Bill Ackman’s Pershing Square H1 2017 letter to investors is out see below for highlights
For the period January 1, 2017 through June 30, 2017, the Company returned -2.3%3 net of fees4. During the first half of the year, a number of holdings made positive contributions to performance, with Restaurant Brands International being by far the most significant. The portfolio’s gains, however, were offset by mark-to-market losses in several holdings, with the Herbalife short, Fannie Mae/Freddie Mac and Mondelez long positions being the largest detractors to performance year-to-date. From July 1, 2017 through August 15, 2017, the Company returned 0.5% net of fees, bringing YTD performance through August 15, 2017 to -1.7%.
For an up-to-date NAV, please refer to our website at www.pershingsquareholdings.com where we publish our NAV on a weekly basis.
NEW INVESTMENT
On August 4, 2017, Pershing Square Capital Management, L.P. (the “Investment Manager,” or “PSCM” or “ Pershing Square”), issued a press release announcing a new investment in ADP. The company fits the long-term profile of historically successful Pershing Square activist investments as it is a simple, predictable, free-cash-flow-generative business with a long-term history of growing cash flows and a dominant market position.
SHARE BUYBACK PROGRAM
On April 19, 2017, PSH announced a share buyback program of up to 5% of PSH’s outstanding Public Shares. Jefferies International Limited, the buyback agent, commenced the program on May 2, 2017. PSH believes that the repurchase is an attractive investment at current discount levels which should contribute to performance, and may assist in reducing the current discount between PSH’s share price and NAV.
As of August 15, 2017, a total of 1,775,793 shares have been repurchased under this program representing 14.8% of the total buyback authorization.
HIGH WATER MARK
As reported in the 2016 Annual Report, the terms of PSH’s investment management agreement with PSCM have a “high water mark” feature such that investors in PSH only pay performance fees on increases in the NAV above the highest NAV at which a performance fee has previously been charged. As a result, PSH investors will not incur performance fees until PSH’s NAV exceeds $26.37 per share
Despite modestly negative performance of the Company year-to-date, our portfolio companies have made substantial business progress which we discuss further below. Over the intermediate to long-term in the stock market, business performance has been inexorably reflected in share price performance.
Fannie Mae (FNMA) / Freddie Mac (FMCC)
Fannie and Freddie have cost us substantial performance this year as their large share price gains after the November U.S. Presidential election have nearly completely retraced. Both stocks have fallen by approximately 30% year-to-date. They are trading modestly above our average purchase prices of nearly four years ago despite substantial increases in intrinsic value since that time (albeit these increases have been offset by a nearly 100% sweep of the profits of both companies by the U.S. government), and the growing potential for a resolution of their status.
Over the last nine years since the financial crisis, the Congressional dialogue around Fannie and Freddie has changed dramatically, and in a manner which we believe is favorable for shareholders. We believe the consensus view in Congress and the White House is that the 30-year prepayable fixed rate mortgage, which is the bedrock of middle-class housing values and affordability, is essential for the economy and the American people, and would not exist without Fannie and Freddie. In addition, there is a growing consensus that the U.S. government must play a role as a catastrophic guarantor for the housing financing system, and that the private sector should pay a market-based fee for that support. As importantly, the government would like the private sector to invest a large amount of capital in a first loss position to protect the government’s guarantee from ever being called upon.
We believe that there is a growing consensus that the simplest and lowest risk solution to address each of these key considerations is the reform and restructuring of Fannie and Freddie supported by a large capital raise from the private sector and the retained earnings of the two companies. In order for this capital to be raised, the investment proposition for new investors has to be appealing. No new investor will invest in Fannie and Freddie unless historic investors are protected from, and compensated for, the expropriation of profits from the two companies that took place with the cash-flow sweep transaction that has swept more than $270 billion of profits from Fannie and Freddie since the crisis.
Wall Street’s memory of injecting tens of billions of dollars into Fannie and Freddie just prior to their conservatorship, and the expropriation of both companies’ profits forever, just as they began to turn profitable, is still fresh. Completing the largest capital raise in history in a newly restructured Fannie and Freddie will not be achievable unless and until investors in the companies are treated fairly and receive commitments that the extra-legal action of the past will be reversed and not reoccur. We believe this is understood in Washington.
We are fortunate that two of the most financially sophisticated Senators in Washington, Senators Corker and Warner, have taken the lead on housing finance reform and have suggested that they will put forth new legislation shortly to address this last remaining restructuring of the financial crisis. We believe that this initiative combined with support from the Treasury Secretary has dramatically increased the chances of a favorable resolution for the country and for investors in Fannie and Freddie, including the government, which is not reflected in their current share prices.
Since the government and taxpayers own 79.9% of the common stocks of both companies, the interests of shareholders and the government are largely aligned. Fannie and Freddie offer one of the few potential opportunities for political compromise in the current political environment as a resolution could generate tens of billions of dollars for taxpayers and reduce the risk of future government outlays. For all of the above reasons, we believe that there is likely to be significant positive developments at both companies in the short term which are not reflected in their share prices.
Herbalife Ltd. (HLF) Short
On Monday, August 14, 2017, Chinese media outlets reported that the Chinese government has launched an investigation and crackdown on multi-level marketing and pyramid selling companies. HLF’s stock declined 5.25% on the day’s news. As we previously noted in our first quarter letter, Herbalife updated its risk-factor disclosures in its first quarter 10Q, adding new language about regulatory risk in China. China is approximately 20% of Herbalife’s revenues. A substantial decline or shutdown of HLF’s China business would have a material adverse effect on the company.
With the implementation of the FTC mandated injunctive relief in late May, the second quarter provided the first opportunity for investors to witness its partial effects on Herbalife’s financial performance. While the changes to its U.S. business practices were only in place for a fraction of the second quarter, Q2 results were disappointing to HLF investors and analysts from a top line perspective as volume declined 8% year-over-year. Year-over-year constant currency sales declines in North America (-18%), South & Central America (-9%), Mexico (-1%) and Asia Pacific (-1%) were partially offset by growth in EMEA (+4%) and China (+5%). Note that China benefited in the quarter from the recognition of certain revenue for product which was shipped in Q1 (ahead of a price increase) but was in transit at quarter end; for context, China volume declined 14% year-over-year, a more accurate measure of current trending. We expect the U.S. business to continue to suffer as distributors attempt to comply with the new restrictive elements of the FTC consent order, with the full impact more evident in Q3 and thereafter. The company materially reduced Q3 implied and full year top-line guidance as the business begins to adapt to the significant changes required in its largest market (the U.S.). Other regions of the world remain weak including major markets such as China, South Korea, Brazil, and Mexico. We expect sequential operational deterioration to continue and to weigh further on Herbalife’s share price.
During the second quarter, HLF stock increased significantly after the company announced a large share buyback despite a reduction in guidance and substantial insider selling. While Herbalife’s share price has declined approximately 16% from its June high, it has still appreciated approximately 30% year-to-date. We believe this result is largely due to technical factors and financial engineering, as significant share repurchases, more than 5% of shares outstanding since February, cost deferrals and one-time tax benefits have enabled the company to meet and increase EPS targets despite deteriorating underlying business performance.
HLF continues to trade at a high valuation multiple particularly when compared to its actual GAAP earnings. Remarkably, investors appear to have accepted the company’s Non-GAAP EPS metric which excludes interest expense on its $1.15 billion substantially out-of-the-money convertible note that is due in 2019. Adding back interest expense to earnings as if it were not an expense is perhaps the most aggressive example we have seen of Non-GAAP earnings addbacks. Herbalife also adds back expenses “related to regulatory inquiries,” expenses “related to the FTC settlement implementation,” and “expenses related to challenges to the company’s business model.”
We expect continued business deterioration and ongoing regulatory and public relations issues for the company, which should lead to further stock price declines. This is likely to be compounded by Herbalife’s aggressive buyback program.'
