MI368: Bill Ackman: The Highs and Lows w/ Shawn O'Malley

25:08By January 2009, Ackman had built up a 7.4 % stake in General Growth Partners, which was the second largest US shopping mall owner, and that stake would eventually grow to over 25%. This may sound funny, but ahead of buying its stock, he actually expected the company to go into bankruptcy. His bet, though, was that General Growth could eventually emerge from bankruptcy while keeping its shareholder base intact. In pushing for the firm to file for bankruptcy protections, he actually saved it from a more damaging collapse. In 2011, Ackman told Bloomberg that the effort, quote, turned$60 million into$1.6 billion after he bought up stock for as cheap as$0.35 per share.

25:47With Ackman's help, General Growth filed the largest real estate bankruptcy in US history after amassing$27 billion in debt during the Great Financial Crisis. As part of its exit from bankruptcy, General Growth spun off 30 retail properties and the Howard Hughes Corporation, which owns a number of master-planned communities. In a Reuters article from the time, Ackman explains that even if general growth emerged from bankruptcy with a 9.4 % cap rate, he would get back 13 times his original investment. He says, quote, this is not your typical bankruptcy. That was because the cap rate, which is a real estate term that divides a property's operating profits by its market value, ultimately underpins the value of general gross assets.

26:30And he felt the cap rates being used to estimate general gross property values were far too low. In other words, Ackman assumed that general gross real estate properties were more resilient than most people believed, meaning they could continue to earn solid operating returns even in a recession. So the cap rate was the biggest question in the debate about general growth. Because the company had such high leverage, even small variations in implied cap rate yielded large differences in its equity value. However, Ackman continued to believe that general growth was well-managed given that it had the second highest occupancy rate among US mall operators, positioning it to generate more cash than it needed to operate.

27:07Its problem was in fulfilling its debt payments during the 2008 crisis, which sent its stock valuation from a peak of$20 billion in April 2007 to as low as$100 million. Yet this was more of a temporary liquidity issue than a structural problem with general gross assets. Ackerman explained that if they could extend their debt for seven years, there'd be no need for a fire sale. He adds, quote, you can make a lot of money investing in a company even if it files for bankruptcy, as long as the assets are worth more than the liabilities. Just to recap things so far, General Growth was a mall-based real estate investment trust struggling to refinance its debts and secure enough cash on hand, yet its assets were quite high quality despite many panicking and writing them off during the great financial crisis.

27:53Ackman recognized this and bought into the company, hoping that it would go into bankruptcy where it could work out a deal with creditors and sort through the true value of its assets, which he thought exceeded the value of general gross liabilities. That would leave plenty of meat on the bone for equity investors, but the market couldn't see it at the time. General growth was not one of these horror stories of extreme risk-taking that were so common in 2008, especially in real estate. Instead, it was more like a victim because debt markets were so frozen that it became unjustifiably difficult for a company of its quality to refinance debts that were coming due.

28:27It's an example of the sometimes destructively circular logic in markets where a panic generally spurs a sell-off in a stock, which drives more people to panic and sell because they think others know something they don't. This continues until the stock hits rock bottom, at which point the implied value of the company's assets becomes so low that creditors won't lend it any money, causing an actual crisis. Fast forward a few years to 2014, and Ackman had cashed out his stake in general growth for$556 million and sold his shares back directly to the company. After General Growth regained its footing from its stint in bankruptcy court, Ackman had lobbied for the firm to put itself up for sale.

29:06While he hoped to get even more out of his investment by orchestrating a sale of General Growth to Simon Property Group that never eventually happened, Ackman still walked away with a more than nine times gain on his original capital. Let's take a quick break and hear from today's sponsors. Hey, it's Sean O'Malley, just popping in with a quick message. If you like this podcast, well, I've got great news for you. We've got a handful of other shows for you to explore, from learning about Bitcoin to embracing a richer, wiser, happier lifestyle. Just go into your podcast app and type in We Study Billionaires to find our collection of shows.

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32:43All right, back to the show. This brings us to the next major episode in Ackman's career running Pershing Square, Herbalife. I touched on it briefly earlier, but this one did not have the happy ending like some of his other big bets. That doesn't entirely mean he was wrong, though. In an interview with Bloomberg in February of this year, Ackman continued to hold his conviction that Herbalife is a fraudulent company. While he closed out his short bet in 2018, he joked that he still has a psychological short on Herbalife, which has been validated by the stock's nearly 25 % drop this year. In 2012, he opened a billion dollar bet against Herbalife, claiming that the supplement company was an illegal pyramid scheme and kickstarting a more than five-year battle with it.

33:26Bloomberg's Scott DeVoe calls it one of the longest and most colorful battles in Wall Street history after Ackman's nemesis at the time, Carl Icahn, took the other side of the trade, becoming Herbalife's biggest shareholder. Ackman's arguments centered on Herbalife legally relying on an army of outside distributors to recruit members with the promise of get-rich-quick schemes. While pouring millions of dollars into investigating the company, he at one point delivered a nearly four-hour anti-Herbalife presentation that backfired on him and sent Herbalife stock up 25 % that same day. He summed up the debacle with two simple words, my bad.

34:02And reflecting on the presentation, Ackman concluded that the event was too long and overhyped, especially since many were expecting an Enron level of corporate fraud to be revealed. He adds, quote, it was a PR failure. I think we raised expectations, people were looking for the dead body and the smoking gun, and instead, what they got was a three-hour detailed regulatory presentation. While Ackman was forced out of betting against Herbalife, Icahn reportedly made over$1 billion by going long its stock, according to CNBC in 2018. Whether Bill Ackman lost the struggle with Icahn is somewhat subjective.

34:37On the one hand, shorting a stock is just really hard. It is the opposite of regular stock investing. Instead of having unlimited upside with your losses capped at zero, like with regular stock investing, when you short a stock, you can at best double the money if the company's equity value is wiped out, while you can rack up unlimited losses if the price surges. That's because short sellers borrow shares of stock and turn around and immediately sell them, holding the proceeds as cash. They then wait for the stock to drop to their target price, where they hope to buy back the shares and return them while pocketing the difference between what they originally sold them for and how much they bought them back for.

35:13So you may generally be right that a company's business is deeply flawed or fraudulent, but if something sends a stock shooting up, you might experience intolerable losses along the way. And since you're technically using borrowed money when short selling, if your position goes underwater, you have to add more and more cash to backstop it. Otherwise, your broker will automatically close out the trade and force you to realize a loss. And that is arguably what Icon was trying to do to Ackman. He wanted to squeeze him out of his big short position, forcing him to buyback shares and push the stock higher as he tried to close out his short bet.

35:47Ackman had made public just how big his bet was, and Icahn saw a chance to make him pay by piling money into Herbalife's shares and speaking publicly in favor of the company with the hope that that would cause a short squeeze forcing Ackman out of the trade. Like I said, short selling is just harder and more complicated than regular stock investing, especially when you have two hedge fund titans vying for influence against each other. Ackman, of course, understands the challenges and limitations of making profitable short trades, but my point is that the investment obviously didn't work out, though you may or may not agree for yourself with whether his critique generally of Herbalife is fair.

36:23On top of that, the episode inspired a book and movie called Betting on Zero that brought enormous media attention to Pershing Square. That has actually been good for business. As Ackman's public persona has grown, so has his ability to raise funds, increasing the assets under management that he can earn fees on. And Ackman's wishes for regulators to examine Herbalife did come true. In 2016, the Federal Trade Commission sued Herbalife following a two-year investigation into its business practices and complaints that the company deceived customers about how much they could make selling its products.

36:56As a result, Herbalife settled with the FTC and agreed to pay a$200 million fine to compensate consumers and restructure its business. The FTC's chairwoman at the time said, quote, Herbalife is going to have to start operating legitimately, making only truthful claims about how much money its members are likely to make, and it will have to compensate consumers for the losses they have suffered as a result of what we charge are unfair and deceptive practices. Yet regulators stopped short of calling the company a pyramid scheme. Herbalife's CEO responded by saying, quote, the settlements are an acknowledgement that our business model is sound and we underscore our confidence and our ability to move forward successfully.

37:36Otherwise, we would not have agreed to the terms. So just to recap the Herbalife episode, Ackman, of course, lost big on it and Icon won hugely. But at the same time, there does seem to be some legitimate claims that the FTC found that Herbalife was not a completely honest business either. So in terms of highlighting the issues with Herbalife, Ackman succeeded, but in terms of actually making an investment gain from that insight, he did not. And that leads us to Ackman's next very public miss, Valiant Pharmaceuticals. In 2017, a year before he would call it quits on Herbalife, Ackman was calling it quits on Valiant.

38:13He sold his shares in the company and did not stand for re-election as a director, while Pershing Square lost something like$4 billion over two years on the investment. As Ackman framed it at the time, quote, the investment required a disproportionately large amount of time and resources. As a result, we elected to sell our investment and realize the large tax loss, which will enable us to dedicate more time to our other portfolio companies and new investment opportunities. Once his biggest position, shares of Valiant fell 96 % from their 2015 highs by spring 2017, a truly epic loss and one that Ackman by his own words called a very big mistake.

38:51The bet was so big and so bad that it drove two years of negative returns at Pershing Square's main hedge fund, while Ackman's assets under management were nearly cut in half. As Forbes frames it, Ackman never made money on Valiant, but he did initially make a lot of money because of it. He first partnered with Valiant's CEO, Michael Pearson, on Valiant's effort to buy another big drug maker, Allergen. Pershing Square took a big stake in Allergen, not Valiant, and championed the deal even as it went hostile and Allergen fought to kill it. Ultimately, Allergen was successful, but to stop Valiant, Allergen had to take a deal to be swallowed by drug company activists.

39:28Since Ackman owned shares in Allergen, his fund benefited greatly from the deal, fueling Pershing Square's best year ever and returns of more than 36 % in its main fund in 2014. From there, Ackman turned his sights directly onto Pearson's company Valiant and quickly became one of its biggest shareholders. Unfortunately for him, the timing really just could not have been worse. Within months of his investment, Valiant came under scrutiny for boosting drug prices and for questionable accounting practices. Pearson was pushed out as CEO, and the company struggled under piles of debt while federal prosecutors started their investigations.

40:03Ackman cited a few lessons that he shared with his own investors in 2017. His listed four takeaways from the investment were that managerial competence in deploying capital doesn't always translate to value added for a business, that changes in regulations, politics, or other external factors can't be accounted for and can dent value, that even a strong management team can make mistakes, and that a big price decline in a stock can destroy substantial amounts of intrinsic value, including morale, retention, and recruitment. As the New York Times puts it in a 2017 article, Ackman staked his own reputation on Valiant even as the company faced steep challenges and regulatory scrutiny for its aggressive pricing tactics.

40:44He went to bat for Valiant when its executives were questioned during a Senate hearing, and he loaded up on the stock when everyone else was selling. At one point in 2015, Ackman compared Valiant to a, quote, very early stage Berkshire. This really couldn't have been more wrong. Meanwhile, in 2015, others were seeing the problems in Valiant that Ackman missed. Andrew Ross Sorkin wrote at the time, quote, how can Mr. Ackman find comfort in Valiant's management, which has expanded its business by buying rival companies, slashing their research and development arms, and then raising drug prices, while at the same time calling Herbalife's chief executive a predator running a criminal enterprise.

41:20Charlie Munger would chime in too, calling Valiant deeply immoral. As just one example of the company's problems, two of its former executives were arrested for running a fraud and kickback scheme that cheated Valiant out of millions of dollars. The two helped Valiant set up a company called Philidor primarily to market and distribute Valiant's drugs in 2013. And a year later, they orchestrated Valiant's agreement to buy an option to purchase Philidor, which cost at least$133 million, while more than$40 million of that went to a shell company controlled by the two executives, where they used that money to buy stocks and luxury goods, including a$50 ,000 custom wine cellar.

41:57Its former CEO, Michael Pearson, and ex-financial officer Howard Schiller would face their own fraud charges, while Congress accused Valiant of price-gouging patients for the 30-year-old drug, Cyprien, which suddenly saw a 3 ,000 % price increase after being acquired by Valiant in 2010. In July 2018, Valiant changed its name to Bausch Health and agreed to pay a$45 million penalty to settle SEC charges of improper revenue recognition and misleading disclosures. Its stock peaked at$257 per share in July 2015, and today trades at around just$7 per share. For Ackman, Andrew Ross Sorkin again captures things well with respect to Valiant and his approach to investing generally.

42:40He says, Mr. Ackman is no charlatan. He genuinely believes what he says, but he also seems to be able to compartmentalize his views and rationalize his investment philosophy in contradictory ways. His declaration that he will never own Coca-Cola because its products are unhealthy is tough to square with his ownership position in Burger King. Wall Street is fascinated by Mr. Ackman because he makes big, bold bets and is never shy about talking about them. He is seemingly interested only in home runs, which means he's also likely to strike out with some frequency. Andrew Left, who runs the short-selling firm Citroen Research, also had criticisms of Ackman during this period to share.

43:18Referencing Ackman's crusade against Herbalife, he says, If Mr. Ackman feels so much moral indignation about a company selling health shakes to people and takes such umbrage at their sales channel that he launches a full-on jihad against them. How can he stand by while a company charges$300 ,000 a year to cure Wilson's disease? So if you didn't believe me before when I suggested that Ackman's career has been one long controversial rollercoaster ride, perhaps you now see why. From the collapse of Gotham Partners and investigations and market manipulation to spotting the looming blowup at MBIA before anyone else, driving Wendy's to spin off Tim Hortons, and being on the right side of one of the best bankruptcy trades ever with general growth partners, to then the overlapping embarrassments surrounding Herbalife and Valiant, it's just been a series of highs and lows for Ackman.

44:07And there are a handful of other stories that I don't even have time to touch on today that highlight both the punishing mistakes and strokes of genius that he's made over his career. These very public dramas have turned Ackman into a huge celebrity today, arguably the embodiment of Wall Street to millions of people around the world. Ackman's successes are truly inspiring, while his losses are just deeply, deeply humbling, such as the cost of making big bets in the public eye. I want to wrap up today's episode by talking about where Ackman is today. I talked about him recently in my episode on Universal Music Group, since he pitched the stock back in 2021 as a target for his SPAC, and it still remains one of his largest holdings overall.

44:50SPAC is an acronym for special purpose acquisition companies, and you may recall how their popularity surged during the pandemic. These are essentially shell companies that IPO on an exchange with just cash as their only assets with the plan to acquire a private company or return funds to shareholders if they can't find an attractive target. In some sense, it's a way for private companies to bypass some of the headaches of the traditional IPO process by instead merging with a shell company that has shares already trading. It's also a way to negotiate a set sale price to raise funds with, whereas the amount of capital companies will raise in IPOs can be uncertain.

45:26Ackman's SPAC raised$4 billion in 2020 and inked a deal with Universal Music Group at one point, only to abandon the deal after the SEC questioned its unconventional structure, which spurred shareholder lawsuits. Shortly thereafter, the SPAC was dissolved and capital was returned to investors. But Ackman has more recently revisited the idea and added his own wrinkle on this trend with an investment vehicle named Pershing Square Spark Holdings, where Spark stands for Special Purpose Acquisition Rights Company. The primary difference between his Spark and a SPAC is that it doesn't require money up front.

46:00SPACs raise capital by generally outlining the characteristics of the type of company they want to acquire without naming a specific target, and SPAC investors have the chance to vote down a potential acquisition. With Ackman's Spark, money is only raised once it has disclosed a deal to buy a company. And while SPACs usually have two or three years to find an acquisition target, Spark has up until 10 years to complete a deal. While the amount of money to be raised for the Spark depends on the target, Ackman has said it will be at least$1.5 billion, and his hedge fund will contribute between$250 million and$3.5 billion as an anchor investor.

46:39Ackman is apparently still hunting for a target to acquire and spark and tweeted last September the following, if your large private growth company wants to go public without the risks and expenses of a typical IPO with Pershing Square as your anchor shareholder, please call me. We promise a quick yes or no. Besides sparks and SPACs, Ackman has made other recent headlines too. In May, Ackman made the big reveal that he was planning on taking Pershing Square public in what the Wall Street Journal described as the, quote, boldest move yet by the hedge fund manager to capitalize on his social media fame.

47:12Ahead of a Pershing Square IPO, Ackman privately sold a stake in his firm that valued it at nearly as much as its current assets under management. Pershing Square's valuation was pegged at$10.5 billion, despite the firm only managing roughly$16.3 billion. To clarify, if that's not clear,$16 billion is the amount of client assets that Ackman manages for other people and earns fees on. So for the value of his investment management business to be placed at more than 60 % of the total assets it manages, despite charging only a small fraction of that amount in fees each year, was shocking to many, to say the least.

47:49That places Pershing Square's market value in the same ballpark as asset managers that oversee several times as much money. So everything about the deal is an anomaly, from the valuation to a hedge fund firm going public, which is something the market generally soured on over 15 years ago, as it became clear during the great financial crisis how volatile hedge fund businesses can be, to say nothing of the rise of low-fee passive investing and how that has pulled capital away from active management. Yet, anomaly or not, it's also a testament to Ackman's star power. The$10 billion valuation almost certainly reflects optimism that Ackman can use his tremendous reach to dramatically increase Pershing's assets under management.

48:29With the billions of dollars of funds raised from selling a stake in Pershing to select investors ahead of a broader IPO, Ackman plans to put at least half of that money into a new closed-in fund aimed at individual investors in the US called Pershing Square USA. From Spark to a potential Pershing Square IPO to most of Pershing Square's capital being tied up in a closed-in fund trading in Europe that investors can sell only on the secondary market but can't actually pull capital from, to the newly planned US closed-in fund, Ackman's approach in recent years has shifted noticeably toward more durable capital.

49:04Whereas money can flow out of an ETF or traditional mutual fund at any time, as well as from hedge funds too, but with some lockup periods usually, Ackman has shifted to managing money that is locked up indefinitely. With Spark, he has 10 years to pick a target and won't actually raise money until a target is picked. By IPO-ing Pershing Square, he raises permanent capital from adding new shareholders instead of raising capital by taking on new clients who can pull their money out if they're unhappy. And as I mentioned, with Pershing's close-in funds, there's another layer of permanence there, since investors cannot redeem their shares to cash in and pull money out.

49:41With close-in funds, money in the fund is tied up indefinitely, which is why they typically trade at a discount to the net asset value of their investments. Ackman is building Persing Square into an investment management juggernaut, one that is as immune as possible from the whims of investors who might want to withdraw their funds. The aim then seems to be tying up large and ever-growing sums of capital through Ackman's name recognition while charging not entirely modest fees for his team's investment management services. In many ways, it's probably every asset manager's dream, to be honest. It's just that few have the clout and status to actually mold their businesses in this way.

50:18As a result of Ackman focusing more on turning Pershing into a diversified asset management behemoth, he's drifted considerably from his maverick hedge fund days. He's also had enough success in the past that he doesn't have to work as hard to convince companies that they should listen to his advice. So he said that he's now less of an activist and more just an engaged investor. He's able to work with companies without staging battles in the media to enact change. At least that's the case for now. His days of corporate activism seem to be behind him as he's increasingly turned his focus onto political and social activism.

50:53Still, Ackman's returns are as good as ever. His European close in fund earned a 31.2 % five-year average annual return at the end of 2023. And with that, since Ackman continues to run an extremely concentrated investment portfolio, I just want to run through some of those names. His largest picks across Pershing Square's funds are Google's parent company Alphabet, Universal Music Group, Chipotle, Hilton, Restaurant Brands International, which owns Burger King, the railroad company Canadian Pacific, and the property development company Howard Hughes. Ackman is just a fascinating person to study and follow, and I know I'll be keeping a close eye on changes to his portfolio, Pershing Square's potential IPO, and new closed-in fund, as well as his spark and anything else that he does really.

51:40After digging into Ackman's career, I think it's hard not to have mixed feelings about him. He's a great activist and value investor, but he's also been caught up in no shortage of controversies and embarrassing mistakes. He comes across as charming and smooth, yet you also know that there's probably a cold-blooded side to him too, as is probably true of many investing legends. And that's all for today, folks. Thanks a lot for tuning in, and I hope I'll see you again next week. Thank you for listening to TIP. Make sure to follow Millennial Investing on your favorite podcast app and never miss out on our episodes.

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