I can calculate the motions of the heavenly bodies, but not the madness of people.
Suffice to say, I am truly perplexed; less than a month ago, Procter & Gamble (PG) declined precipitously on the news that near term results wouldn’t meet expectations, largely due to weakness in China. As an investor (as opposed to a trader/renter) in P&G, the fact that 90 days might be weaker than originally anticipated is essentially noise; by the markets calculation, this was worthy of a 3% decline, or roughly $5 billion in the company's market capitalization.
Fast forward three weeks, and the news of an investment by Bill Ackman has resulted in an even larger gain (3.75%); to put this into context, let's assume that Mr. Ackman’s fund bought $3-4 billion worth of P&G common stock (estimated AUM of $10B), enough to give them control of roughly 2% of the outstanding shares. Whether or not he will be able to cause an activist change from a position of such limited ownership is yet to be seen…
The fact that the stock shot on Pershing Square’s disclosure doesn’t quite surprise me: The fund has a proven track record, and has generated net returns for investors of 412% since inception in 2004, compared to 50% for the S&P 500 over the same period. What perplexes me is why the market would be so enamored by the fund’s miniscule stake in P&G (and believe they can push changes from that position), while at the same time they are uninterested in his significant minority ownership position (and board seat) in J.C. Penney (JCP).
For those who have such faith in Mr. Ackman, let’s take a look back at something he said in his first quarter letter to investors:
"When we first announced our stake in JCP, the stock price increased to the low $30s per share. Shortly after announcing our stake, we were approached by one of the most well-respected private equity funds in the world who expressed an interest in acquiring the company at a substantial premium. While we welcomed this fund as an owner of the stock, we had no interest in selling the company for a quick premium because we believe in the long-term value creation opportunity.”
So we know Pershing Square has a significant stake in JCP with a cost basis of roughly $26/share, and we also know (or should believe if we trust Mr. Ackman) that a “well-respected” private equity fund expressed interest in buying JCP outright at a substantial premium to the low 30’s share price of a few months ago, implying private market upside of 80-95% at a premium of 20-30% from the market price (assuming $30 market price, buyout price of $36-39 per share); not only that, but that have influence on management and the company as a whole, meaning that investors’ have the added comfort of knowing that Mr. Ackman will be representing their interests, which is far from a guarantee in the case of Procter & Gamble.
The question is simple: Why would anyone looking at this situation disregard the JCP opportunity, but feel gung-ho about riding Ackman’s coattails with P&G?
I think the answer is pretty clear: For one, the market doesn’t care about long term value creation; most buyers (I refuse to call them investors) are simply looking for a couple percentage point pop, and then will abandon ship. While JCP may very well be an attractive long term investment, it is of little interest to renters, particularly when one looks at the wild volatility (to the downside as of late); P&G, on the other hand, offers the potential for a quick gain, which is enough to lure in traders far and wide.
Secondly, and just as importantly, very few people actually take the time to research the companies that they are buying stock in; this is likely due to the fact that most people won’t spend weeks or months researching a company that they plan on holding for hours or days. As a result, they get a substantial portion of their information from sources like CNBC, which is just about as clueless as they are: In this case, it comes in the form of the talking heads announcing JCP’s strategy a failure – even though it hasn’t started yet…
So be it; while this is irritating to listen to, the investor should be jumping for joy: This lack of understanding results in the type of buying opportunities that we current see with Penney’s, where the valuation is justified (and then some) by the cost saving initiatives on their own.
While I’m perplexed by the madness of people (particularly their inability to align their long-term financial goals with their investment strategy), I’m more than happy to use their blindness to solidify my stake in what essentially amounts to a free call option in JCP common.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, "Patience followed by pretty aggressive conduct."
I run a concentrated portfolio, with a handful of positions accounting for the majority of my equity holdings (currently two). From the perspective of a businessman, I believe this is adequate diversification.