Pershing Square Capital Bond Offering:
PSH issued $1 billion, seven-year senior unsecured notes on June 26, 2015.
- Maturity: July 15, 2022.
- Coupon: 5.500%.
- Payable semiannually on Jan. 15 and July 15.
- Ratings: BBB (negative outlook) / BBB+ (S&P / Fitch).
- Over 90 investors participated in the offering.
- No NAV maintenance covenants.
“Permanent” Capital
“Permanent” capital (1) represents nearly half of our assets.
Current portfolio update
Principal mistakes we made in 2015
A year when many lessons were learned, 2015 was also an important reminder that stocks can trade at any price in the short term.
Other factors also contributed to poor results
Despite our missteps, our portfolio holdings today trade at a substantial discount to intrinsic value partially because of certain unique market dislocations.
Concerns regarding oil prices and China’s economy have significantly impacted the market prices of many of our investments, despite their limited exposure to these risks.
Pershing Square “followers” are liquidating funds creating intense selling pressure on our investments with strong “follower” ownership.
Huge capital inflows into index funds have created support for indexed constituent company valuations.
- Most of our long positions (representing 54% of our portfolio) are not components of major market indices.
While we wait for the weighing machine
Over the long term, we believe that the market prices and intrinsic values of our investments will converge.
- Permanency of our capital base will allow us to weather this volatility.
- Our influence on our portfolio companies should allow us to continue to enhance the value of our investments.
In the near term, new investment opportunities abound.
- Recent market conditions have created new opportunities.
- Many high quality businesses with catalysts to increase value are currently at or nearing attractive valuations.
We are unlikely to make wholesale changes in the short term to the current portfolio as we find our current investments attractive. That said, we would be surprised if we did not add at least one major new investment in the next few months.
Valeant Pharmaceuticals International (VRX, Financial)
- Multinational pharmaceutical and medical device company.
- >$12 billion 2016 estimated sales.
- ~21,000 employees.
- Market leadership in dermatology, gastroenterology, ophthalmology and consumer health products.
- In 2008, new management implemented an unconventional business model that has historically created large amount of shareholder value.
- Innovative marketing, management and R&D strategies designed to avoid waste and maximize return on capital.
- Acquisitions of assets in attractive categories.
- Valeant is adapting its model in response to recent criticism.
- Pershing Square’s history with Valeant.
- Pershing Square partners with Valeant in 2014 to acquire Allergan.
- On Feb. 9, 2015, Pershing Square purchases first shares of Valeant at a price of $161.
The company's major franchises are underappreciated
Bausch & Lomb:
- Durable product portfolio.
- 11% organic growth in 2014, ~6% growth through Q3 2015.
- Growth drivers include favorable secular trends and strong product portfolio.
- Increased prevalence of eye disease supports growth of surgical, drug and consumer markets.
- Capacity expansion to accommodate strong demand for contact lens products.
- ~25% of sales are made in emerging markets.
- Late stage pipeline includes Vesneo, a potential $1 billion new glaucoma drug.
- Traded at an average of 20x forward EPS as a public company.
Gastrointestinal (Salix): ~20% of sales
Strong collection of products treating patients with diseases such as:
- Hepatic Encephalopathy, Ulcerative Colitis, Opioid Induced Constipation.
- Xifaxan has nearly $1 billion of annualized sales and recent volume growth of 25%+ Y/Y3.
- October Y/Y volume growth of other significant products: Apriso +8%, Uceris +30%, Relistor +33%.
Pipeline: Likely approval of Relistor Oral in 2016.
The company's major franchises and Walgreens partnership are underappreciated
U.S. Dermatology: ~15% of sales
- Largest portfolio of nonbiologic medical dermatology products in the U.S.
- Prescribers often strongly prefer branded alternative to generics.
- Retained ~80% of volume following Philidor disruption.
- ~30% of Q3 2015 sales from four recently launched products.
- Drug Pipeline: Seven Phase III or FDA Submitted, Eight Pre-Phase III Products.
Emerging markets branded generics: ~10% of sales
- Durable portfolio of branded generic products in growing markets.
- Opportunity to grow existing drugs and launch new products.
Partnership With Walgreens:
- Will support growth of Rx Dermatology, Ophthalmology and Off-Patent portfolio.
- Benefits to patients and physicians: Convenient access, financial and administrative support, cash pay option.
- Benefits to payors: $600 million of price cuts, transparency, no mail order.
Mondelez International (MDLZ, Financial)
- One of the world’s largest snack companies with 2014 revenues of $30 billion.
- $66 billion equity market capitalization.
- Born out of the breakup of Kraft Foods in 2012.
- High quality, simple, predictable, free-cash-flow generative business.
- Only large, publicly traded, uncontrolled “pure-play” snacks company.
- We currently own shares and derivatives representing a ~6.6% ownership stake in the company.
Snacks is one of the best food categories
Strong global growth and scale:
- $1.2 trillion global market with historical growth of 6% per annum.
- Tremendous future growth opportunity in emerging markets.
- Category responds well to advertising and in-store merchandising.
High category margins:
- Low private-label penetration.
- Strong sales in highly profitable immediate consumption channels.
Secular winner in global packaged foods:
- Well-aligned with consumer trends of eating more frequently, smaller meals and convenience.
- “Small treats” significantly better positioned than processed meals and other center store products.
Mondelez is effectively a new company
We believe Mondelez’s enormous efficiency opportunity exists because it was created through a series of acquisitions made by legacy Kraft that were never properly optimized or integrated.
Mondelez zero-based budgeting (ZBB)
While management has embraced ZBB to address their high G&A, Mondelez’s version of ZBB is much less robust than the 3G approach.
Gross margin opportunity: Advantaged assets
Mondelez has invested ~$1.5 billion to upgrade its manufacturing base, which should expand gross margins by ~250 bps by 2018.
- We are looking forward to a significant gross margin increase as the new Salinas, Mexico, facility ramps up.
- We believe the potential for long-term gross margin expansion is strong.
Additional levers for margin expansion
Mondelez can dramatically improve its profitability using the same tools used by 3G.
Net revenue management:
- Elimination of unproductive trade spending, particularly in Europe.
- Reduction in global SKU count from ~74,000 in 2014.
Procurement Productivity:
- Consolidation of suppliers from ~100,000 in 2013.
SG&A rationalization:
- Implementation of zero-based budgeting across the organization.
- Creation of an “ownership culture” through appropriate incentives.
Opportunity far exceeds established targets
While management’s plan to increase margins to 15% to 16% by 2016 is a step in the right direction, optimized margins are far higher.
Air Products (APD, Financial): Overview
- One of four global industrial gas companies.
- Air Products’ business is diversified by geography, with modest exposure to emerging markets including China.
- Air Products is diversified by supply mode, with significant exposure to the highest-quality on-site supply mode.
Air Products: Investment thesis
High-quality, simple, predictable, free-cash-flow generative business:
- Global oligopoly that enjoys attractive returns due to local incumbency advantages driven by utilitylike contracts with large customers and the high transportation costs of distributing additional product to surrounding customers.
- Buffered from macro: diversified; contracted; low-cost, critical and consumable input.
- GAAP earnings meaningfully understate cash flow as the useful life of APD’s assets far exceeds GAAP depreciable life (which is set by initial contract length).
Substantial untapped potential, cheap “as-fixed”:
- Decades of underperformance, but shortfalls were fixable.
- Historical 600 bps+ operating margin gap to comparable Praxair could be closed.
- Potential to substantially improve earnings in medium term; Air Products' shares did not reflect this latent opportunity at the time of our purchases.
Air Products’ transformation begins
CEO Seifi Ghasemi’s first year marked the beginning of a successful transformation of Air Products.
2015 was a year of substantial progress:
- Successfully restructured Air Products, creating a decentralized organization with greater accountability.
- Took action to reduce corporate overhead costs by $300 million run rate ($170 million realized in FY 2015).
- Operating margins improved 310 bps to 19%.
- Significant capex brought on-stream and producing.
- FY 2015 EPS of $6.57 up 14%, despite 7% foreign exchange headwind.
Exceeded the high-end of initial guidance despite unforeseen macroeconomic and foreign exchange headwinds.
- Announced significant high-quality project wins, which will fuel growth.
- Announced spinoff of noncore materials technology business, Versum Materials, on or before September.
Air Products’ upside remains significant
- Despite Air Products' significant progress, recent macroeconomic concerns have caused Air Products' stock to trade at a material discount to its intrinsic value.
- Air Products' business remains resilient: diversified; contracted; low-cost, critical and consumable input.
- FY 2016 guidance calls for $7.25 to $7.50 of EPS (+10% to 14%).
Assumes no global growth and continued economic weakness.
Catalysts for value creation are not dependent on macroeconomic strength.
Cost savings and efficiency:
- Industrial gas margins of 18% still ~500 bps behind Praxair.
- $430 million, or 72%, of total cost savings, will be achieved in 2016 and beyond.
APD is well on its way to achieving its goal of being the safest and most profitable industrial gas company in the world, which we believe will create significant value for shareholders
Significant capital expenditures brought on stream.- Spinoff of Versum Materials will create two leading, pure-play companies.
Canadian Pacific Railway (CP, Financial): Overview of the business and recent trends
Canadian Pacific’s business is diversified by freight and destination:
Freight Mix (% of '15 revenue)
- International Intermodal – 9%.
- Domestic Intermodal – 10%.
- Forest Products – 4%.
- Automotive – 5%.
- Crude – 6%.
- Metals, Minerals, Cons. Products – 10%.
- US Grain – 8%.
- Canadian Grain – 15%.
- Coal – 10%.
- Potash - 6%.
- Fertilizer & Sulphur – 4%.
- Chems & Plastics – 10%.
Destination Mix (% of '14 revenue)
- Canada – 17%.
- U.S. – 17%.
- Cross-Border – 31%.
- Global – 35%.
Despite macro weakness, Canadian Pacific’s volume declined just 2% in 2015.
Most freight types were up or down modestly:
- Canadian commodities performed well, aided by their low-cost position and a weakening Canadian dollar.
- Portions of Canadian Pacific’s business are not overly sensitive to macro (i.e., intermodal).
Material declines were seen in just a few categories: U.S. Grain (-9%), Crude (-17%) and Metals, Minerals and Consumer Products (-14%).
Canadian Pacific remains a high-quality, infrastructure asset with strong pricing power.
Canadian Pacific: Another year of great progress
Canadian Pacific’s remarkable transformation continued at an accelerated pace in 2015.
- Operating Ratio (“OR”) of 61% improved 370bps.
Approaching four-year OR target in first year.
OR result is second-best in industry.
- Canadian Pacific repurchased ~8% of its shares at $203 CAD per share, a discount to Canadian Pacific’s intrinsic value.
- EPS growth of 19% despite muted top-line growth of 2%.
In November, Canadian Pacific revealed its offer for Norfolk Southern (NSC, Financial).
- Offer would create meaningful value for both Canadian Pacific and Norfolk Southern shareholders while improving the North American rail network and enhancing service to customers.
- Announced $1.8 billion of operational efficiencies and synergies.
Despite Canadian Pacific’s continued progress on its operational efficiency, its efforts were mostly overshadowed by its slowing top-line growth and a weakening macroeconomic environment.
Canadian Pacific remains an attractive investment
Recent macroeconomic concerns have caused Canadian Pacific’s shares to trade at a substantial discount to their intrinsic value.
2016 guidance calls for an operating ratio below 59% and double-digit EPS growth.
- Tailwinds to EPS growth from a lower share count, pensions and f/x.
Canadian Pacific is right-sizing its network to the currently tepid demand environment, which management has stated will improve results meaningfully:
Margins should be 200-300 bps higher at current volume levels.
Annual capital expenditures will be $400 million lower than Canadian Pacific’s original plan.
Long-term potential remains significant under a superlative management team; management has highlighted a potential operating ratio of 56% to 57%.
- Note that declines in fuel prices, which are passed through to customers via a fuel surcharge, raise the operating ratio potential by ~350-400 bps.
- Pension expense is an incremental tailwind of ~180bps.
Potential for a value-enhancing merger.
Restaurant Brands International (QSR, Financial)
Franchised business model is a capital-light, high-growth annuity:
- Brand royalty franchise fees (4% to 5% of unit sales) generate high margins.
- Significant unit growth opportunity requires little capital.
- Same-store sales are relatively insulated from economic cycles.
Control shareholder 3G is ideal operating partner and sponsor.
- Installed excellent management team.
- Created unique and impactful culture, compensation system and business processes.
Current economic environment is favorable to Restaurant Brands.
- Customers have more disposable income and drive more when gas prices are low.
Restaurant Brands International’s intrinsic value meaningfully increased in 2015 despite substantial headwinds from strengthening U.S. dollar.
Strong financial performance in 2015: ~20% EBITDA growth before FX.
Impressive SSS growth at both Burger King (BKW, Financial) (~6%) and Tim Hortons (THI) (+5%):
- Continued progress on Burger King U.S. turnaround (SSS +7%.
Significantly reduced Tim Hortons expenses and capex:
- Overhead costs reduced by more than 40%.
Maintained high level of net unit growth (5%) at both Burger King and Tim Hortons.
Strengthening of the U.S. dollar has materially reduced reported financial results:
- FX reduced reported EBITDA growth ~13%.
We have taken advantage of recent price declines to add to our position and believe Restaurant Brands International remains a compelling long-term investment.
