Pershing Square Holdings is burdened by the Ackman Malus. After a disastrous performance over the last three years the investment community is turning its back on former activist star investor Bill Ackman. Pershing Square Holdings, managed by Ackman and his team, offers access to a hedge fund charging relatively low fees, trading at a large discount to NAV with the benefit of permanent capital. In addition to that, some downside protection comes from a potential liquidation of Pershing Square Holdings.
Pershing Square Holdings (PSH) is a closed end investment scheme trading on the stock exchanges in Amsterdam and London and as ADR in the US. PSH has USD 5.3 bn in total investable capital consisting of USD 4.2 bn in net assets attributable to public shareholders, USD 0.2 m of management shares and USD 1.0 bn in outstanding 5.5% senior notes due in 2022. Pershing Square Capital Management (PSCM) is responsible for the investment management of PSH and other investment vehicles. PSCM has a total of USD 9.4 bn assets under management (excluding PSH’s senior notes):
Total Strategy AUM includes PSH and other vehicles (i.e. Pershing Square International, Pershing Square and Pershing Square II). They have a similar allocation to investments. The difference between “Total Firm AUM” and “Total Strategy AUM” stems from Pershing Square Master VI that is primarily holding securities of Automatic Data Processing.
Bill Ackman is the founder of PSCM. As an investor it is hard to ignore him, because of his regular media appearance be it on Bloomberg, CNBC or one of his marathon conference call sessions. He is taking an activist approach on most of the companies he is buying a share in (most recently Automatic Data Processing) trying to get on the board, hence getting access to private information and influencing decision making in the way he thinks the company should be run. Ackman makes use of the media and public to either put pressure on the management of companies that deny his demands or to promote his investment cases. Over the last years, he also tends to take a more passive approach with some investments (i.e. Valeant at the beginning, Mondelez, Air Products)
With PSCM’s semi-activist approach comes a concentrated portfolio. If you look at the performance attribution below, you will see what significant effect single investments had on total performance:
“If I had to pick one stock out of the ten stocks we own that is perhaps the most undervalued I would say it is Valeant today. It is probably the most attractive from a risk reward perspective over the next year or so.”
Over the following year Valeant’s share price lost more than 90% with Ackman describing the investment in Valeant as an “anomaly” due to a deviation from Pershing’s intrinsic investment style by taking a large passive stake of a fully priced company. There have been other significant failures throughout Ackman’s career like the almost full wipe out of an investment in Target in 2008 and the forced wind down of his partnership with Bruce Berkowitz in 2002.
Edit: as a follow up to the investment in Valeant / Allergan, PSCM is currently fighting a class action lawsuit in a California court accusing Ackman of insider trading. PSCM has set aside USD 75m split between USD 29 m at PSH, and the remainder from its other funds. In an agreement with Valeant made in February 2017, the drugmaker would cover 60% of any costs from the class action suit. Whether the costs will be higher than the current provision in place remains unclear.
As a consequence of recent events, Ackman has been described as “un-investable” by a number of fellow investors and redemption requests from his ex-PSH funds started to increase. Three years ago, PSCM had assets under management of USD18.0 bn declining by 48% to USD 9.4 bn until the end of October 2017. Given the generous lock up periods, PSCM was able to negotiate with investors during the company’s heydays, more redemption can still be expected. Further redemption put pressure on PSCM’s existing investments given the need to liquidate large ownership to fulfill demands by existing investors.
Since inception of Pershing Square Holdings performance has been disastrous:
Taking a longer-term view since the inception of Pershing Square L.P. in 2004 however, the PSCM managed fund with the longest track record, provides a more pleasant picture:
PSH is an investment vehicle managed by an asset manager who has a mixed track record: At Pershing Square he significantly underperformed from 2015 to 2017 and outperformed from 2004 to 2014. His partnership Gotham performed reasonably well from 1993 to 1999 but had to be liquidated due to large exposure to illiquid investments followed by redemptions (Edit: the term “mixed track record” is referring to Ackman’s investment career starting in 1993);
PSCM / Ackman lost almost half of his assets under management over the last three years;
PSCM /Ackman run a highly concentrated portfolio mostly invested in large cap companies;
PSCM / Bill Ackman is an activist investor who does not shy away from attacking the leaders of target companies publicly;
Indeed, Ackman eagerly pursues public appearance to defend his investment cases.
Why I invest in Pershing Square Holdings:
PSH provides access to a classic hedge fund vehicle. PSH faces minimal investment restrictions compared to most institutional investors. They can go long/short, can invest in derivatives and have access to over the counter transactions (OTC). The usage of derivative instruments increases the inherent leverage of an investment. For instance, based on the August 7, 2017 and August 31, 2017 filings with the SEC, PSH invested USD 1.2 bn in Automatic Data Processing buying OTC and listed call options, trading OTC equity forwards, and exercising a small part of the options later on. Consequently, PSH as of the last filing has an economic interest in 21.6 m shares or 4.9% of the company, while PSH owns 3.0 m common shares only.
The use of derivatives can produce/increase many types of risk. At the same time, derivatives can offer a great way to build large exposure to underlying investments without moving prices too much. In the right hands the usage of derivatives provides significant potential for return enhancement and can also reduce risk. For instance, Ackman recently switched his short exposure in Herbalife from selling shares short to buying deep in the money put options. I think this was a good move. So far, with Carl Icahn betting against him and the Herbalife management eagerly reducing the free float it was hard to imagine that the share price could fall significantly. I think now the likelihood for Ackman’s thesis being reflected in Herbalife’s share price is much higher. This flexibility in using the right instrument provides value to an investor in PSH.
According to the third quarter 2017 reporting, PSH’s largest position is in Automatic Data Processing (ADP) followed by Mondelez (MDLZ), Restaurant Brands (QSR) Howard Hughes (HHC), Chipotle (CMG), Fannie Mae (FNMA) / Freddie Mac (FMCC), Platform Specialty (PAH) and an undisclosed investment. On the short side PSH owns a 3% to 5% position in Herbalife put options. Based on my information, currently all investments include the usage of derivatives except from Restaurant Brands (QSR), Chipotle (CMG) and Platform Specialty (PAH). Based on PSH’s SEC filings and latest financials, I estimate the effect on PSH’s total performance from the largest three investments (ADP, MDLZ and QSR) to be up to 70%. At the same time, the investment in terms of total assets allocated to these three investments is much lower at 30% to 40%.
PSH will charge relatively modest fees before reaching the historic high-water mark. PSH charges a management fee of 1.5% of net assets. A 16% incentive fee will not be charged before the NAV reaches USD 26.4 per share. Hence, from its current level of USD 17.7, the NAV needs to increase by 51% before PSCM will be able to charge a performance fee. This provides for an attractive fee structure compared to most other alternative investment funds charging up to 2% asset management fee plus a 20% performance fee.
PSH’s unit price is trading at a 23% discount to NAV. While this is a reflection of missing investor confidence in Ackman’s ability to produce attractive risk adjusted returns in the future, it is detrimental to the fact that PSH is offering a more economical way to participate in a PSCM managed asset than in the past. Until the beginning of 2016, unit prices traded closer to NAV with the discount reaching a maximum of roughly 10%. So even assuming Ackman’s returns are random, PSH’s value proposition now is much better than in the past given the lower fee structure. In addition, PSH started to repurchase shares in April 2017. Obviously, this has an accretive effect on NAV per share.
PSH is a pool of permanent capital getting more important for PSCM. With increasing redemptions in PSCM’s other funds, PSH becomes more important to Ackman and his team. In hindsight, PSH might turn out as Ackman’s safety net which he might have established as insurance for his career as investor? Anyway, with less than half of assets under management compared to three years ago and a larger proportion of permanent capital (in addition to that a large part of Ackman’s personal wealth is invested in Pershing funds), Ackman will face a broader investment universe in the future (i.e. he can invest in lower capitalization names where activist investors face less opposition from management).
PSH has access to relatively cheap financing. PSH has USD 1 bn in 5.5% senior notes maturing in 2022. Unlike margin debt, the bonds do not have mark-to-market covenants which could require forced sales when equity prices decline. Right now, market participants would be reluctant to provide PSH with debt based on the same conditions, but the senior notes were issued before the Valeant debacle in 2015. With 4.5 years to go the notes provide additional access to permanent capital.
PSH liquidation as downside protection scenario. In case, PSCM continues to underperform and/or the discount to NAV widens and/or Bill Ackman needs access to his funds invested in Pershing Square vehicles, a wind down of PSH could follow. Given that most funds are allocated to liquid investments an investor could expect a liquidation close to NAV. There will be costs most noteworthy related to the early redemption of the outstanding senior notes. Overall, I expect shareholder returns will reach roughly 20%, if PSCM decides to unwind PSH tomorrow. (Note: A supermajority voting share is held by a special entity “with the sole objective to vote in the best interest of the Company’s shareholders as a whole” and “no affiliation to the investment manager”).
Over the last two days I accumulated a 4.5% portfolio position at 13.7 USD per share.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!