Pershing Square trades at a steep discount to asset value

After two very costly and very public investment mistakes in Valeant and Herbalife, Bill Ackman’s Pershing Square Capital Management has seen its share price decline by nearly 50% since the summer of 2015. Karol Hochschorner of Twin Capital believes it is a perfect time to take a chance on Pershing’s publicly traded, Guernsey incorporated closed end fund, PSH:NA as it trades significantly under net asset value (NAV). Hochschorner believes if Ackman performs well, this trade could yield 15% or more return as the discount closes to previous performance fee high-watermarks.

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SumZero: What about Pershing Square Holdings (“PSH”) initially caught your eye as a value investor?

Karol Hochschorner: The first thing was the fund manager, Bill Ackman, and the second was that the fund is trading deeply below its NAV. Many individual investors are investing in funds at NAV or at a premium; with PSH they got a chance to invest with a top money manager at a substantial discount.

SumZero: What is PSH? How is it related to Bill Ackman’s hedge fund, Pershing Square Capital Management?

Karol Hochschorner: PSH is a closed-ended investment scheme created by Bill Ackman. It follows the same investment strategy as his hedge fund, Pershing Square Capital Management.

SumZero: What is the market missing?

Karol Hochschorner: PSH is trading at a deep discount because of short-term bad performance and because investors would rather replicate PSH’s portfolio. From August 4, 2015 to November 8, 2016, the fund lost 43.2%. Investors quickly forgot the superior performance of PSH for the last 13 years. PSH is outperforming the S&P 500 by a wide margin even with the recent drawdown. Over the years PSH has gained 500% after fees compared to the S&P 500’s 158%. The biggest reason of the drawdown was the investment in Valeant. Now Valeant represents just 4% of assets under management. PSH is selling at a 21.5% discount to NAV so investors get Valeant for free and they still have a 17.5% discount to NAV.

Investors believe they can replicate PSH’s portfolio without paying fees to the fund manager. There is a management fee of 1.5% and a 16% performance fee. But PSH uses a high water mark performance fee so investors don’t have to pay that fee until NAV exceeds $26.37 per share. That gives us almost 100% upside without paying that fee.

SumZero: Currently, PSH trades at a 20+% discount to NAV, higher than most other funds. When do you believe this discount will begin to decrease? How close do you believe the share price can get to the NAV/share?

Karol Hochschorner: One of PSH’s investments has to turn out to be successful or PSH needs to have a profitable year to regain confidence from investors. The market is still concerned with Herbalife and Valeant.

I believe PSH should trade at least for NAV. If people invest in an open-ended fund, they do so at NAV or for premium. Even if investors invest directly to the hedge fund Pershing Square Capital Management, they do so at NAV. But those same shares of PSH trading on the Amersterdam stock exchange are selling at a deep discount.

SumZero: Bill Ackman and PSH have been hit hard with bad returns over the last two years, a stark reversal from the several year-long streak of positive performances since the inception of the fund. How can an investor be sure PSH will get back on track?

Karol Hochschorner: They can never be sure. Past performance is not an indication of future returns. However, there is a high probability that PSH will get back on track. PSH admitted they made two mistakes in the last two years by missing the opportunity to sell some of their investments at intrinsic value and assigning too much value to the so-called “platform value” in a few of their holdings. I believe the PSH investment team learned their lesson, and today the team is much more experienced.

SumZero: As an activist investor, PSH tries to reshape a company’s infrastructure in order to increase efficiency. With Ackman’s rough last two years, will he face less trust and more pushback from future boardrooms?

Karol Hochschorner: I have very little information to judge this and do not know the relationship between managers of big funds and management of the companies they invest in. PSH strategy is not based on trust but on strong arguments. They lay down the facts and investors decide if they agree. Trust definitely makes the whole process easier, but it is not the most important element.

SumZero: PSH has five investments that each account for 10+% of available capital: Restaurant Brands International, Mondelez International, Air Products, Chipotle Mexican Grill, and the Howard Hughes. Do you see substantial risk in any of these equities?

Karol Hochschorner: No, I don’t see any substantial risk. All of the companies fall in the PSH circle of competence: “simple, predictable and free-cash-flow-generative with substantial barriers to competition and strong pricing power due to brands, unique assets, long-term contracts, and/or dominant market position.”

SumZero: Bill Ackman is facing a lawsuit for insider activity after trading Allergan stock while leading Valeant to make an offer to acquire Allergan. Does this worry you as an investor? How will your outlook on PSH change if Ackman is found guilty?

Karol Hochschorner: I would not say it worries me but I certainly will pay attention to the lawsuit. I think it represents a small risk to PSH. Even if Bill Ackman is found guilty it will not change my view on PSH substantially because I don’t believe he did anything immoral. He bought Allergan because he knew that he and Valeant wanted to acquire the whole company. It is not insider trading and certainly not immoral.