Dear Pershing Square Investor,
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 (VRX, Financial) 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 for the human resources and substantial mindshare that this investment had and would have continued to consume if we had remained a shareholder. Furthermore, while Valeant has made significant progress and we expect management to continue to do so, there is still a lot of work to be done.
Clearly, our investment in Valeant was a huge mistake. The highly acquisitive nature of Valeant’s business required flawless capital allocation and operational execution, and therefore, a larger than normal degree of reliance on management. In retrospect, we misjudged the prior management team and this contributed to our loss. We deeply regret this mistake, which has cost all of us a tremendous amount, and which has damaged the record of success of our firm.
While there are many lessons from our investment in Valeant which we have previously discussed at length, we highlight a few important reminders from this experience:
- Mana gement’s historic ability to d eploy capital i n acquisitions and earn high rates of return is not a sufficiently durab e asset that one can assign m aterial value t o in assessing the intrinsic va lue of a busin ess.
When we acquired Valeant, we viewed our purch ase price as re presenting a m odest discount to the value of the compny’s existing assets, but a large discount to intrinsic value in light of ou r expectation that managem ent would continue to b e able to invest capital in new transactions on terms that w ould create significant long term value as it had done over the previ ous eight years . In retrospect, it appears that prior management substantially overp aid for the com pany’s largest acquisition – its acquisition of Salix – which occurred c ntemporaneo sly with t he substantial majority of ou r investment in the company.
- Intrin ic value can be dramatically affected by ch anges in regulations, politics , or other extrinsic factors we cannot control, and the existence of these factors is a highly im portant consideration in position sizing.
In retrospect, our in estment in Valeant was too large a percentage of capital in light of the greater risk of these factors having a negative impact on intrinsic value.
- A management team with a superb long-term investment record is still capable of making significant mist akes.
We had the opportunity to work al ongside Valeant management for nearly one year on the Allergan (AGN, Financial) transaction, and were favorably impressed. In particular, management’s decision to walk away from the Allergan deal on terms that we believed continued to offer high ra tes of return an d significant s trategic value reinforced our view that the company had a highly disc iplined approach to investin g capital. This coupled with the company’s histor c acquisition a nd integration track record o ver approximately 100 previous transactio ns gave us com fort that the Salix transa tion would be highly value-creating for Va leant. In retro spect, it appea rs that the com pany substantially overpaid for Salix, and it has not yet achieved the results anticipated by prior anagement.
- A large stock price decline can destroy substantia l amounts of intrinsic value due to its effects on morale, retent on and recruitment, and the perception and reputation of a company.
Our superb investment results in General Growth Properties, where the stock price had declined more tha 99% before we made our first purchase, gave us confi dence that we could assist Valeant in a turnaround after its stock price collapse . In retrospect, Valeant’s un derlying busin esses were not sufficiently d urable to withstand the impact of the rep utational dam age caused by the stock price decline, negative media atte ntion, and its impact on employee morale, retention, recruitment and the repu tation of the company.
My appro a ch to mistakes is that I personally assume 100% of the responsibility on behalf of the firm while sha ring the credit f or our successes. While I an d the rest of the Pershing Square team have suffered significant losses from this failed investment as we are collectively the largest investors in the funds, it is much more pa inful to lose our shareholders’ money, and for this I deeply and profou ndly apologiz e.
We are extremely focused and working hard to contin ue to repair the damage from our investment in Valeant y diligently overseeing ou r existing portfolio companies and identifying new opportunities. With a strong commitment to the core principles that have generate d the vast majo rity of our ret urns since ince ption and the best and most e xperienced tea m that we have had since th e formation of the firm more than 13 years ago, we are w ell positioned for a strong recovery.
We are extremely grateful for your support.
Sincerely,
William A. Ackman
