market folly

Today we're covering the latest investor letter from Bill Ackman's hedge fund Pershing Square Capital Management. We like to detail the thoughts expressed in such letters as they often give us an insider glimpse into their portfolios and the manager's mind; something we cannot necessarily get with 13F filings. Just yesterday, we covered the latest from David Einhorn's Greenlight Capital and we found some intriguing tidbits of information and we're sure Ackman has some interesting updates as well. If you're unfamiliar with Ackman & Pershing Square, then make sure to check out the profile/biography we did very recently. Let's see what ole Ackman has been up to, shall we?

Target (TGT)

Firstly (and rightly so), Ackman focuses on their Target (TGT) position. After all, they have an entire hedge fund dedicated to a position in it and have been pushing for change for some time now. While he lost the proxy vote, Ackman still says they have succeeded in other ways as they have got the company thinking about a transaction involving their credit card segment somewhat along the lines of what Pershing originally proposed. An interesting fact is that they spent seventeen cents per each Target share they owned on the proxy contest. Though one could argue that is negligible when you consider that Target was up $14 within the timeframe of the proxy fight. In the end, Ackman "continue(s) to believe that Target stock offers an attractive potential reward for the risk of ownership at current prices, particularly in light of the motivational impact on the company of the recent proxy contest." Well, we shall see. Ackman did go on to say that he sees Target remaining a longer term holding for the funds.

Borders Group (BGP)

Secondly, Ackman focuses on their Borders (BGP) position. Ackman was happy to report that year-to-date, Borders has appreciated 985% due to the management change amongst other things (ex-Pershing Square member Mick McGuire is now chairman). Ackman did concede that sales continued to decline, but he points out that they "appear to have stabilized at a lower level than last year." Currently, Pershing has an economic interest of 40% of the shares outstanding (including total return swaps, warrants, and common stock). Pershing "received 14.7 million warrants originally struck at $7.00 per share in connection with a $42.5 million loan we made to the company in March of 2008 and our commitment to purchase Borders' foreign subsidiaries in certain circumstances. Our commitment to purchase these subsidiaries could only be exercised at a price we believed to be materially below the fair value of these foreign subsidiaries and was subject to a no-material-adverse-change condition." Ackman still believes that despite a harsh economy and risks to Borders in general (digital book sales, etc) that there is still room for discount bookstores in the US. He actually sees bookstores morphing in business model as time goes on to adapt to the changing environment. In the end, the average price of their position is $6.98 per share.

General Growth Properties (GGWPQ)

Thirdly, Ackman turns his focus to General Growth Properties (GGWPQ) where he sees the company emerging from bankruptcy because their assets are greater than their liabilities. In the end, he thinks that the equity will still have value as well. Pershing owns around a 25% economic interest in General Growth through stock and cash-settled total return swaps. He points out that the company has strong cash flows but just has a refinancing problem due to the inoperability of real estate capital markets. Pershing Square owns both debt and equity and they purchased it knowing full well that GGWPQ would have to go through bankruptcy. On the negative side, Ackman did fail to become the DIP financier (debtor-in-possession) of the company. However, he has since joined the board of directors and as such is restricted somewhat in the ability to trade their position. They fully realize the risks associated with the investment (although they think they will make plenty of money off of it) and they have hedged the position through "certain short equity and CDS invesments in other companies."

Positions They Sold

They sold out of Wendys Arbys (WEN), Visa (V), Dr Pepper Snapple (DPS) and cited valuation and more attractive opportunities as their reasoning. Due to the economic environment, they have become increasingly concerned with the valuations they are willing to pay for certain companies. They also have reduced the CDS (credit default swap) portion of their portfolio as well, selling investment grade CDS (which they are calling a hedge) as risk started to dwindle away.

CDS Positions

While they sold out of some CDS, they "continue to hold substantial single-name CDS positions in the holding company debts of financial institutions which we believe have a reasonable likelihood of requiring large amounts of additional equity capital." Ackman goes on to cite that these CDS offer the potential of large profits and have low carrying costs, which make it an attractive opportunity, as well as a hedge.

Short Positions

Pershing typically does not short individual equities, as they prefer to use CDS and other instruments that offer greater reward. However, they have currently taken on two shorts (to coincide with GGP and Target) where they "believe correlated short equity opportunities exist which offer less upside stock price potential and have downside potential which is highly correlated with our corresponding long investments." Ackman cites this as a response to the inability to predict the true length and severity of the recession we are currently in.

New Positions

They also started 2 new longs in "large capitalization U.S.-based businesses with dominant global franchises which generate growing free cash flows" and Ackman does not see them going activist on these two holdings. Right now, one of the holdings is only 3% of their fund (as it has appreciated in price, not allowing them to establish their full position size). The other position is around 7% of their portfolio and they are looking to take it to an even higher percentage of the overall portfolio.

In terms of recent performance, Pershing was up 1.4% for the month of June and is up 11.3% year to date as of that timeframe all as noted in our June 2009 hedge fund performance update. In terms of number of positions that are each greater than 0.5% of the portfolio, Pershing has 9 longs and 3 shorts. The vast majority of their longs are Large Cap names, while the same can be said for their shorts. Keep in mind that Pershing also has long CDS exposure (credit default swaps) to the tune of around $900 million. You can view Pershing Square's portfolio here.

Overall, interesting insight from Bill. As you can see, he runs a pretty concentrated portfolio and likes to focus on his "best ideas" so he can devote time to those positions that desire activist change (namely: Target & General Growth). Since Pershing only has a few short equity positions, it would have been interesting to gain more insight regarding those, but let's be honest... short positions are more often than not a hedge fund's prized possession and won't slip out easily. However, inquisitive minds can take the hints provide and make an educated guess as to what they are shorting. As always, we'll continue to track Ackman & Pershing's movements and will post updates as we see them. We've covered Bill Ackman plenty on the blog and you can check out our profile on him here, Pershing Square's portfolio here, as well as his presentation on General Growth Properties (GGWPQ) here. Stay tuned as we continue to sift through some of the recent batch of hedge fund investor letters!