Bill Ackman’s Pershing Square 2016 Letter to investor is out. Below are highlights and full letter at the bottom.
Photo by NCinDC
The Board has delegated the task of managing the Company’s assets to the Investment Manager, as set out in the Investment Management Agreement (the “IMA”) entered into by PSH and PSCM at inception of PSH. However, as described in the Corporate Governance Report on page 23, although the Board does not approve individual investment decisions, the Board is still accountable for the performance of the Investment Manager and the system of internal controls used to manage the risks to which the Company is exposed. The Board undertook a formal review of the Investment Manager’s performance in 2016, along with a review of the Investment Manager’s investment processes, particularly in connection with the investment in Valeant. The lessons learned from the investment have been discussed at length in prior communications with PSH shareholders and a further update is given in the Investment Manager’s Letter to Shareholders in this report. The Board appreciates the openness of the Investment Manager in analyzing the reasons for the Valeant losses, and welcomes the impact which the lessons learned will have on future investment decisions. The Board is satisfied that it is in the best interests of PSH for the Investment Manager to continue to manage our portfolio and create value for our shareholders. News about the Investment Manager has been dominated by events at Valeant. I would also like to draw your attention to progress made by the Investment Manager in other areas. In the June 30, 2016 Interim Financial Report, I commented that the Investment Manager might make one or more new investments. During the second half of the year, PSCM exited two successful but mature investment positions and freed up capital for two new investments. Also, PSCM implemented a long-term compensation arrangement for eligible Pershing Square employees. After a period of negative investment performance, it is important that the Investment Manager’s employees are committed to creating long-term value for the shareholders of PSH.
High water mark
INVESTMENT MANAGEMENT FEES/HIGH WATER MARK
The Board is aware that there has been much discussion in the media and elsewhere about the level of fees paid to investment managers. For many years the industry standard has been a 2% asset-based management fee and a 20% performance fee paid on annual profits. The terms of our IMA with PSCM (a 1.5% management fee and a 16% performance fee) are substantially below this level, and include a variable performance fee (the “Variable Performance Fee”) provision that is unique in the industry. The Variable Performance Fee has the potential to further reduce the 16% PSH performance fee by an amount equivalent to 20% of the performance allocation/fees generated by PSCM and its affiliates from its affiliated fundsiii.
In 2016, the Investment Manager offered a new fee structure to its private fund investors that will increase the level of total fees paid in years in which the gross return exceeds 16.5% and decrease the level of total fees paid in years when the gross return is less than 16.5%. PSCM has generated an annualized gross return of 20.6% since the inception of its fund with the longest track record. Over the long run the Investment Manager believes that it will earn higher performance fees from this share class, and this in turn will benefit PSH shareholders by reducing the 16% PSH performance fee.
The terms of PSH’s IMA with PSCM also have a “high water mark” feature such that investors in PSH only pay performance fees on increases in NAV above the highest NAV at which a performance fee has previously been charged. As a result, PSH investors will not incur any performance fees until PSH’s NAV exceeds the high water mark of $26.37 per share.
Despite negative performance for the year, 2016 was an important year of progress for Pershing Square. Our progress is reflected in the 16.3% increase in NAV from the bottom on March 31, 2016 through the end of 2016 despite a further 390 basis point headwind from our investment in Valeant. More importantly, with the benefit of the perspective which comes from looking in the rear view mirror, we have had the opportunity to understand and learn from our mistakes, to reaffirm the core principles that have driven our substantially above-market returns since inception, and to make a number of important human resource and process changes to the organization that should serve us well going forward.
Viewed in its entirety, our 13-year performance since the inception of our strategy (as represented by Pershing Square, L.P., our fund with the longest-term record) has been strong, despite the recent period, as we have generated a compound annual return of 14.8% compared to the S&P returns of 7.7% for a cumulative total return of 503.1% vs 163.4% as depicted in the chart on page 8 of this report. While our long-term record has been strong, this is not helpful to investors who have joined us more recently due to the large loss we incurred in Valeant over the last 20 months.
While Valeant was initially a passive investment, after the stock price collapsed, in March 2016, our Vice Chairman, Steve Fraidin, and I joined the board. Over the past year, the company has replaced senior management with new executives, recruited 10 new directors, refinanced and renegotiated covenants on the company’s debts, initiated a non-core asset sale program which has resulted in asset sales at value- and credit-accretive prices, provided improved investor transparency, increased R&D investment, and achieved major new product approvals. Normally, one would have expected this progress to be reflected in an increase in share price, but that has not yet materialized.
We have grown to admire Joe Papa and the new, extremely hard-working, Valeant management team. We have enormous respect for the other very talented members of the Valeant organization who have stayed at the company through this challenging time. Valeant would not exist without the commitment of these individuals. The new board, which includes a few members of the original board, is doing an excellent job overseeing the company and navigating a difficult situation.
With a new senior management team, new board, and the company’s recently executed debt transactions, we believe that Valeant has been stabilized and now has sufficient resources to enable it to recover to its full potential. In addition, we continue to believe that the company owns high quality non-core assets which can be sold at prices which will enable the company to reduce debt on an economic and credit-accretive basis. We wish Joe, the new board, and the entire Valeant team great success in the future.
We recently sold Valeant at a price that may end up looking cheap. Why?
At the time of sale, Valeant represented about 3% of the Company. If the stock price had increased even very substantially from here, the impact on our overall performance would have been modest, and would not compensate us