hours" adult entertainment site. In
initial tests, that site has achieved extremely high usage despite being one of
the only services for which a fee was charged. Not surprisingly, the bill will
only show an "internet communication" fee for these users. The company is
testing the new service in hotels currently and hopes to have at least 50,000
of its rooms wired during next year.
Media.
Note written by Matt Ervin, Vice President and Co-Portfolio Manager, Baron
Growth Fund.
Radio Investments. In 1996 the Telecom Act affected many industries other than
the telephone industry. It created an opportunity for radio station operators.
The new law allowed significant consolidation of local radio markets.
Traditionally, radio operators were able to own one or two stations in a market
and no more than 20 stations nationwide. After the bill passed, buyers had the
leeway to purchase up to 8 radio stations in a local market and the freedom to
operate in an unlimited number of markets around the country. Consolidate then
cut expenses? No, savvy operators recognized that there was a much bigger
opportunity: Upgrade sales staffs and steal dollars from local television
stations and newspapers. Consolidation gave the leading operators the necessary
scale and market power to stabilize ad rates, attract the best sales talent and
bring in a new class of advertisers. The net effect has been significant upward
pressure on rates and strong ad volumes.
To capitalize on this opportunity, Baron Growth Fund made significant
investments in American Radio, Cox Radio, and Hispanic Broadcasting, in
addition to an existing position in Saga Communications. Subsequently we have
invested in Entercom, RadioOne, and Citadel Communications.
Citadel Communications. Citadel Communications controls 124 radio stations
across 23 midsized markets, mostly in the West, Southwest, and MidWest. The
company is usually the dominant player in its markets with 34% average
marketshare. Larry Wilson, Citadel's CEO, feels that the company still has
significant room for growth. He classifies 77 of his radio stations as
"developmental stage" and these stations are generating only 10% cash flow
margins. Larry travels 4 or 5 days a week to tune-up his station group. Big
changes often happen fast. At developmental stations in Saginaw, MI, Citadel
increased the number of salespeople from 6 to 21 in less than a year. Such
investments in staff result in low margins in the near-term, but we think
margins can expand from 10% to north of 30% when programming and sales efforts
gel. In the six markets that Citadel has operated in since 1994, margins moved
from 20% to 34%, while marketshare rose from 37% to 52%. Larry gets results by
recruiting the best people. He seeks acolytes from industry giants such as
Clear Channel or AMFM. His goal is to make Citadel the better place
<PAGE>
to work. One perk that seems to get people's attention: exceed sales targets and
you will attend summer seminars on Larry's ranch in Montana.
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OTHER DEVELOPMENTS
Eighth Annual Baron Investment Conference...October 15, 1999, Grand Hyatt New
York, New York City.
Please see preceding Baron Asset Fund letter on page 9 for details. We hope to
see you in October.
Baron Growth Fund Dividend.
Baron Growth Fund's portfolio was restructured this year to be certain mutual
fund rating agencies will continue to categorize the Fund as a "small cap
growth fund." This entailed significant sales of several very profitable long
term holdings that had become "mid cap" and "large cap" companies. The Fund was
able to offset a significant portion of these gains by realizing losses on
other portfolio holdings. Baron Growth Fund's net gains will be paid to its
shareholders as a dividend in late October. We currently estimate that the
dividend should approximate $1.80 per share and will be virtually in its
entirety a long term capital gain.
Thank you for investing in Baron Growth Fund.
We recognize it cannot be an easy task for most individuals when you choose to
invest in stocks through mutual funds. Your decision must be especially
difficult when you have to consider how to invest your hard earned savings to
pay for your children's education, a new home or your retirement. It is
especially daunting now since there are more mutual funds than there are
stocks...and well respected advisors often give conflicting opinions.
We hope our quarterly shareholder letters, interviews in the financial press,
investment adviser conference calls and annual investment conferences have made
it easier for you to determine if Baron Asset Fund is an appropriate investment
for you and your family.
We want to thank you again for joining us as fellow shareholders in Baron Asset
Fund. We will continue to work hard to justify your confidence.
Sincerely,
/s/ Ronald Baron /s/ Matt Ervin /s/ Mitch Rubin
- -------------------- ------------------ --------------------
Ronald Baron Matt Ervin Mitch Rubin
Chairman & Co- Vice President Vice President
Portfolio Manager & Co-Portfolio & Co-Portfolio
August 30, 1999 Manager Manager
15
<PAGE>
GRAPHIC
BARON
FUNDS
3 BARON SMALL
CAP FUND
PERFORMANCE........................................................16
PORTFOLIO
COMPOSITION........................................................16
CORPORATE
DEVELOPMENT........................................................17
INVESTMENT THEME...................................................17
www.baronfunds.com
767 Fifth Avenue
NY, NY 10153
212-583-2100
1-800-99-BARON
<PAGE>
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BARON SMALL CAP FUND
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QUARTERLY REPORT JUNE 30, 1999
DEAR BARON SMALL CAP
FUND SHAREHOLDER:
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PERFORMANCE
Baron Small Cap Fund did well in the June quarter. The Fund gained 12.4% and
year-to-date is up 26%. This compares favorably with the Russell (+10%) and the
S&P 500 (+12%) for the first half of 1999. In the second calendar quarter, the
Fund continued to get strong broad-based performance, especially from
communications holdings United Global Com, Radio One, CoreComm, and Comnet and
Rural Cellular. Other strong performers included International Technology,
Heidrick & Struggles, and Corporate Executive Board. The only significant poor
performer in the quarter was our holding in ResortQuest, whose poor performance
we believe is just temporary.
The quarter was also significant because the business trends in our portfolio
companies are very strong. As we will touch on later, this serves to confirm
our investment thesis, thereby increasing our confidence in our hold
ings. We will also discuss a major investment theme for the portfolio.
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PORTFOLIO COMPOSITION
At the end of June, Baron Small Cap Fund had net assets of $644M and owned 46
securities. In keeping with our practice of running a relatively concentrated
portfolio, both by number of positions and industry focus, the top ten holdings
accounted for 46% of the assets and the top 15 were 59%. The top four industry
sectors in which we are invested, communication, media, business services and
leisure, accounted for 62% of our investments.
The turnover in the Fund remains modest, annualizing at about 40%. We are
constantly seeking to find new, exciting investments and adding to our present
positions at what we perceive are advantageous prices, while pruning holdings
that meet our price targets and selling positions we lose confidence in. In the
June quarter, we initiated new positions in Heidrick & Struggles, Radio One,
Lamar Advertising, High Speed Access, and Hyperion Telecom, and we added
significantly to Corporate Executive Board. We sold our position in Unova and
in Jeffries Group. Jeffries Group actually split into two companies during the
quarter. We sold the investment bank,
[GRAPHIC]
- ------------------------ ----------------------- ------------------------
PERFORMANCE PERFORMANCE PERFORMANCE
FOR THE 3 MONTHS ENDED FOR THE 6 MONTHS ENDED SINCE INCEPTION
JUNE 30, 1999 JUNE 30, 1999 JUNE 12, 1987 THROUGH
JUNE 30, 1999
BARON SC FUND 12.4% BARON SC FUND 26.8% BARON SC FUND 34%
S&P 500* 7.0% S&P 500* 12.3% S&P 500* 47%
RUSSELL 2000* 15.6% RUSSELL 2000* 9.3% RUSSELL 2000* 3%
- ----------------------- ----------------------- -----------------------
* THE S&P 500 AND RUSSELL 2000 ARE UNMANAGED INDEXES. THE S&P MEASURES THE
PERFORMANCE OF THE STOCK MARKET IN GENERAL; THE RUSSELL 2000 OF SMALL AND
MID-SIZED COMPANIES.
<PAGE>
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B A R O N S M A L L C A P F U N D
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(Jeffries Group), as the stock reached our target and added to our position in
the specialty trading firm, Investment Technology Group, on weakness.
Since the beginning of the year, the portfolio has been pretty similar. Of the
top ten holdings at June 30th, eight were in the top ten at the beginning of
1999. However, the portfolio is quite different than one year ago. Only four
stocks in the present top ten were in the top ten as of June 1998. Of the other
six positions, two companies were acquired, three positions were sold
and one we still own, but is much smaller.
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CORPORATE DEVELOPMENT
As we have explained in the past, in choosing our investments we spend
significant time with the management of our portfolio companies to understand
their business plans. We are most excited when we find people and ideas that
have been proven on a small scale, yet have applications that are much grander.
If we establish a position early, we benefit tremendously as a small company
becomes much larger. We can also closely monitor if our investment thesis is
developing as we hoped. We had a handful of confirmatory events this summer
which we find very exciting.
We became interested in SFX Entertainment in the fall of 1997 and actually
purchased its predecessor, SFX Broadcasting, a radio company, to participate in
the subsidiary after the radio assets were sold. The live entertainment
industry, encompassing music, theater, sports and family events, is large and
growing but was regional and fragmented. The dream of SFX was that if the
assets were commonly owned, not only could they be more professionally managed,
but opportunities would be available to the circuit that didn't exist before. A
year and a half into its existence, we feel SFX has proven that it has
revolutionalized the live entertainment industry. The near-term results are
terrific and their long-term implications are compelling.
For instance, after investing about $1B to acquire 20 separate companies in the
concert promotion business, SFX now controls 40 of 47 outdoor amphitheaters in
the country. By instituting best practices and consolidating operations, SFX
quickly accomplished major cost savings, better concession/merchandising deals,
a greatly improved commission from TicketMaster and sold additional venue
naming rights. Just these initial activities should increase cash flow from
$90M to $140M. However, the key to the investment thesis was that the theaters
themselves could be more productive as a circuit, which will have even greater
growth implications.
This summer, SFX has proven this, as CEO Bob Sillerman recently said, "Our
results are as if we won the Triple Crown at Aqueduct". Play dates per
amphitheater are up 15%, attendance per date is up 5% and receipts per patron
in attendance are up 4%. This is causing same store revenue growth of greater
than 20% and same store cash flow growth of over 40%. This success increases
our confidence for continued growth in the theaters. The company also has major
opportunities to sell sponsorships to national advertisers (SFX Live),
consolidate and enhance the touring theatrical business, expand its concert
promotion activities internationally and exploit its properties over the
internet.
<PAGE>
We originally invested in Premier Parks because we bought into the thesis that
capital-starved regional amusement parks could grow substantially if new rides
were added and if they were professionally managed and promoted. When Premier
acquired Six Flags last spring, we thought that adding this brand to the local
parks would supercharge their growth. And we believed that little Premier could
manage the Six Flags chain, which was twice its size, better than its former
corporate parent. This summer's results at the parks have proven this to be
true. Premier recently reported that park level attendance, on a same store
basis, is up 17% year-to-date. We expect same-park cash flow to grow over 30%
this year. The four newly-branded Six Flags parks reported attendance gains of
25% and 34% revenue increases. The margins at the original Six Flags parks are
close to 40% versus the mid-20's when acquired. We feel there is still
substantial earnings growth ahead for this portfolio of parks. There are also
significant capital projects coming; for example, Premier will build a world
class water park in New Jersey at Great Adventure and spend additional capital
to create a small destination resort. Premier also owns six parks in Europe and
one park in Mexico, which are growing nicely this year, and over time expects
to double its footprint primarily through international expansion. Based on
management's success to date, we believe they will generate many years of
growth.
We invested in Kenneth Cole Productions (KCP) on the thesis that it could
become the next mega lifestyle brand, following the path of Ralph Lauren and
Tommy Hilfiger. We feel that KCP has attained that stature this year. KCP
started as an avant garde men's shoe company in the 1980's. The company's
initial growth was in women's shoes and two off-shoot brands, Reaction and
Unlisted. These wholesale businesses are performing well, but what is most
exciting is the company's licensing and retail ventures.
KCP has had considerable success in licensing for many years (outerwear,
luggage, watches) and retail sales of licensed goods have gone from $60M in
1996 to $180M in 1998. In late 1998, KCP entered a much larger category, men's
sportswear, which got terrific placement and is selling well. We estimate that
this will drive licensed product sales to over $300M this year. Recently, we
became even more excited after KCP signed a deal with Liz Claiborne to
introduce three lines of women's licensed clothing. This is an enormous
category. In three years women's clothing could be as big as the entire present
licensing business and could add $0.75 to earnings per share (against 1999
estimates of $1.60).
Due to the growth in licensed products, KCP is greatly expanding its store base
to house all the additional merchandise. Retail sales were up 58% in the second
quarter and comparable store sales were up 18%, the fourth straight quarter of
near 20% comps. Square footage should grow at least 25% this year and next, as
the company opens larger stores. The average store size in the year 2000 is
expected to be 4,000 square feet versus its present average of 2,400 square
feet. The company envisions opening stores of 10,000 square feet in the future.
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INVESTMENT THEME
The Fund has four investments in "out-of-home" media, which together account
for about 10% of the portfolio (we will discuss two of them). By "out-of-home"
media, we mean radio and outdoor advertising, as opposed to the larger media
groups of television, newspapers, magazines and cable.
17
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B A R O N S M A L L C A P F U N D
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The United States advertising market is approximately $120B and has grown in
line with GDP for the last decade. Near-term, the outlook for advertising
growth is stronger because of the "triple witching" effect of the Millenium,
the Olympics and the Presidential election. Additionally, the focus of
advertising is on brand building, not promotion, as companies focus on Internet
extensions or protecting their brand from Internet insurgents. The growth in
spending by new Internet start-ups is the third driver of the strong outlook
for this segment.
Radio and outdoor advertising now capture about 9% of the advertising pie and
it is our feeling that their share will grow to 13-15%. "Out-of-home" is
gaining share because it is cheaper, has proven to be as effective, and has
become easier to buy because of the consolidation of radio and outdoor
companies. It is benefiting from the fragmentation of in-home media: network
television ratings are eroding, newspaper readership is declining, and there is
substitution of internet and video games. Year-to-date, radio and outdoor
advertising growth is double digit while advertising in general is growing at
about 5%. As an example of share gain, the internet company CNET just unveiled
its $100M advertising plan for the next 18 months and radio and outdoor
received 28% of the business versus its typical 9% share.
Radio stations and billboards are fabulous businesses. The successful companies
in the field do upwards of 40% cash flow margins. The businesses require little
maintenance capital expenditures, generate incremental margins well over 50%
and throw off substantial free cash flow. Both industries are a few years into
a massive consolidation, which to date has been focused on establishing
platforms of assets and taking out costs, and now is primarily focused on
growing revenues through taking share.
Radio One is an operator of urban radio stations. The company was founded 20
years ago by Catherine Hughes and is now run by her son, Alfred Liggins. Radio
One purchases under-performing Anglo stations in large markets with big
African-American populations, reprograms them to an urban format, increases its
listening share, and aggressively sells the increased ratings. The results to
date are extraordinary. In 1992 and 1993, Radio One bought two FM stations and
an AM station in Baltimore for $14M. The two FMs are now the two top stations
in the market of any genre. We expect them to do over $9M in cash flow in 1999
and continue to grow at 20% per year, and are now probably worth $150M. Radio
One has four stations in Washington, D.C., which were purchased from 1990 to
1995, for a total of $46M. We expect them to generate $12M in cash flow in
1999, also growing at double digits. These stations are probably worth $200M.
Since the beginning of 1998, the company acquired 18 additional stations and
established toeholds in nine of the top 30 African-American markets. They went
public this spring to finance these acquisitions and be capitalized to further
grow their assets.
Selling at $42 per share, Radio One has a market capitalization of
approximately $900M, which is full for its present cash flow run rate of $40M.
However, we feel that if they have moderate success at increasing the ratings
of their expanded station group, then cash flow will double to $80M in three or
four years and the company will be worth $70 per share, a double from our
purchase price. In addition, we expect the company to grow beyond these 25
stations through additional acquisitions. We hope to hit
<PAGE>
some ratings home runs, not just singles that our aforementioned estimates
assume, and we encourage the company to explore other related media
opportunities. All this would add to our returns.
Metro Networks is the largest outsource provider of information to the radio
industry. Their primary business is doing local traffic reports which are given
for free to radio stations in exchange for commercial air time that the company
sells to advertisers. Metro also does "expanded" services, which are news and
sports reports, and provides information and video feeds to television
stations, also in exchange for commercial inventory.
Metro started in business over a decade ago and now services almost 2,000 radio
stations. Their concept of exchanging information for airtime is well accepted
by the radio industry. They have grown revenues and cash flow at a compound
rate of over 25% for the last five years. Even though the stock is up threefold
since its initial public offering in 1996, the stock sold at a discount because
its largest competitor (Shadow Traffic) was controlled by a respected radio
group operator (Infinity Broadcasting).
In June, Metro announced that it would merge into Westwood One, the owner of
Shadow Traffic. There are obvious cost synergies by putting the two companies
together, in reducing duplicative offices, people and aircraft. There are also
tremendous revenue opportunities created by teaming the two sales forces into
cooperative, as opposed to competitive, selling group.
In addition to the expected growth in the base traffic service, Metro has
developed a new digital audio workstation, called "Metro Source", which
provides continuous news flow to affiliate radio stations. This has been well
received in the industry and we expect it to be embraced by Infinity as well.
The Source should almost double Metro's inventory in time. We are also very
impressed with Westwood's new management, new CEO Joel Hollander and with its
efforts to better manage their existing radio networks and develop additional
content for the radio industry and the internet.
We feel the combined company will grow revenues at 15% and cash flow over 20%.
We expect $150M in cash flow for Year 2000, which equates to after-tax cash
flow of $1.50 per share. We believe this figure can grow at greater than 30%
per year through organic growth and stock repurchases, which we expect to
continue at Westwood postmerger. At 22 times next year's earnings, we feel the
stock is a bargain and will get a premium multiple.
- --------------------------------------------------------------------------------
THANK YOU
Thank you for investing with us at Baron Capital.
I look forward to seeing many of you at our investment conference in October. I
will be available to answer any of your questions concerning the particulars of
our investments or our methodology.
Sincerely,
/s/ Cliff Greenberg
- --------------------
Cliff Greenberg
18
<PAGE>
- --------------------------------------------------------------------------------
B A R O N F U N D S
- --------------------------------------------------------------------------------
Table I
- --------------------------------------------------------------------------------
Portfolio Market Capitalization (Unaudited)
- --------------------------------------------------------------------------------
The Funds invest primarily in small and medium sized companies. Table I ranks
the Funds' investments by market capitalization and displays the percentage of
the Funds' portfolios invested in each market capitalization category. At times
the Funds invest in companies with market capitalizations greater than $5
billion. These larger cap companies have increased in value since the Funds
first invested in them and still offer attractive opportunities for further
appreciation.
- ------------------------------------------------------------------------------
Baron Asset Fund
- ------------------------------------------------------------------------------
Equity
Market Cap % of
Company (in millions) Net Assets
- ------------------------------------------------------------------------------
Large Capitalization
- ------------------------------------------------------------------------------
Charles Schwab Corp. ...................... $44,777 19.1%
Outdoor Systems, Inc. ..................... 6,734 0.6
NTL, Inc. ................................. 6,318 4.2
Univision Communications, Inc. Class A 5,983 1.1
-----
25.0%
Medium Capitalization
- ------------------------------------------------------------------------------
Hispanic Broadcasting Corp. ............... $ 3,744 3.5%
American Tower Corp. Class A .............. 3,734 1.7
Century Communications Corp. .............. 3,460 0.8
Mirage Resorts, Inc. ...................... 3,330 1.8
United Intl. Hldgs., Inc. ................. 2,914 0.9
Citizens Utilities Co. .................... 2,892 1.1
Premier Parks, Inc. ....................... 2,825 1.8
Dollar Tree Stores, Inc. .................. 2,696 2.3
HCR Manor Care, Inc. ...................... 2,686 3.8
Flextronics Intl., Ltd. ................... 2,671 2.2
Spieker Properties, Inc. .................. 2,461 1.3
Robert Half Intl., Inc. ................... 2,359 2.6
Kimco Realty Corp. ........................ 2,358 0.5
Sotheby's Holdings, Inc. Class A .......... 2,198 11.3
Williams-Sonoma, Inc. ..................... 1,944 0.3
Polo Ralph Lauren Corp. ................... 1,892 2.8
Post Properties, Inc. ..................... 1,574 0.1
DeVry, Inc. ............................... 1,553 1.5
Cox Radio, Inc. ........................... 1,552 0.6
Four Seasons Hotels, Inc. ................. 1,510 0.5
Sun Intl. Hotels, Ltd. .................... 1,503 2.1
-----
43.5%
Small Capitalization
- ------------------------------------------------------------------------------
FelCor Lodging Trust, Inc. ................ $ 1,412 0.3%
Prison Realty Trust, Inc. ................. 1,149 0.1
Industrie Natuzzi SPA ADR ................. 1,117 1.6
Choice Hotels Intl., Inc. ................. 1,091 3.7
ChoicePoint, Inc. ......................... 987 1.6
Quorum Health Group, Inc. ................. 918 0.2
Commonwealth Telephone Ent., Inc. ......... 893 0.2
Metro Networks, Inc. ...................... 893 0.9
Storage USA, Inc. ......................... 892 0.1
Iron Mountain, Inc. ....................... 888 0.3
Unova, Inc. ............................... 872 0.2
OM Group, Inc. ............................ 818 1.2
CD Radio, Inc. ............................ 708 0.4
Taubman Centers, Inc. ..................... 701 0.1
Cross Timbers Oil Co. ..................... 665 1.0
ITT Educational Services, Inc. ............ 664 0.6
<PAGE>
Equity
Market Cap % of
Company (in millions) Net Assets
- ------------------------------------------------------------------------------
Small Capitalization (continued)
- ------------------------------------------------------------------------------
Seacor Smit, Inc. ......................... $ 650 1.0%
CoreComm, Ltd. ............................ 648 1.0
Southern Union Co. ........................ 646 0.6
Vail Resorts, Inc. Class A ................ 622 2.5
Sun Communities, Inc. ..................... 615 0.2
Education Management Corp. ................ 612 0.6
Young Broadcasting, Inc. Class A .......... 580 0.6
American Mobile Satellite Corp. ........... 529 0.8
AMF Bowling, Inc. ......................... 503 1.2
Libbey, Inc. .............................. 471 1.2
Budget Group, Inc. Class A ................ 442 0.4
Stein Mart, Inc. .......................... 425 0.3
Cellular Communications of P.R., Inc. ..... 394 0.5
Alexander's, Inc. ......................... 369 0.3
Smart and Final, Inc. ..................... 305 0.5
DVI, Inc. ................................. 242 0.4
Saga Communications, Inc. Class A ......... 242 0.8
Learning Tree Intl., Inc. ................. 241 0.4
Avatar Holdings, Inc. ..................... 174 0.2
Counsel Corp. ............................. 170 0.2
Bristol Hotels & Resorts, Inc. ............ 133 0.2
Sunburst Hospitality Corp. ................ 117 0.4
Caliber Learning Network, Inc. ............ 58 0.1
-----
26.9%
Baron Growth Fund
Equity
Market Cap % of
Company (in millions) Net Assets
- ------------------------------------------------------------------------------
Large Capitalization
- ------------------------------------------------------------------------------
Charles Schwab Corp. ...................... $44,777 11.3%
NTL, Inc. ................................. 6,318 6.4
-----
17.7 %
Medium Capitalization
- ------------------------------------------------------------------------------
Hispanic Broadcasting Corp. ............... $ 3,744 2.9%
Time Warner Telecom, Inc. ................. 2,965 0.1
United Intl. Hldgs., Inc. ................. 2,914 0.3
Dollar Tree Stores, Inc. .................. 2,696 2.7
HCR Manor Care, Inc. ...................... 2,686 3.8
Flextronics Intl., Ltd. ................... 2,671 2.8
Robert Half Intl., Inc. ................... 2,359 1.4
Kimco Realty Corp. ........................ 2,358 1.5
Sotheby's Holdings, Inc. Class A .......... 2,198 3.5
Entercom Communications Corp. ............. 1,589 0.5
Post Properties, Inc. ..................... 1,574 1.1
DeVry, Inc. ............................... 1,553 1.5
Sun Intl. Hotels, Ltd. .................... 1,503 2.7
-----
24.8%
19
<PAGE>
- --------------------------------------------------------------------------------
B A R O N F U N D S
- --------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Baron Growth Fund
- ------------------------------------------------------------------------------
Equity
Market Cap % of
Company (in millions) Net Assets
- ------------------------------------------------------------------------------
Small Capitalization
- ------------------------------------------------------------------------------
Aurora Foods, Inc. ........................ $1,173 1.7%
Industrie Natuzzi SPA ADR ................. 1,117 2.3
Choice Hotels Intl., Inc. ................. 1,091 10.5
ChoicePoint, Inc. ......................... 987 3.0
Citadel Communications Corp. .............. 942 1.3
Metro Networks, Inc. ...................... 893 1.3
Storage USA, Inc. ......................... 892 1.3
Radio One, Inc. ........................... 842 2.3
OM Group, Inc. ............................ 818 1.8
Taubman Centers, Inc. ..................... 701 0.3
Cross Timbers Oil Co. ..................... 665 0.7
ITT Educational Services, Inc. ............ 664 0.7
Seacor Smit, Inc. ......................... 650 0.8
CoreComm, Ltd. ............................ 648 2.4
Electric Lightwave, Inc. .................. 647 1.3
Southern Union Co. ........................ 646 2.7
Vail Resorts, Inc. Class A ................ 622 1.1
Sun Communities, Inc. ..................... 615 1.7
Education Management Corp. ................ 612 1.2
American Mobile Satellite Corp. ........... 529 1.6
Steiner Leisure, Ltd. ..................... 503 0.8
Gabelli Asset Management, Inc. ............ 474 1.2
Libbey, Inc. .............................. 471 0.8
American Classic Voyages Co. .............. 442 0.3
Smart and Final, Inc. ..................... 305 1.9
Medallion Financial Corp. ................. 267 1.3
DVI, Inc. ................................. 242 1.0
Saga Communications, Inc. Class A ......... 242 1.6
Rural Cellular Corp. Class A .............. 180 0.9
ResortQuest Intl., Inc. ................... 143 0.3
Bristol Hotels & Resorts, Inc. ............ 133 0.4
----
50.5%
- ------------------------------------------------------------------------------
Baron Small Cap Fund
- ------------------------------------------------------------------------------
Equity
Market Cap % of
Company (in millions) Net Assets
- ------------------------------------------------------------------------------
Medium Capitalization
- ------------------------------------------------------------------------------
American Tower Corp. Class A .......... $3,734 2.1%
Century Communications Corp. .......... 3,460 4.5
TMP Worldwide, Inc. ................... 2,965 0.2
United Intl. Hldgs., Inc. ............. 2,914 10.5
Premier Parks, Inc. ................... 2,825 5.4
Lamar Advertising Co. ................. 2,506 1.0
SFX Entertainment, Inc. ............... 2,402 4.3
United Rentals, Inc. .................. 2,111 2.4
Williams-Sonoma, Inc. ................. 1,944 1.9
Entercom Communications Corp. ......... 1,589 0.7
Four Seasons Hotels, Inc. ............. 1,510 3.8
Sun Intl. Hotels, Ltd. ................ 1,503 1.1
----
37.9%
<PAGE>
Equity
Market Cap % of
Company (in millions) Net Assets
- ------------------------------------------------------------------------------
Small Capitalization
- ------------------------------------------------------------------------------
High Speed Access Corp. ..................... $1,328 1.2%
Central Parking Corp. ....................... 1,256 3.7
Centennial Cellular Corp. ................... 1,112 0.4
Hyperion Telecommunications, Inc. Class A . 1,029 0.4
Iron Mountain, Inc. ......................... 992 1.5
ChoicePoint, Inc. ........................... 987 2.4
Investment Technology Group, Inc. ........... 921 0.6
Commnet Cellular, Inc. ...................... 893 2.6
Metro Networks, Inc. ........................ 893 3.1
IT Group, Inc. .............................. 888 3.8
Radio One, Inc. ............................. 842 2.7
United Stationers, Inc. ..................... 812 1.6
CoreComm, Ltd. .............................. 648 2.6
Electric Lightwave, Inc. .................... 647 1.0
Loews Cineplex Entertainment Corp. .......... 638 1.7
Commonwealth Telephone Ent., Inc. ........... 595 1.4
Young Broadcasting, Inc. Class A ............ 580 0.3
El Paso Electric Co. ........................ 540 1.4
Gabelli Asset Management, Inc. .............. 474 0.7
Corporate Executive Board Co. ............... 469 1.9
Intrawest Corp. ............................. 365 3.4
Kenneth Cole Productions, Inc. .............. 365 2.7
Province Healthcare Co. ..................... 307 2.0
Heidrick & Struggles Intl., Inc. ............ 289 2.1
Career Education Corp. ...................... 264 3.7
Rural Cellular Corp. Class A ................ 180 1.4
Caribiner Intl., Inc. ....................... 147 1.0
ResortQuest Intl., Inc. ..................... 143 1.0
Morton's Restaurant Group, Inc. ............. 116 1.0
AVTEAM, Inc. ................................ 84 0.9
The Sports Club Co. ......................... 73 0.3
Strategic Distribution, Inc. ................ 72 0.2
Equity Marketing, Inc. ...................... 65 0.6
----
55.3%
Table II
- ------------------------------------------------------------------------------
Portfolio Risk Characteristics
- ------------------------------------------------------------------------------
The Funds are diversified not only by industry, but also by external risk
factors that might impact the companies in which the Funds invest. Table II
displays some of the risk factors that are currently monitored and the
percentage of each portfolio considered exposed to these factors. The Funds use
this tool to avoid concentration of risk within the portfolios.
<TABLE>
<CAPTION>
Baron Baron Baron
Asset Growth Small
Fund & Income Fund Cap Fund
- ------------------------------------------------------------------------------
% of % of % of
Portfolio Portfolio Portfolio
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Leverage (Debt > 40% of
Market Cap) ........................ 21.6% 24.5% 37.0%
Foreign Sales Dependent
(Sales > 15%) ...................... 25.4 18.3 21.0
Oil Price Sensitivity ................ 17.8 23.9 5.9
Volatility (Beta > 1.2) .............. 33.3 23.8 28.1
Over-the-Counter Securities .......... 20.8 30.1 46.3
Unseasoned Securities
(Publicly owned for <3 years) ...... 20.2 31.2 45.6
(Publicly owned for <1 year) ....... 3.1 7.9 12.3
Turnarounds .......................... 1.9 1.9 4.7
Development Companies ................ 3.9 2.9 6.9
</TABLE>
20
<PAGE>
- --------------------------------------------------------------------------------
B A R O N F U N D S
- --------------------------------------------------------------------------------
Table III
- ------------------------------------------------------------------------------
Historical Information (Unaudited)
- ------------------------------------------------------------------------------
Table III displays on a quarterly basis the Funds' closing net assets and net
asset value per share, dividend distributions and the value of $10,000 invested
in a Fund at the time of its inception.
- ------------------------------------------------------------------------------
Baron Asset Fund
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value of Shares
Value Owned, if Initial
Date Fund Net Assets Per Share Dividends Investment was $10,000*
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
06/12/87 $ 108,728 $10.00 $10,000
- ----------------------------------------------------------------------------------------
06/30/87 1,437,521 10.71 10,710
- ----------------------------------------------------------------------------------------
09/30/87 3,905,221 11.95 11,950
- ----------------------------------------------------------------------------------------
12/31/87 4,406,972 10.10 $ 0.197 10,298
- ----------------------------------------------------------------------------------------
03/31/88 6,939,435 11.56 11,786
- ----------------------------------------------------------------------------------------
06/30/88 9,801,677 12.68 12,928
- ----------------------------------------------------------------------------------------
09/30/88 11,734,509 12.98 13,234
- ----------------------------------------------------------------------------------------
12/31/88 15,112,031 12.87 0.701 13,843
- ----------------------------------------------------------------------------------------
03/31/89 22,269,578 14.75 15,864
- ----------------------------------------------------------------------------------------
06/30/89 31,397,929 16.06 17,273
- ----------------------------------------------------------------------------------------
09/30/89 47,658,616 17.22 18,521
- ----------------------------------------------------------------------------------------
12/31/89 49,007,084 14.66 1.409 17,299
- ----------------------------------------------------------------------------------------
03/31/90 50,837,946 13.87 16,367
- ----------------------------------------------------------------------------------------
06/30/90 54,413,786 14.32 16,898
- ----------------------------------------------------------------------------------------
09/30/90 40,002,612 10.88 12,838
- ----------------------------------------------------------------------------------------
12/31/90 42,376,625 11.75 0.198 14,100
- ----------------------------------------------------------------------------------------
03/31/91 47,104,889 13.88 16,656
- ----------------------------------------------------------------------------------------
06/30/91 45,600,730 13.81 16,572
- ----------------------------------------------------------------------------------------
09/30/91 47,409,180 14.80 17,760
- ----------------------------------------------------------------------------------------
12/31/91 46,305,042 15.71 0.035 18,895
- ----------------------------------------------------------------------------------------
03/31/92 48,011,634 16.72 20,109
- ----------------------------------------------------------------------------------------
06/30/92 42,289,409 15.28 18,377
- ----------------------------------------------------------------------------------------
09/30/92 43,816,305 16.20 19,484
- ----------------------------------------------------------------------------------------
12/31/92 47,955,530 17.73 0.162 21,522
- ----------------------------------------------------------------------------------------
03/31/93 50,015,244 18.82 22,845
- ----------------------------------------------------------------------------------------
06/30/93 52,432,090 19.70 23,912
- ----------------------------------------------------------------------------------------
09/30/93 59,916,570 21.91 26,595
- ----------------------------------------------------------------------------------------
12/31/93 64,069,114 21.11 0.774 26,576
- ----------------------------------------------------------------------------------------
03/31/94 63,099,109 20.69 26,047
- ----------------------------------------------------------------------------------------
06/30/94 68,880,300 20.40 25,682
- ----------------------------------------------------------------------------------------
09/30/94 80,258,542 22.82 28,728
- ----------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Net Asset Value of Shares
Value Owned, if Initial
Date Fund Net Assets Per Share Dividends Investment was $10,000*
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
12/31/94 $ 87,058,228 $22.01 $ 0.656 $28,547
- ----------------------------------------------------------------------------------------
03/31/95 160,603,528 24.29 31,505
- ----------------------------------------------------------------------------------------
06/30/95 202,259,502 25.79 33,450
- ----------------------------------------------------------------------------------------
09/30/95 289,973,331 29.30 38,003
- ----------------------------------------------------------------------------------------
12/31/95 353,095,409 29.74 0.034 38,618
- ----------------------------------------------------------------------------------------
03/31/96 638,297,904 34.14 44,332
- ----------------------------------------------------------------------------------------
06/30/96 1,124,647,802 36.65 47,591
- ----------------------------------------------------------------------------------------
09/30/96 1,166,057,654 35.50 46,098
- ----------------------------------------------------------------------------------------
12/31/96 1,326,321,785 36.23 0.039 47,097
- ----------------------------------------------------------------------------------------
03/31/97 1,663,347,667 34.98 45,472
- ----------------------------------------------------------------------------------------
06/30/97 2,306,228,855 41.74 54,260
- ----------------------------------------------------------------------------------------
09/30/97 3,224,498,394 47.43 61,656
- ----------------------------------------------------------------------------------------
12/31/97 3,793,013,753 48.51 0.000 63,060
- ----------------------------------------------------------------------------------------
03/31/98 5,187,450,337 53.68 69,781
- ----------------------------------------------------------------------------------------
06/30/98 5,545,334,568 52.20 67,857
- ----------------------------------------------------------------------------------------
09/30/98 4,410,506,448 39.96 51,946
- ----------------------------------------------------------------------------------------
12/31/98 5,672,309,694 50.54 0.041 65,752
- ----------------------------------------------------------------------------------------
03/31/99 6,087,986,855 54.17 70,474
- ----------------------------------------------------------------------------------------
06/30/99 6,991,160,511 60.63 78,879
- ----------------------------------------------------------------------------------------
</TABLE>
* Assumes all dividends were reinvested and no shares were redeemed.
BARON ASSET FUND'S
AVERAGE ANNUAL RETURN
Period ended June 30, 1999
One year 16.2%
- ------------------------------------------------------------------------------
Two years 20.6%
- ------------------------------------------------------------------------------
Three years 18.3%
- ------------------------------------------------------------------------------
Four years 23.9%
- ------------------------------------------------------------------------------
Five years 25.2%
- ------------------------------------------------------------------------------
Ten years 16.4%
- ------------------------------------------------------------------------------
Since inception June 12, 1987 18.7%
- ------------------------------------------------------------------------------
21
<PAGE>
- --------------------------------------------------------------------------------
B A R O N F U N D S
- --------------------------------------------------------------------------------
- ------------------------------------------------------------------------------
Baron Growth Fund
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value of Shares
Value Owned, if Initial
Date Fund Net Assets Per Share Dividends Investment was $10,000*
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
01/03/95 $ 741,000 $10.00 $10,000
- ----------------------------------------------------------------------------------------
03/31/95 3,425,507 11.78 11,780
- ----------------------------------------------------------------------------------------
06/30/95 7,231,619 13.18 13,180
- ----------------------------------------------------------------------------------------
09/30/95 28,632,467 14.77 14,770
- ----------------------------------------------------------------------------------------
12/31/95 41,043,705 15.11 $ 0.142 15,254
- ----------------------------------------------------------------------------------------
03/31/96 77,337,831 16.90 17,061
- ----------------------------------------------------------------------------------------
06/30/96 172,070,435 18.20 18,373
- ----------------------------------------------------------------------------------------
09/30/96 207,234,494 18.40 18,575
- ----------------------------------------------------------------------------------------
12/31/96 243,983,507 19.04 0.255 19,483
- ----------------------------------------------------------------------------------------
03/31/97 273,907,177 18.57 19,002
- ----------------------------------------------------------------------------------------
06/30/97 316,981,759 21.82 22,328
- ----------------------------------------------------------------------------------------
09/30/97 390,831,861 24.89 25,469
- ----------------------------------------------------------------------------------------
12/31/97 415,134,319 24.88 0.073 25,535
- ----------------------------------------------------------------------------------------
03/31/98 511,405,730 27.28 27,998
- ----------------------------------------------------------------------------------------
06/30/98 478,748,484 26.07 26,757
- ----------------------------------------------------------------------------------------
09/30/98 315,557,850 20.32 20,855
- ----------------------------------------------------------------------------------------
12/31/98 343,695,555 24.87 0.035 25,561
- ----------------------------------------------------------------------------------------
03/31/99 313,002,293 26.75 27,493
- ----------------------------------------------------------------------------------------
06/30/99 396,879,495 31.42 32,293
- ----------------------------------------------------------------------------------------
</TABLE>
* Assumes all dividends were reinvested and no shares were redeemed.
BARON GROWTH FUND'S
AVERAGE ANNUAL RETURN
Period ended June 30, 1999
One year 20.7%
- ------------------------------------------------------------------------------
Two years 20.3%
- ------------------------------------------------------------------------------
Three years 20.7%
- ------------------------------------------------------------------------------
Four years 25.1%
- ------------------------------------------------------------------------------
Since inception January 3, 1995 29.8%
- ------------------------------------------------------------------------------
<PAGE>
- ------------------------------------------------------------------------------
Baron Small Cap Fund
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Net Asset Value of Shares
Value Owned, if Initial
Date Fund Net Assets Per Share Dividends Investment was $10,000*
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
10/01/97 $112,604,624 $10.00 $10,000
- ----------------------------------------------------------------------------------------
12/31/97 285,270,924 10.31 0.000 10,310
- ----------------------------------------------------------------------------------------
03/31/98 449,240,304 11.84 11,840
- ----------------------------------------------------------------------------------------
06/30/98 571,568,792 11.97 11,970
- ----------------------------------------------------------------------------------------
09/30/98 403,727,998 8.61 8,610
- ----------------------------------------------------------------------------------------
12/31/98 470,029,904 10.54 0.000 10,540
- ----------------------------------------------------------------------------------------
03/31/99 521,729,028 11.89 11,890
- ----------------------------------------------------------------------------------------
06/30/99 644,583,528 13.36 13,360
- ----------------------------------------------------------------------------------------
</TABLE>
* Assumes all dividends were reinvested and no shares were redeemed.
BARON SMALL CAP FUND'S
AVERAGE ANNUAL RETURN
Period ended June 30, 1999
One year 11.6%
- ------------------------------------------------------------------------------
Since inception October 1, 1997 18.0%
- ------------------------------------------------------------------------------
The performance data represents past performance. Investment returns and
principal value will fluctuate so that an investor's shares, when redeemed, may
be worth more or less than their cost. For more complete information about
Baron Funds including charges and expenses, call or write for a prospectus.
Read it carefully before you invest or send money. This report is not
authorized for use as an offer of sale or a solicitation of an offer to buy
shares of Baron Funds unless accompanied or preceded by the Funds' current
prospectus.
22
<PAGE>
- --------------------------------------------------------------------------------
B A R O N A S S E T F U N D
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
- --------------------------------------------------------------------------------
June 30, 1999 (Unaudited)
Shares Value
- -------------------------------------------------------------------------
Common Stocks (96.57%)
- -------------------------------------------------------------------------
Amusement and Recreation Services (9.58%)
10,210,000 AMF Bowling, Inc.*# $ 86,146,875
7,675,000 Mirage Resorts, Inc.* 128,556,250
3,510,000 Premier Parks, Inc. 128,992,500
3,315,000 Sun Intl. Hotels, Ltd.*# 148,346,250
6,066,000 Vail Resorts, Inc. Class A*# 109,188,000
4,000,000 Vail Resorts, Inc. Class A*# @ 68,400,000
--------------
669,629,875
Business Services (4.24%)
1,640,000 ChoicePoint, Inc.*# 110,085,000
1,749,532 Correctional Management Services
Corp.*@ 8,000,085
6,910,000 Robert Half Intl., Inc.*# 178,364,375
--------------
296,449,460
Chemical (1.17%)
2,367,500 OM Group, Inc. # 81,678,750
Communications (9.24%)
3,500,000 American Mobile Satellite Corp.*# 57,312,500
5,000,000 American Tower Corp. Class A* 120,000,000
1,272,500 Cellular Communications of P.R.,
Inc.*# 36,266,250
254,200 Commonwealth Telephone Ent., Inc.* 10,279,213
1,470,000 CoreComm, Ltd.*# 70,927,500
3,391,636 NTL, Inc.* 292,316,628
875,000 United Intl. Hldgs., Inc.* 59,171,875
--------------
646,273,966
Education (3.09%)
957,500 Caliber Learning Network, Inc.*# 4,548,125
4,700,000 DeVry, Inc.*# 105,162,500
1,868,300 Education Management Corp.*# 38,767,225
1,550,000 ITT Educational Services, Inc.*# 40,396,875
2,487,600 Learning Tree Intl., Inc.*# 27,208,125
--------------
216,082,850
Energy (1.95%)
4,472,800 Cross Timbers Oil Co.# 66,532,900
1,300,000 Seacor Smit, Inc.*# 69,550,000
--------------
136,082,900
Financial (19.55%)
12,200,000 Charles Schwab Corp. 1,338,187,500
1,680,000 DVI, Inc.*# 28,770,000
--------------
1,366,957,500
Health Services (4.29%)
2,557 Chesapeake Healthcare Corp.* @ 4,000,196
2,240,000 Counsel Corp.*# 14,280,000
11,000,000 HCR Manor Care, Inc.*# 266,062,500
1,250,000 Quorum Health Group, Inc.* 15,703,125
--------------
300,045,821
Hotels and Lodging (4.80%)
2,191,150 Bristol Hotels & Resorts, Inc.*# 16,433,625
13,225,300 Choice Hotels Intl., Inc.*# 261,199,675
715,000 Four Seasons Hotels, Inc. 31,504,687
4,256,702 Sunburst Hospitality Corp.*# 26,072,301
--------------
335,210,288
<PAGE>
Shares Value
- -------------------------------------------------------------------------
Manufacturing (2.35%)
2,780,000 Flextronics Intl., Ltd.*# $ 154,290,000
640,000 Unova, Inc.* 10,160,000
--------------
164,450,000
Media and Entertainment (9.43%)
800,000 CD Radio, Inc.* 24,374,960
1,260,400 Century Communications Corp.* 57,978,400
830,000 Cox Radio, Inc.* 45,027,500
3,260,000 Hispanic Broadcasting Corp.
(Formerly Heftel Broadcasting Corp.
Class A)*# 247,352,500
1,240,000 Metro Networks, Inc.*# 66,185,000
1,200,000 Outdoor Systems, Inc.* 43,800,000
2,937,002 Saga Communications, Inc. Class A*# 54,701,663
1,230,000 Univision Communications, Inc.
Class A* 79,950,000
940,000 Young Broadcasting, Inc. Class A* 40,008,750
--------------
659,378,773
Real Estate and REITs (3.45%)
276,000 Alexander's, Inc.*# 20,389,500
750,000 Avatar Holdings, Inc.*# 14,203,125
1,000,000 FelCor Lodging Trust, Inc. 20,750,000
655,000 Iron Mountain, Inc.* 18,749,375
800,000 Kimco Realty Corp. 31,300,000
179,999 Post Properties, Inc. 7,379,959
635,200 Prison Realty Trust, Inc. 6,232,900
2,400,000 Spieker Properties, Inc. 93,300,000
240,000 Storage USA, Inc. 7,680,000
335,000 Sun Communities, Inc. 11,892,500
700,000 Taubman Centers, Inc. 9,231,250
--------------
241,108,609
Retail Trade and Restaurants (17.58%)
3,725,000 Dollar Tree Stores, Inc.*# 163,900,000
10,360,000 Polo Ralph Lauren Corp.* 196,840,000
3,393,500 Smart and Final, Inc.# 35,631,750
20,775,000 Sotheby's Holdings, Inc. Class A# 792,046,875
1,940,000 Stein Mart, Inc.* 18,187,500
650,000 Williams-Sonoma, Inc.* 22,628,125
--------------
1,229,234,250
Transportation (0.38%)
2,130,000 Budget Group, Inc. Class A* 26,225,625
Utility Services (1.69%)
6,635,600 Citizens Utilities Co.* 73,821,050
2,050,000 Southern Union Co.# 44,587,500
--------------
118,408,550
Wholesale Trade (2.79%)
5,687,000 Industrie Natuzzi SPA ADR# 110,541,063
2,920,000 Libbey, Inc.# 84,680,000
--------------
195,221,063
Miscellaneous (0.99%) 69,175,831
--------------
Total Common Stocks
(Cost $4,382,720,904) 6,751,614,111
--------------
23
<PAGE>
- --------------------------------------------------------------------------------
B A R O N A S S E T F U N D
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
- --------------------------------------------------------------------------------
June 30, 1999 (Unaudited)
Shares Value
- -------------------------------------------------------------------------
Convertible Preferred (0.21%)
- -------------------------------------------------------------------------
Transportation
400,000 Budget Group Capital Trust Conv. Pref.+
(Cost $20,000,000) $ 15,000,000
--------------
Principal Amount
- -------------------------------------------------------------------------
Corporate Bonds (0.31%)
- -------------------------------------------------------------------------
Communications
$ 21,500,000 American Mobile Satellite Corp. 6.0%
Jr. Sub. Secured Exch. Note due
09/30/2006 (Cost $21,500,000)@ 21,500,000
--------------
- -------------------------------------------------------------------------
Short Term Money Market Instruments (2.83%)
- -------------------------------------------------------------------------
197,600,000 Associates Corp. of N. A. 5.50% due
07/01/1999 (Cost $197,600,000) 197,600,000
--------------
Total Investments (99.92%)
(Cost $4,621,820,904**) 6,985,714,111
--------------
Cash and Other Assets Less Liabilities (0.08%) 5,446,400
--------------
Net Assets (Equivalent to $60.63 per share
based on 115,306,725 shares of beneficial
interest outstanding) $6,991,160,511
==============
- ----------
% Represents percentage of net assets
+ Rule 144A Securities
@ Restricted securities
# Issuers deemed to be "affiliated"
* Non-income producing securities
** For Federal income tax purposes the cost basis is $4,623,166,259.
Aggregate unrealized appreciation and depreciation of investments are
$2,932,225,896 and $569,678,044 respectively.
24
<PAGE>
- --------------------------------------------------------------------------------
B A R O N G R O W T H F U N D
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
- --------------------------------------------------------------------------------
June 30, 1999 (Unaudited)
Shares Value
- -------------------------------------------------------------------------
Common Stocks (93.32%)
- -------------------------------------------------------------------------
Amusement and Recreation Services (4.84%)
55,000 American Classic Voyages Co.* $ 1,320,000
100,000 Steiner Leisure, Ltd.* 3,031,250
237,200 Sun Intl. Hotels, Ltd.* 10,614,700
235,000 Vail Resorts, Inc. Class A* 4,230,000
--------------
19,195,950
Business Services (4.39%)
175,000 ChoicePoint, Inc.* 11,746,875
220,000 Robert Half Intl., Inc.* 5,678,750
--------------
17,425,625
Chemical (1.82%)
210,000 OM Group, Inc. 7,245,000
Communications (13.13%)
390,000 American Mobile Satellite Corp.* 6,386,250
200,000 CoreComm, Ltd.* 9,650,000
400,000 Electric Lightwave, Inc.* 5,200,000
292,804 NTL, Inc.* 25,236,045
185,000 Rural Cellular Corp. Class A* 3,700,000
20,000 Time Warner Telecom, Inc.* 580,000
20,000 United Intl. Hldgs., Inc.* 1,352,500
--------------
52,104,795
Education (3.41%)
270,000 DeVry, Inc.* 6,041,250
235,000 Education Management Corp.* 4,876,250
100,000 ITT Educational Services, Inc.* 2,606,250
--------------
13,523,750
Energy (1.48%)
180,000 Cross Timbers Oil Co. 2,677,500
60,000 Seacor Smit, Inc.* 3,210,000
--------------
5,887,500
Financial (15.06%)
93,333 Bingham Financial Services Corp.*@ 1,174,829
410,000 Charles Schwab Corp. 44,971,875
220,000 DVI, Inc.* 3,767,500
299,000 Gabelli Asset Management, Inc.* 4,727,938
270,000 Medallion Financial Corp. 5,146,875
--------------
59,789,017
Food & Agriculture (1.68%)
380,000 Aurora Foods, Inc.* 6,650,000
Health Services (3.81%)
625,000 HCR Manor Care, Inc.* 15,117,187
Hotels and Lodging (11.15%)
218,800 Bristol Hotels & Resorts, Inc.* 1,641,000
2,100,000 Choice Hotels Intl., Inc.* 41,475,000
140,000 ResortQuest Intl., Inc.* 1,155,000
--------------
44,271,000
Manufacturing (2.80%)
200,000 Flextronics Intl., Ltd.* 11,100,000
<PAGE>
Shares Value
- -------------------------------------------------------------------------
Media and Entertainment (10.03%)
145,000 Citadel Communications Corp.* $ 5,247,187
50,000 Entercom Communications Corp.* 2,137,500
150,000 Hispanic Broadcasting Corp. (Formerly
Heftel Broadcasting Corp. Class A)* 11,381,250
100,000 Metro Networks, Inc.* 5,337,500
200,000 Radio One, Inc.* 9,300,000
343,750 Saga Communications, Inc. Class A* 6,402,344
--------------
39,805,781
Real Estate and REITs (5.87%)
150,000 Kimco Realty Corp. 5,868,750
109,999 Post Properties, Inc. 4,509,959
160,000 Storage USA, Inc. 5,120,000
190,000 Sun Communities, Inc. 6,745,000
80,000 Taubman Centers, Inc. 1,055,000
--------------
23,298,709
Retail Trade and Restaurants (7.99%)
240,000 Dollar Tree Stores, Inc.* 10,560,000
707,781 Smart and Final, Inc. 7,431,700
360,000 Sotheby's Holdings, Inc. Class A 13,725,000
--------------
31,716,700
Utility Services (2.75%)
501,000 Southern Union Co. 10,896,750
Wholesale Trade (3.11%)
470,000 Industrie Natuzzi SPA ADR 9,135,625
110,000 Libbey, Inc. 3,190,000
--------------
12,325,625
--------------
Total Common Stocks
(Cost $221,075,317)
370,353,389
--------------
Principal Amount
- -------------------------------------------------------------------------
Short Term Money Market Instruments (6.61%)
- -------------------------------------------------------------------------
$26,254,000 Associates Corp. of N. A. 5.50%
due 07/01/1999 (Cost $26,254,000) 26,254,000
--------------
Total Investments (99.93%)
(Cost $247,329,317**) 396,607,389
-------------
Cash and Other Assets
Less Liabilities (0.07%) 272,106
-------------
Net Assets (Equivalent to $31.42 per
share based on shares of 12,632,238
beneficial interest outstanding) $ 396,879,495
=============
- ----------
% Represents percentage of net assets
@ Restricted securities
* Non-income producing securities
** For Federal income tax purposes the cost basis is $246,666,378. Aggregate
unrealized appreciation and depreciation of investments are $154,019,802
and $4,078,791 respectively.
25
<PAGE>
- --------------------------------------------------------------------------------
B A R O N S M A L L C A P F U N D
- --------------------------------------------------------------------------------
STATEMENT OF NET ASSETS
- --------------------------------------------------------------------------------
June 30, 1999 (Unaudited)
Shares Value
- -------------------------------------------------------------------------
Common Stocks (93.17%)
- -------------------------------------------------------------------------
Amusement and Recreation Services (9.10%)
250,000 Intrawest Corp. $ 3,828,125
1,000,000 Loews Cineplex Entertainment Corp.* 10,875,000
950,000 Premier Parks, Inc. 34,912,500
165,000 Sun Intl. Hotels, Ltd.* 7,383,750
400,000 The Sports Club Co.* 1,650,000
--------------
58,649,375
Business Services (13.02%)
1,000,000 Caribiner Intl., Inc.* 6,187,500
700,000 Central Parking Corp. 23,975,000
235,000 ChoicePoint, Inc.* 15,774,375
350,000 Corporate Executive Board Co.* 12,446,875
725,000 Heidrick & Struggles Int'l., Inc.* 13,775,000
580,000 Strategic Distribution, Inc.* 1,341,250
475,000 United Stationers, Inc.* 10,450,000
--------------
83,950,000
Communications (22.48%)
575,000 American Tower Corp. Class A* 13,800,000
75,000 Centennial Cellular Corp.* 2,671,875
406,500 Commonwealth Telephone Ent., Inc.* 16,437,844
350,000 Commnet Cellular, Inc.* 9,187,500
350,000 CoreComm, Ltd.* 16,887,500
500,000 Electric Lightwave, Inc.* 6,500,000
150,000 Hyperion Telecommunications, Inc. 2,821,875
Class A
450,000 Rural Cellular Corp. Class A* 9,000,000
1,000,000 United Intl. Hldgs., Inc.* 67,625,000
--------------
144,931,594
Consumer Products (0.64%)
400,000 Equity Marketing, Inc.*# 4,150,000
Education (3.67%)
700,000 Career Education Corp.*# 23,668,750
Environmental (3.36%)
1,350,000 IT Group, Inc.*# 21,684,375
Financial (2.23%)
299,000 Gabelli Asset Management, Inc.* 4,727,937
300,000 Investment Technology Group, Inc. 9,637,500
--------------
14,365,437
Health Services (1.97%)
650,000 Province Healthcare Co.* 12,675,000
Hotels and Lodging (4.72%)
550,000 Four Seasons Hotels, Inc. 24,234,375
750,000 ResortQuest Intl., Inc.* 6,187,500
--------------
30,421,875
Manufacturing (0.85%)
750,000 AVTEAM, Inc.* # 5,484,375
<PAGE>
Shares Value
- -------------------------------------------------------------------------
Media and Entertainment (17.93%)
625,000 Century Communications Corp.* $ 28,750,000
100,000 Entercom Communications Corp.* 4,275,000
300,000 High Speed Access Corp.* 7,687,500
150,000 Lamar Advertising Co.* 6,140,625
375,000 Metro Networks, Inc.* 20,015,625
380,000 Radio One, Inc.* 17,670,000
435,000 SFX Entertainment, Inc.* 27,840,000
20,000 TMP Worldwide, Inc.* 1,270,000
45,000 Young Broadcasting, Inc. Class A* 1,915,312
--------------
115,564,062
Real Estate and REITs (3.78%)
850,000 Iron Mountain, Inc.* 24,331,250
Retail Trade and Restaurants (8.03%)
625,000 Kenneth Cole Productions, Inc.* 17,421,875
350,000 Morton's Restaurant Group, Inc.*# 6,671,875
525,000 United Rentals, Inc.* 15,487,500
350,000 Williams-Sonoma, Inc.* 12,184,375
--------------
51,765,625
Utility Services (1.39%)
1,000,000 El Paso Electric Co.* 8,937,500
--------------
Total Common Stocks
(Cost $421,486,001)
600,579,218
--------------
Principal Amount
- -------------------------------------------------------------------------
Corporate Bonds (0.33%)
- -------------------------------------------------------------------------
Health Services
$ 3,250,000 U.S. Diagnostic, Inc. 9.00%
Conv. Sub. Deb. due 03/31/2003
(Cost $2,520,000) 2,112,500
--------------
- -------------------------------------------------------------------------
Short Term Money Market Instruments (6.07%)
- -------------------------------------------------------------------------
39,119,000 Associates Corp. of N. A. 5.50%
due 07/01/1999 (Cost $39,119,000) 39,119,000
--------------
Total Investments (99.57%)
(Cost $463,125,001**) 641,810,718
--------------
Cash and Other Assets
Less Liabilities (0.43%) 2,772,810
--------------
Net Assets (Equivalent to $13.36 per
share based on shares of 48,245,016
beneficial interest outstanding) $ 644,583,528
==============
% Represents percentage of net assets
# Issuers that may be deemed to be "affiliated"
* Non-income producing securities
** For Federal income tax purposes the cost basis is $463,664,701. Aggregate
unrealized appreciation and depreciation of investments are $208,750,514 and
$30,604,497, respectively.
26
<PAGE>
GRAPHIC
BARON
FUNDS
767 Fifth Avenue
NY, NY 10153
3QR99
