Invest in legendary stock-picker Bill Ackman at 77 cents on the dollar

Ackman’s stellar long-term record has been overshadowed by 3 years of underperformance and PSH shares now offer significant value.

Summary

• Pershing Square Holdings (PSH) is a hedge fund run by legendary value/activist investor Bill Ackman.
• Over the last 3 years, PSH’s concentrated fund has drastically underperformed the market by 70.1%.
• As a result, PSH is currently trading at a ~23% discount to Net Asset Value (NAV).
• However, despite recent results, I argue that: (1) PSH’s long-term track record and performance is excellent, outperforming the market by over 272.8% over the last 13 years. (2) PSH is extremely undervalued compared to its peers. (3) Significant catalysts exist that are expected to narrow the discount to NAV.

Performance worries

The major reason for the large discount to NAV is the underperformance over the last few years. Indeed, PSH has returned an abysmal -20.5% in 2015, -13.5% in 2016 and -2.1% in 2017, compared to +1.4%, +11.9% and +21% respectively by the S&P 500 for a total underperformance of 70.1%.

While the past few years have undoubtedly been disappointing, even accounting for these terrible years Ackman and PSH’s track record since inception is still stellar. Indeed, in the 13 years since 2004, PSH has generated 493.6% compared to 220.8% by the S&P 500, beating it by 272.8%. Put another way, from 2004–2017, PSH has generated compounded annual returns of 13.6% compared to 8.7% by the S&P 500. This is an incredible long-term performance and 2018 results (8.8% vs 0.97% S&P) suggest mean reversion is underway and his 3 year losing streak may be over.

The gross results (i.e. actual investment results without accounting for hedge fund fees) are even more impressive, showing Ackman beating both the S&P 500 and Berkshire Hathaway by over 770%, with gross compounded annual returns of 18.2%.

Source: Slide 9 of this presentation

It’s worth noting that PSH runs a notoriously concentrated portfolio with generally less than 10 positions and thus suffers from much higher volatility than most funds. This isn’t necessarily a bad thing as many of the great value investors believe in concentration as it allows you to get to know a few companies very well. Greenblatt’s Gotham Capital achieved 40% annualized returns from 1995–2006 while having 6–8 positions make up 80% of the portfolio.

The downside of this is that afew big losers/winners can heavily skew the results. While in the past this benefitted Ackman with big winners such as General Growth Properties (GGP), Wendy’s (WEN) and Canadian Pacific (CP), he’s made his fair share of mistakes over the last few years, the biggest of which being Valeant (VLX) on which he reportedly lost $4.6B and the Herbalife (HLF) short on which he lost $1B. Together, these two companies account for over 80% of the underperformance over the last three years.

He’s stated he has learned from these mistakes and will be going “back to basics” as an activist investor and avoiding the limelight going forward (i.e. no more public shorts and CNBC live-broadcast arguments with Carl Icahn). His current portfolio seems to demonstrate this, consisting largely of solid, cashflow-generating businesses. While the quality of his current portfolio doesn’t pertain to this investment thesis, it is worth noting that PSH is extremely transparent regarding their investments and the research behind them, with much of their analysis being found in annual letters here or individual company reports. PSH’s portfolio is up 8.8% this year versus 0.97% by the S&P500.

Comparables

In the US, the average closed-end fund trades at a 4.5% discount to NAV. In fact, there is only one fund in the US trading at a similar discount to PSH and that’s Foxby (FXBY), a fund with a track record that doesn’t even come close to PSH’s with only about $5M AUM and -5.12% annual returns since inception.

Indeed, the most similar firms can be seen as Carl Icahn’s investment fund IEP and Buffett’s Berkshire Hathaway, both of which have similar long-term track records to Ackman. Indeed, IEP has yielded an annualized rate of return of approximately 7.5% since 2004 (source: page 15 of this presentation) and Berkshire Hathaway 9% return since 2004. In the same time period, PSH provided annualized returns of 13.7% and yet it trades at a 23% discount to NAV while IEP and BRK trade at 30% and 40% premiums to their respective NAV’s.

Catalysts

1. Stock buyback — $300M stock buyback offer has been completed at a strike price of $13.47/share, reflecting a 20.5% discount to NAV. While this had very little effect on the discount to NAV, it decreased free float and is likely to have a positive effect if demand for PSH shares go up following other catalysts. Also, it further increased insider ownership and commitment to improving PSH’s performance.
2. Insider ownership limit removed — PSH shareholders have voted to remove the 4.99% insider ownership limit, thus allowing insiders to purchase more PSH stock and further narrowing the discount to NAV. In the first 2 weeks of May alone, Ackman purchased 10,804,142 public shares at an average price of $14.79/share ($160M total) while Mr Botta (CFO of PSH) purchased 18,648 shares at an average price of $14 ($261,072 total).
3. Personal investments by Ackman — Ackman himself has stated in the latest shareholder letter that he plans to invest significant personal funds (“several hundred million dollars”) into purchasing PSH stock over the next year. There are reports he is selling luxury apartments from his successful real-estate venture in Philadelphia in order to reinvest the money into repurchasing PSH stock.
4. No fees — While closed-end funds normally trade at a small discount to NAV due to fees charged (US closed-end funds trade at an average of ~4.5% discount to NAV), PSH’s management agreement has a “high water mark” features such that investors only pay performance fees on increases in NAV above the highest NAV at a which a performance fee has recently been charged. As a result, investors will not be charged any performance fees until the NAV reaches the “high water mark” value of $26.37 per share. For reference, NAV is currently $18.75 and thus the next ~40% of NAV appreciation will be fee-free.
5. Possibility of liquidation- As a result of the above “high water mark” feature, some analysts have speculated that PSH management may eventually be incentivised to liquidate the fund in order to start a new one where they could immediately earn performance fees. If this is the case, investors would realise an immediate gain equivalent to the discount to NAV (currently 23.5%). It is worth noting that, unlike many hedge funds, PSH’s portfolio doesn’t include any venture investments or other illiquid investments and in fact consists only of highly liquid securities.
6. Improved performance — Performance is improving as PSH is up 19% this quarter and 8.8% this year, compared to the S&P500 which is up 0.37%.
7. Lawsuits settled — Alergan/Valeant insider trading lawsuits have now been settled, eliminating one of the major sources of uncertainty regarding PSH stock price and allowing Ackman to focus solely on delivering alpha.
8. Size of fund — Ackman currently manages around $8B in assets (down from nearly $20B at his peak), making the set of available investment opportunities much larger and potential returns far greater. As Buffett says, “size is the enemy of performance” in investment.
9. Personal factors — Ackman is clearly fiercely competitive and is unsatisfied with recent results. Many factors seem to point to the fact that Ackman is now back focussed and devoting himself fully to PSH. He has divested other investments in order to pour significant personal funds into PSH. He has delegated all marketing and PR duties to Ben Hakim in order to stay in the office focussing on financial analysis. In addition, the insider trading law-suits have now been settled and his divorce proceedings, initiated in 2017, are now concluded as well (the financial ripping he reportedly took here may provide additional motivation to improve PSH’s results). Overall, many factors look to be lined up for Ackman to return to his winning ways and narrow the discount to NAV.

Conclusion

At this point, PSH and more specifically Bill Ackman are effectively distressed assets. The last 3 years of underperformance have put Ackman hate at an all-time high, new negative news pieces are written about him everyday and many in the industry are completely dismissing him as an investor. Indeed, this sentiment is perfectly encapsulated by One WallStreetOasis member who refers to him as Bill “destroyer of capital” Ackman.

As with most distressed assets, the rampant negativity prevents most people from looking deeper and analysing the situation objectively. In this case, I have argued analysis reveals an interesting investment opportunity; paying 77 cents on the dollar to gain access to an investor with one of the stronger long term track records (and who only a few years ago was called “Baby Buffett”) and who also seems to have learned from his recent mistakes as his portfolio is up 8.8% this year. Add to this all the catalysts which should act to close the discount to NAV and I believe Ackman’s fall from grace provides savvy investors with a solid investment possessing a clear margin of safety

From Forbes cover in 2015 to “destroyer of capital” in 2018 — fame is fickle.