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 (NYSE:VRX) 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 V aleant, we vie wed our purch ase price as re presenting a m odest discount to the value of the comp ny’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 arge a percentage of capital in light of the greater risk of these factors having a negative impact o n intrinsic valu e.
- A ma agement team with a superb long-term investment record is still capable of making significant mist akes.
We ha d the opportu ity to work al ongside Valea nt management for nearly one year on the Allergan transa ction, and were favorably impressed. In p articular, ma nagement’s de cision to walk away from the Allergan deal on terms that we believed continued t o 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 approxima tely 100 previous transactio ns gave us com fort that the Salix transa tion would be highly value- reating for Va leant. In retro spect, it appea rs that the com pany substantially overpa d for Salix, and it has not yet achieved the results anticipated by prior anagement.
- A large stock price d ecline can destroy substantia l amounts of intrinsic value due to its effe cts on morale, retent on and recruitment, and the perception and reputation of a company.
Our s perb investme nt 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 V aleant 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 00% of the responsibility on behalf of the firm while sha ring the credit f or our successes. While I an d the rest of th e Pershing Square team hav e suffered significant losses f rom this failed investment as we are collectively the large t investors in the funds, it is much more pa inful to lose our shareholders’ money, an d for this I deeply and profou ndly apologiz e.
We are ex tremely 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.
From 2016 annual letter to shareholders of Pershing Square by Bill Ackman (Trades, Portfolio).
