Dear Pershing Square Investor,
For the first nearly 12 years of the Pershing Square strategy from January 1, 2004 through July 31, 2015 investors earned a 20.5%(1, 5) compounded annual return (a nine-fold return on a day-one investment) compared to 7.8% for the S&P 500 over the same period. As a result of three calendar years of underperformance, our compounded annual return since inception has been reduced to 13.6% representing a six-fold return on a day-one investment in the strategy. While the overall record is satisfactory for early investors, it has been very disappointing for PSH investors who invested in recent years. Our recent underperformance has been further impacted by the widening of the discount to NAV at which PSH shares trade. The obvious question is: What are we going to do about it?
We have taken a number of important steps in 2017 and early 2018 that position the portfolio and our investment operation for profits in the future. These steps included: (1) minimizing potential risk exposures by (a) receiving preliminary approval from the Court for the settlement of the Allergan (AGN, Financial) litigation (which we anticipate to be finalized later this year), and (b) by capping our exposure to Herbalife (HLF, Financial) by converting our short position into put options and then subsequently exiting the position; (2) restructuring the management company into a smaller investment-centric organization with future asset growth driven by investment results; and (3) reinforcing the implementation of our core investment principles which have guided the substantial majority of our performance since inception.
2017 should have been a stronger year for Pershing Square. I attribute our underperformance last year to three principal factors. First, legacy issues impacted performance including the cost of the Allergan settlement, losses on the exit from Valeant (VRX, Financial) and from our short position in Herbalife. Second, while we generated a substantial number of profitable investment ideas - including ADP, Hilton, Nike, and S&P Global - other than for ADP (ADP, Financial), increases in the prices of these investments due to the rapid rise of the market, both during the research process and the accumulation period, prevented us from building large enough positions to materially impact performance. Third, although positive contributors to returns in 2017 generated +14.6%, four positions accounted for negative contribution of -13.5% (-4.0% HLF, -3.5% MDLZ, -3.3% FNMA and FMCC and -2.7% CMG). Excluding HLF, which we have exited, we remain optimistic about the risk/return profile of these positions to a greater extent than before because of their reduced prices.
With respect to the NAV discount, and as discussed in the Chairman’s Statement, PSH proposes to conduct a Company Tender for $300 million subject to applicable shareholder approvals which will be sought at the April 24, 2018 AGM. I and the other members of the PSCM management team believe that PSH and our current portfolio are substantially undervalued. Subject to applicable laws and restrictions (including art. 7 para. 7 of the Dutch Decree on Public Takeover Bids), I, along with others on the management team, remain at liberty to purchase, directly or indirectly, PSH publicly traded shares, including through open market purchases (regelmatig beursverkeer), although we do not intend to do so until the company tender is completed.
We believe that this is a particularly attractive time to invest in PSH because:
- our portfolio trades at a wide spread to intrinsic value with catalysts which we believe should contribute to value recognition (which we discuss in detail in the Portfolio Update);
- the shares are currently trading at approximately 23% discount to NAV, which we would expect will narrow with improved investment performance;
- the idea generation engine is intact and productive;
- we have largely resolved the potential liabilities that have caused concern, namely the risk of a short squeeze at Herbalife and the Allergan litigation; and
- fees are low as we have reduced management fees by $14.4 million over the next eight quarters in connection with the Allergan settlement, and performance fees will not be payable until PSH recovers above the high water mark NAV of $26.37 per share.
While none of the above factors guarantee a good investment outcome, they substantially increase the probability of our success. PSH’s negative performance was accentuated by PSH’s leverage (it has $1 billion of bonds outstanding), and its stock price performance was further impacted by the widening of the NAV discount. If we are successful in delivering substantial positive investment performance, shareholders should receive the benefit of a reversal of these two factors, further enhanced by the substantially reduced fees charged by the investment manager.
As the largest investor in the Pershing Square funds, I and the other members of the Pershing Square team have experienced our recent underperformance first hand, but it is much worse to generate losses for shareholders who are relying on our efforts for their needs. You can be assured that we are working very hard to deliver the results that you expect from us.
Thank you for your patience and support.
Sincerely,
William A. Ackman
