November 22, 2011

Dear Pershing Square Investor:

The Pershing Square funds’ performance trailed the major market indexes for the third quarter of 2011 and year to date, but have continued to outperform the market since inception as set forth below:

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In last quarter’s letter, I explained that recent market volatility had created the opportunity for us to increase our exposure to existing and new investments at attractive prices. As of the August 17th letter, we had invested $600 million in these existing and new investments. Since then we have invested an additional $1.6 billion of capital in existing and new commitments including a large stake in Canadian Pacific Railway Ltd., which we discuss below.

Stock price appreciation since the time of these investments has contributed to a recovery in the market value of the funds by approximately 11% since the end of the quarter. As the largest investor in the funds on an absolute and percentage-of-net-worth basis, I “feel” these changes in market value more than most. This volatility does not concern me,


Past performance is not necessarily indicative of future results. Please see the additional disclaimers and notes to performance results at the end of this letter.


however, for we focus our attention on the value and business progress of the companies we own rather than their daily market quotations. Because we manage an unleveraged, and often negatively leveraged portfolio, we have the luxury of largely ignoring short- term market movements in our holdings. Investors who operate with margin leverage must, in contrast, be highly sensitive to short-term, market price movements.

Based on fundamental business measures, our holdings have made significant progress since the beginning of the year, while the funds’ year-to-date performance remains negative. As a result, the gap between the intrinsic value of our holdings and their quoted prices has widened significantly, thereby reducing risk and increasing the potential for profits in the portfolio. To take advantage of this opportunity, we have increased our invested exposure. As of this date, we are approximately 98% invested (less if one excludes the approximate 5% of capital in the Justice Holdings Ltd. cash shell).

Since inception, our average cash position has been approximately 20% of capital, although our cash balance has varied significantly. Our invested exposure does not reflect our expectations of short-term movements in the overall market, but rather is a function of the relative opportunity set in the current portfolio and the timing of new investments and realizations.

Our greater long equity exposure means that we are likely to have greater daily correlation with short-term moves in the market than if we had less exposure. Over longer periods, we expect our portfolio to continue its high degree of divergence from overall stock market performance because of the high degree of concentration in our holdings and the event-driven nature of most of our investments.

Many investors have dramatically reduced their equity exposures because of a belief that the world is more uncertain now with continued struggles in the Eurozone and a political stalemate in the United States. Putting aside whether the current amount of macro uncertainty is greater or less than that of other periods in recent and long-term investment history, we have not adopted this approach because it is inconsistent with our investment strategy.

While a more positive macro environment will increase the value of our holdings, we expect to generate high long-term rates of return from our existing holdings even without a substantial improvement in the economy. I have come to think of our investment approach as akin to a form of long-term arbitrage, where we invest and then work with our portfolio companies to cause the spread between our purchase price and intrinsic value to narrow. In some cases, in addition to unlocking existing value, we can assist a company in increasing its long-term intrinsic value by bringing in new management, adopting a change in strategy, modifying its structure and approach to allocating capital, by selling or spinning off non-core assets, through cost control and with other approaches.

Our ability to cause the price-value spread to narrow is, in most cases, unrelated to macro events, and has improved significantly over the last eight years. It is largely a function of Pershing Square’s growing influence in the capital markets, our experience with previous investments, and specific circumstances with each of our holdings.

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Portfolio Update

JCPenney (JCP) JCPenney is now our largest investment. In August, we negotiated a partial waiver of the company’s poison pill, allowing us to increase our economic exposure by an additional 7.5% of the company at a price of $26, slightly above our initial average cost, and well below the stock’s recent high of approximately $41 in May of this year. We now own a 26.1% economic stake in the company, representing approximately 18% of our capital. The size of the position reflects our confidence in the future prospects of this investment, the margin of safety offered by the current valuation and the company’s robust balance sheet and cash flow generation.

While we viewed our initial stake in the company last year as an opportunistic purchase, the ability for us to add to our position at a similar price per share one year later became even more compelling with the new senior management team in place.

A number of you have questioned whether our investment in JCP and our strategy for unlocking value should be compared with Sears. While many shopping malls contain both a JCP and Sears store and they are both department stores, the analogies largely stop there. Sears strategy over the last seven years appears tantamount to that of a liquidation. The company has starved the store base from needed investments and used the resulting cash flows for share buybacks at prices considerably above current market levels. Sears has had enormous turnover in the executive suite with the company’s recent CEO coming from the telecommunication industry with no retail industry expertise.

By comparison, our approach to effectuating change at JCP has principally been to identify and recruit the best retail CEO in the industry to run the company. While asset monetization and capital allocation may make a minor contribution to our investment in JCP, they are largely a sideshow to the fundamental transformation in the business that we expect will occur under an extremely talented and experienced new senior management team.

While the logic for our approach to overseeing this investment is self-evident in our view, the ancillary benefits are also important. Namely, while it required time and energy to identify and recruit the right executive to run the company, now that he is in place, the amount of Pershing Square time and energy required going forward is greatly diminished, freeing up time for our core responsibilities–the identification and management of other investments.

I have had the opportunity to spend time with Ron Johnson over the last nine months as he finished his career at Apple and began planning for his leadership role at JCP. Based on this experience and my assessment of his talents, creativity, and relevant expertise, I expect to look back on the decision by the company to hire Ron, and our role in identifying and

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