Pershing Square Holdings, lead by Bill Ackman (Trades, Portfolio), reported in its second quarter letter to shareholders that its net asset value increased by 44.1% year to date.
The firm benefitted from a great short call on index CDS markets and then unwinding that hedge in March and plowing the proceeds into the market. With hindsight, we now know it was a very opportune time to do so. The Pershing Square vehicle, essentially a closed-end fund, lagged the net asset value performance as the discount to its NAV widened further. The discount now stands at 28%.
In the latest letter, Ackman complained about the discount to the net asset value. I've been following the company for years, and Ackman has gone to great lengths to try and close that discount.
It is not completely unheard of for closed-end-funds to trade at a discount. In fact, they usually do. But this is quite a large discount even in the context of U.S. closed-end-funds. There are only four closed-end funds in the U.S that trade at a larger discount, all of them much smaller funds.
Pershing Square trades in Amsterdam as well as London. In the UK, there are about 500 closed-end funds trading, and Pershing Square is among the 10% most discounted.
Ackman goes to great lengths in this letter to address the discount, and I think he's making a very compelling case that's worth highlighting. Since its annual letter in March 2018, Pershing Square has executed the following accomplishments:
-NAV per share has increased by 153%
-Pershing Square bought back 19.2% of shares outstanding
-The company started paying a quarterly dividend
-Insiders have increased their ownership from 3.9% to 25.2%.
Meanwhile, the discount to net-asset-value has widened by nearly 10%. In his most recent letter, Ackman flags a potential catalyst as the fund is close to being eligible for inclusion in the FTSE 100. FTSE 100 inclusion is based on market capitalization of a company's listed shares. To remain eligible for inclusion Pershing Square must maintain a market capitalization equal to or greater than the 90th company, by market cap, within the index at quarter's end in September and December.
Ackman thinks that inclusion in the FTSE 100 index could be a material positive catalyst in increasing demand for the shares by index funds. Pershing Square is planning to convert its management shares to public shares because these shares are otherwise not counted for index inclusion purposes. This increases the odds of Pershing Square making it into the FTSE 100.
But to meet the threshold, Pershing Square's share price is currently slightly too low. The discount to NAV would need to decrease to 20%. Ackman also believes the holding is discounted way too far given Pershing's track-record:
"When the record of PSH is considered over the long term, calculated beginning with its predecessor funds' inception on January 1, 2004, we have earned a greater than 16% annual return on equity for nearly 17 years, and more than double this return over the last two years.11 Companies that have long term track records of earning mid-teens returns on equity generally trade at more than two times book value, and rarely, if ever, trade at a discount to book value."
From my experience, it is very rare that closed-end-funds with long-term double-digit returns trade at such deep discounts, especially as the names within the portfolio are, for the most part, liquid and well-known.
There's one other interesting development. In its net-asset-value calculations, Pershing Square ascribes about $85 million of value to its sponsor warrants in a SPAC (special purpose acquisition company) called Pershing Square Tontine Holdings, Ltd. (PSTH.U). This company, which is Ackman's SPAC, completed a $4 billion IPO. Pershing Square Holdings also committed $1 billion to the vehicle.
This vehicle plans to merge with a currently private company to bring it into the public markets. At that point, the warrants would become 10-year warrants on 5.95% of the newly merged company shares. The sponsor warrants have a strike price 20% above Pershing Square's IPO price. They can't be sold for three years, but they lose all value if the vehicle doesn't consummate a transaction.
Tontine Holdings is looking for a company with a post-merger market cap of between $15 billion and $30 billion or more. Because out-of-the-money warrants become much more valuable when the underlying shares appreciate, these can become very valuable. This is much more likely to happen if Ackman can convince a private company that the market will be very interested in.
According to Bloomberg, Airbnb rebuffed him but did not close the door entirely. In my opinion, the risk that a transaction won't be consummated is low because it is very favorable for Pershing Square Holdings (where Ackman is a large shareholder) to get a deal done given the presence of these sponsor warrants.
All things considdred, Pershing Square Holdings trading at a 28% discount to NAV seems too large of a discount in itself, but in my opinion, the asset value doesn't even fully reflect the optionality of the Sponsor Warrants. In addition, Pershing Square gets the right to increase its stake of $1 billion by another $2 billion if it chooses to do so. Obviously, it is only going to do so under favorable circumstances.
Ackman makes a compelling case that Pershing Square Holding is likely discounted to0 steeply. It remains uncertain whether the discount will actually shrink. With the possible FTSE 100 inclusion and the chance of the SPAC finding a target, there are two major factors that could serve as a catalyst to make it happen.
Disclosure: author is long PSH [Pershing Square Holdings]
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