Description

2015.10.22 Pershing Square Holdings Ltd (Ticker PSH.AS; $19.49 last) write-up

This idea is simple, and I believe it timely.  The write-up will be necessarily short as I rush to get it out while it is still actionable.

I am recommending a long position in Pershing Square Holdings (ticker PSH.AS), while hedging out the major components of the underlying portfolio, especially the embedded Valeant (ticker VRX) exposure.  I am by no means a healthcare specialist and don’t have anything insightful to add to the debate on it, so I prefer to hedge it out.  For those who have a fundamental view on one or more of the underlying major portfolio companies in the PSH portfolio, a case could be made to only lightly hedge or not hedge those companies which you’d like to own anyway.  However, such a move would change this idea from more of an arbitrage type of trade to more of a fundamental investment.

PSH shares fell dramatically yesterday given the large underlying VRX holding, but the move in PSH was well in excess of the implied change to NAV from the VRX holding.  This has resulted in the implied discount to NAV having increased substantially.  For example, the Q2’15 PSH letter dated August 26, 2015 states that the average discount to NAV for the period of IPO through Jan 31, 2015 was 7.1%; from Jan 31, 2015 through July 31, 2015 was 3.7%; and in July 2015 was 2.8%.  

I calculate that the discount to NAV as of today’s close is now ~12% ($19.49 / share closing price vs my estimate of NAV at today’s close of $22.18 / share detailed below).  Assuming that the discount to NAV shrinks back to 5% would imply that PSH trades up 8.1%.  Here is a sensitivity table showing the implied PSH share price and upside at different assumed discounts to NAV.

The most significant assumption I’m making in my calculations is that Bill Ackman hasn’t meaningfully changed the portfolio components around since the most recent filings and the announcement of the incremental purchase of VRX shares yesterday.  (I assume that the VRX shares purchased yesterday were purchased at an average cost equal to the closing price – obviously well below the opening price yesterday, but also well above the price prior to the trading halt).

I start with the long positions for the firm as a whole listed in the most recent 13-F filing (positions as of June 30, 2015):

http://www.sec.gov/Archives/edgar/data/1336528/000117266115001657/xslForm13F_X01/infotable.xml

Next, I include the Mondelez (Ticker MDLZ) investment (subsequent to June 30, 2015) as detailed in the 13-D filings:

http://www.sec.gov/Archives/edgar/data/1336528/000119312515280396/0001193125-15-280396-index.htm

http://www.sec.gov/Archives/edgar/data/1336528/000119312515324699/0001193125-15-324699-index.htm

I treat the call options on MDLZ as share equivalents (delta = 1.0) given they are deep in the money.  I also treat the forward purchase contracts on MDLZ as share equivalents (delta =1.0).

Then, I estimate the delta-adjusted short position in Herbalife (ticker HLF) to represent the bearish position Ackman has taken in HLF via put options.

I also take into account additional shares of VRX that Pershing bought yesterday per this press release from last night:

http://assets.pershingsquareholdings.com/2015/10/Pershing-Square-Holdings-Ltd.-Increases-Position-In-Valeant-Pharmaceuticals-International.pdf

While I don’t know precisely how many shares “in excess of 2 million” represents, I assume 2.1mm.

Thus I arrive at this estimate of the firm’s holdings in shares:

I then take those numbers of shares and multiply by the closing prices to get to $ values for the firm for these positions:

Next, I estimate the fraction of the total firm’s positions that are held by PSH (the publicly traded closed end fund vehicle) from the September Monthly Performance Report:

http://assets.pershingsquareholdings.com/2014/09/Performance-Report-September-2015-PSH.pdf

I’m not sure which positions are included in Firm AUM but excluded from Strategy AUM -- it appears to be “PS V, L.P., PS V International, Ltd. and affiliated entities (collectively, “PSV”), less amounts invested in PSV by the entities listed above (as applicable)”.  So I’m not sure whether to take 35.9% of the size of the firm’s positions listed above, or 34.8% of the size of the firm’s positions listed above.  Since the answer doesn’t change materially, I decided to take an average of the two methods and use 35.4%.  So now I multiple the firm’s $ values in the above positions by 35.4% to arrive at an estimate for PSH’s $ values in these positions:

These total estimates “foot” pretty closely to long, short, and net exposure % figures that are given in the PSH monthly performance reports for June and September:

http://pershingsquareholdings.com/media/2015/07/Performance-Report-June-2015-PSH.pdf

http://assets.pershingsquareholdings.com/2014/09/Performance-Report-September-2015-PSH.pdf

This gives me confidence that my methodology, while imperfect, is likely reasonable.

Next, I calculate PSH’s total NAV in $ as of the close October 20 from the share count disclosures given in the monthly performance reports above, and the NAV / share estimate of $23.41 given at:

https://www.pershingsquareholdings.com/company-reports/weekly-navs/

Then, I take the $ changes to PSH’s above positions in each of the past 2 days subsequent to October 20 and apply those $ changes to the PSH NAV of October 20 to arrive at an NAV estimate as of today’s close.  The implied 5.7% decline in NAV as of yesterday’s close vs October 20 (implying yesterday’s NAV / share at $22.08) and today’s implied 0.4% increase in NAV vs yesterday’s close gets me to an estimate of NAV / share as of today’s close of $22.18.

Some would argue that closed-end funds historically trade at discounts to NAV and what is to say the discount to NAV won’t further increase?  However, I would note that PSH is far larger and more liquid than your “garden-variety” closed-end funds and the long term track record for Pershing Square is also dramatically different than (superior to) the “garden-variety” closed-end fund.  I would also note that GLRE and TPRE typically trade right around BV, as opposed to large discounts, and GLRE historically traded at a premium to BV.  Moreover, I think of the NAV at PSH as being of arguably higher quality than GLRE or TPRE given the lack of insurance-related assets on the balance sheet.  TPOU.LN (Third Point’s closed-end fund) has generally traded at a low single digit discount to NAV during 2014-2015 despite being far, far less liquid than PSH.AS.  In fact, notwithstanding the current hit that Ackman’s credibility is taking in certain circles in the wake of the VRX situation, I think Bill Ackman has done a good job in PSH presentation decks and other materials of laying out a case for PSH to trade to a premium to NAV over time (similar to Berkshire Hathaway, or George Soros’ Quantum Fund back in the day).  

There is certainly some basis risk (to the extent that Pershing Square’s holdings have changed since their most recent filings), but I think this risk is mitigated by Pershing’s historically low turnover rate.  (We should also get an updated view on the underlying longs at Sept 30, 2015 before November 15 when their next 13-F filing is posted.)

As the PSH Q2 letter notes, “While stocks can trade at any price in the short term, because we do not use margin leverage, we will not be forced out of any investment at any inopportune time.”

I’m not sure how long it will take for the NAV discount to shrink from current levels, but I think there is a very good chance that much of it occurs after the next NAV / share is published.  Based on the PSH description of their updated policy for releasing NAV (http://assets.pershingsquareholdings.com/2015/10/Pershing-Square-Holdings-Ltd.-Changes-its-NAV-Reporting-Policies.pdf), I believe the Oct 31 NAV / share will be published after the market close on Nov 2.  (But I could also see a possible interpretation being that the Oct 27 NAV / share will be published after the market close on Oct 28.  I’m not sure which date is right, but I’m not sure it matters much).  Given the ability to largely hedge this position and to put it on in reasonable size, I think the prospect for very attractive risk-adjusted returns in a very short period of time are quite appealing.

Catalyst

NAV / share as of Oct 31 should be posted on Nov 2 after the market close (unless I misinterpreted the new policy and it should be the Oct 27 NAV / share posted on Oct 28 after the close)

Q3’15 earnings call Nov 9, 2015 at 11am Eastern

Pershing Square 13-F filing as of Sept 30, 2015 gets posted before November 15

Pershing Square Q3’15 letter likely to be posted before the end of November, and may include an update through the end of October (similar to Q2 letter being posted late in August and including an update through the end of July)

Catalyst

NAV as of Oct 31 should be posted on Nov 1 after the market close

Q3’15 earnings call Nov 9, 2015 at 11am Eastern

Pershing Square 13-F filing as of Sept 30, 2015 gets posted before November 15

Pershing Square Q3’15 letter likely to be posted before the end of November, and may include an update through the end of October (similar to Q2 letter being posted late in August and including an update through the end of July)