Pershing Square Holdings (PSH) is a closed-end investment fund run by Bill Ackman.
The fund recently released its annual report and it’s extremely interesting to dig into it to discuss whether Ackman is doing well or poorly, if it’s a good time to invest in the fund now, to look at a few of his positions, and to elaborate on the everlasting debate between active and passive investment strategies.
The Fund’s Performance
PSH’s return in 2017 was a negative 4% which is extremely bad when comparing it to the 21% the S&P 500 delivered. Since inception, the fund is up a cumulative 1.5% while the S&P 500 is up 108%.
Now, you would think that passively managed funds are much better than actively managed funds. Well, Bill Ackman isn’t famous for nothing. His long-term performance is still much better than the S&P 500. His performance since starting to manage assets is 13.4% while the S&P 500 delivered 8.7% per year in the same time frame.
Apart from just investing, Ackman is an activist investor who likes to influence the management of the companies the fund owns. Sometimes this works out well, sometimes it doesn’t.
The reasons for the 2017 underperformance according to Ackman are the obvious Herbalife failed short, the Valeant disaster, and the Allergan settlement. Further, he discussed how they didn’t build large enough positions in the stocks they owned that did go up while they had significant positions in the stocks that went down.
According to Ackman, the reasons to invest in his fund now are the following:
I recently quoted Benjamin Graham on the long term perspective vs the short term perspective and by looking at PSH’s stock price, it’s clear that everyone has written Ackman off but are we going to judge him and make decisions by his 4 year performance or 15 year performance? Similarly, are you going to judge yourself by last year’s performance or your 15 year performance?
Let’s dig into PSH’s positions to see how are they positioned:
Automatic Data Processing, Inc. (NASDAQ: ADP)
The current PE ratio is 29, but Ackman believes that the company will be able to grow at 7%, increase operating margins from the current 19% to 35%, increase net profit margins by 500 basis points which should lead to EPS of $20 by fiscal year 2022.
EPS of $10 would definitively revalue a company trading at $112 now.
Restaurant Brands International Inc. (NYSE: QSR)
Ackman believes there is much more scalability in QSR’s business coming from acquisitions and organic growth. The PE is 22 and the price to free cash flow is 21 where Ackman sees it as undervalued as peers trade at 24.
My commentary here is that the company should really be a great business to be a good investment over the long term no matter what happens in the market. The question is: Can Ackman pick out great businesses? Let’s look further.
Mondelez International (NASDAQ: MDLZ)
Mondelez trades at 18 times consensus 2018 earnings and Ackman says: “We expect continued acceleration in revenue growth, double-digit EPS growth, and clarity on Mr. Van de Put’s strategy will cause MDLZ’s valuation to rise to levels approaching intrinsic value.”
The Howard Hughes Corporation (NYSE: HHC)
HHC is the longest standing holding for PSH. It was the 2017 Sohn Conference idea for Ackman and you can check a detailed investment case on the company on PSH’s website.
Chipotle Mexican Grill, Inc. (NYSE: CMG)
Ackman believes CMG represents a compelling turnaround opportunity. If I had a dime for every time I heard someone say that I would be rich. Nevertheless, let’s see what Ackman has to say about it. Ackman helped the company hire Brian Niccol, the former CEO of YUM’s Taco Bell division, and believes he will reinvigorate the company and make it exploit its potential.
Here the bet lies on housing reform where Ackman believes the prices will be multiples of what they are now if everything goes through. This investment is a bet and bets are usually asymmetrically priced. There is potential for zero and there is potential for a much, much higher value. The stock price is also very volatile.
Platform Specialty Products Corporation (NYSE: PAH)
Ackman states that the fair value for PAH is $19 because the company “generated 7% organic EBITDA growth driven by 4% organic revenue growth and cost savings. The company also refinanced ~$4 billion of debt, significantly lowering interest expense. In August 2017, PAH announced that it intends to separate its Ag and Performance Solutions businesses into two publicly traded companies by the second half of this year in order to increase long-term value.”
A spin-off is a potential value unlocking catalyst, so we’ll see how that works out.
Nike Inc. (NYSE: NKE)
Ackman describes NKE as a “high quality business that we expect can compound long-term earnings at a high rate due to strong revenue growth and margin expansion.” I must agree with him on that, so the only question with such a stock is the price.
And that’s exactly why PSH closed its position in NKE recently. So great business, yes, but always compare the price to other investments and the market might see no threats to NKE now, but remember that it saw huge threats just 6 months ago when it was trading at a big discount to the market.
Herbalife Ltd. (NYSE: HLF) – Short
Ackman was short HLF for 5 years and had to exit his position as the float got smaller and the buyback program really made it difficult to remain short. He also says that he was correct on the fundamental call but underestimated HLF’s “ability to access debt capital and use financial engineering which – coupled with Mr. Icahn’s share purchases to materially reduce the company’s free float – has driven share price appreciation.”
Ackman still believes HLF is an attractive short.
Ackman exited S&P 500 which he sees as another great business, but he was unable to establish a full position due to the stock price appreciation.
PSH also exited its investments in Air Products, Hilton, Nomad Foods, an additional undisclosed position, and Valeant during the year.
The one thing that Ackman can’t really do is to do nothing if the risk reward isn’t really attractive. He can’t stay in cash with a fee structure as shows in the following figure:
No one can stay in cash with a 3% management fee because why would you pay somebody 3% to do nothing? This is why Buffett had, and still has, a completely different structure when he was actively managing other people’s money. If Buffett lost your money, he would take a hit with you as he would cover part of the losses with his own money. Try finding such an investment manager now.
As for the debate on active and passive management, I still think active will always be better because it allows you to manage your risks according to your financial needs and goals. Perhaps Bill Ackman active isn’t the way to go even if he may outperform the market. Perhaps the returns won’t be that positive over the next few years as they were in the first years, but you never know.