Bill Ackman has published his 1Q10 letter to investors. He discussed the major positions he is holding, some of the positions he sold, and the major investments he made during the quarter.
A copy of the letter is at the end of this article. Here are his comments on positions he acquired during 1Q10:
Read the complete letter:
33089409 Pershing Q1 2010 Investor Letter
A copy of the letter is at the end of this article. Here are his comments on positions he acquired during 1Q10:
Kraft
We discussed our rationale for our investment in Kraft Foods at the annual dinner and in a presentation entitled “A Krafty Combination” given at the Harbor Investment Conference on
February 3, 2010. Kraft is currently one of our largest positions and we see significant upside from the recent stock price with limited downside risk.
We believe that Kraft’s takeover of global confectionary leader Cadbury will help transform the company into a higher quality and faster growing business. Confectionary is one of the most attractive global food categories because of its strong pricing power, high gross margins, economic resiliency and limited competition from private label products. Cadbury, a company we know well from our past ownership of the stock, is extremely well-positioned in the confectionary business, with world leading brands and roughly 40% of its sales in fast-growing emerging markets.
We believe that Kraft was able to acquire Cadbury at an attractive price largely as a result of the hostile nature of the acquisition. Unlike your typical acquisition, in which a company or a division is “dressed up” for sale in a competitive auction, Cadbury was acquired outside of an auction process at a time when the business was materially under-earning and the cost of debt financing was very cheap. Before the sale, Cadbury management had been investing significantly in its business with increased capital expenditures, R&D and advertising – not the actions of a management team looking for a near-term sale. These investments are currently pressuring Cadbury’s margins, but should lead to margin improvement over the next 12-24 months, all for the benefit of Kraft shareholders. Including the expected cost savings from the transaction, Kraft paid approximately 12 times Cadbury’s 2011 after-tax earnings, an extremely attractive price for one of the great businesses of the world.
The “New Kraft” looks a lot like another great company we have owned in the past: Nestle. Over 50% of “New Kraft’s” products are in the high quality confectionary and snack categories, with over 25% of its sales in emerging markets, higher than any of Kraft’s North American food peers. Kraft’s portfolio of iconic and affordable dry goods including Oreos, Chips Ahoy, Kool Aid, and Mac & Cheese, is ideally suited for Cadbury’s strong distribution in many parts of the emerging world. In the developed world, Cadbury’s strength in instant consumption channels will help Kraft expand its reach in convenience stores, a channel in which Kraft is currently under represented. Ultimately, we believe Kraft stock will enjoy considerable multiple expansion as it demonstrates the growth potential and resiliency of its enhanced portfolio and distribution platform.
We believe there is also an impending turnaround in Kraft’s legacy business (excluding Cadbury). Despite multiple years of ongoing restructuring efforts, Kraft has seen operating profit margins fall from over 20% in 2002 to ~13.5% currently. One of the reasons we believe the stock is undervalued is because there is tremendous investor fatigue given the company’s historically unsuccessful restructuring efforts. Turning around a company the size of Kraft often takes many years and requires more than just cost cutting. We believe Kraft, today, under CEO
Irene Rosenfeld, has taken many of the necessary steps to reinvigorate its business, including increasing R&D and advertising, improving product quality, lowering prices to more competitive levels, decentralizing key business functions, and investing in its supply chain. While these efforts have pressured margins, we believe that Kraft is near an inflection point in business performance and should begin to experience better-than-expected organic growth and margin improvement in the near future. Given the company’s mix of products and dominance in its categories, EBIT margins should be in the mid-to-high teens rather than the current approximate
13.5% margins.
At its current stock price, Kraft trades at less than 11 times our estimates for earnings in 2012, the first year when we expect the vast majority of cost savings from the Cadbury deal will be achieved. We believe this a substantial discount to Kraft’s intrinsic value. As the company demonstrates progress in the merger and in its restructuring, the stock price should rise commensurately.
Citigroup
We recently acquired 146.5 million shares of Citigroup, representing approximately 9% of fund
Beginning with the big picture, we believe that this is a favorable moment in history to be a large-scale financial institution. The combination of extremely low-cost funds and deposits, relatively high spreads on new loans, more conservative lending standards, and a less competitive lending environment, creates an opportunity for large profits from the traditional banking business of collecting deposits and making loans. Citigroup also presents an attractive opportunity in the banking business because of its certain unique attributes.
Citigroup is comprised of two principal components: Citicorp, the business that will form the core of the company going forward with approximately $1.5 trillion of assets, and Citi Holdings, a liquidating portfolio comprised of several operating businesses as well as various legacy asset pools (primarily mortgages and RMBS) that will be wound down or sold over the next several years. Citicorp has three principal businesses: Regional Consumer Banking, Securities and Banking, and Transaction Services. At its recent price of $3.64, Citi trades below tangible book value, and at five or so times management’s earnings guidance, a fair reflection, we believe, of Citicorp’s core earnings power.
We think there are two important elements of Citi that the market does not fully appreciate: first, a $21 billion operating deferred tax asset that will shield earnings from taxes over the next several years; and second, approximately, $24 billion to $30 billion of excess capital supporting the wind down of Citi Holdings that will be available to be returned to shareholders as these assets are liquidated.
If one were to adjust the company’s current valuation for its tax asset and the excess capital from the wind down of Citi Holdings, an investor who buys the stock at $3.64 per share is paying approximately three to four times earnings for the core Citicorp. While the eventual outcome of financial reform will likely be a net negative for Citigroup, we believe the ultimate impact will be less than feared. We also believe that the conversion of the government’s TARP preferred stock to common equity has given the company a robust capital position (it has a current tier 1 common ratio of 9.1%), and that the bank is better insulated from potential late-cycle credit issues with substantially less home equity and commercial real estate exposure than its domestic peers.
In our view, there is a much greater degree of uncertainty associated with our investment in Citigroup than for Kraft, or for a number of our other holdings. That said, we believe the current stock price, capital structure, and hidden assets provide a sufficient margin of safety, in light of the large potential for reward from this investment.
Aliansce
We rarely invest in initial public offerings. We rarely invest in small cap companies. Historically, we haven’t invested in emerging market equities. In January 2010, we participated in the initial public offering of a small cap Brazilian mall company called Aliansce. Why?
We learned about Aliansce through our investment in GGP. GGP owned just shy of a majority of Aliansce prior to the company’s IPO in January. Because of our approximately 25% economic interest in GGP, we were already indirect owners of approximately 12% of Aliansce. As a result of our participation in the IPO, we now own directly and indirectly approximately 22% of Aliansce including our ownership of GGP, making us the company’s second largest (inclusive of indirect holdings) shareholder. Since going public, Aliansce’s share price has increased by 17%, to BRL 10.54 per share, as of yesterday’s close.
Although we do not normally invest in emerging market securities, we chose to increase our stake in Aliansce in the IPO because it was attractively priced, the company and industry fundamentals are outstanding, we like the management, and it was helpful to Aliansce and to our investment in GGP to assist in getting the IPO done. The Brazilian mall industry is massively under-supplied, with roughly one-fortieth the retail square footage per capita than we have in the U.S. Additionally, Brazilian malls operate at higher occupancies, substantially higher sales per square foot, and with lower occupancy costs (rent is a lower percentage of sales creating more opportunity for future rental increases) than their U.S. counterparts. Despite these favorable fundamentals and much greater growth potential, Brazilian mall companies trade at a meaningful discount to their U.S. mall REIT peers.
We were further comforted by GGP’s continued involvement in Aliansce: it owns a 35% equity interest and has two of five board seats. We believe GGP’s expertise will continue to aid Aliansce as the premier mall developer in Brazil and will provide Aliansce with access to international tenants that should help it achieve continued operational success. While this is a small investment – at today’s price our direct interest in the stock is approximately 1.8% of fund capital – we expect to earn an attractive risk-adjusted return on capital and the time invested.
Read the complete letter:
