market folly

Bill Ackman's hedge fund Pershing Square Capital Management released their second quarter letter to investors and courtesy of Dealbreaker we're going to take a look at a few of his latest portfolio moves. Pershing's main fund was up 3% for the year net of fees at the end of Q2. Keep in mind that Bill Ackman will be presenting at the upcoming Value Investing Congress next month in New York City as well, and you can receive a discount here before the event sells out to hear his next idea. In the mean time, let's see what he's been up to.

Firstly, Pershing sold completely out of Yum Brands! (YUM) as the stock approached their estimate of intrinsic value. Secondly, they re-added shares of Automatic Data Processing (ADP) as the stock dropped despite reporting strong results. The 'undervalued high quality large cap' theme has been prevalent in many hedge fund portfolios and Pershing is no different as they've acquired shares of Kraft (KFT) in quarters prior (see their Kraft thesis here). Of this theme Ackman writes, "The resulting investor pessimism has caused stocks - even those of large capitalization, dominant, economically resilient business franchises which are the focus of our investment strategy - to trade at substantial discounts to our estimates of business value."

New Investments

The most notable takeaway from Pershing's Q2 letter is their disclosure of two new positions: a position in BP (BP) credit default swaps (CDS) as well as a portion of the securitization of debt on the Peter Cooper Village/Stuyvesant Town. Regarding BP Ackman feels that "the Gulf disaster has (1) likely permanently impaired the ability of BP to operate effectively in the US, (2) the clean-up costs, penalties, and legal liabilities of the spill will continue to impair the company's credit for many years, and (3) there is a substantially greater probability than is reflected in the pricing of the CDS that current liability estimates that have been publicly promulgated materially underestimate the ultimate costs to BP."

In the past, Ackman and fellow hedge fund manager Whitney Tilson of T2 Partners have shared some of the same positions in their portfolios. Not this time. You'll recall that Tilson is long BP and we detailed his in-depth analysis of BP here. It's intriguing to see this dichotomy of opinion between the two managers who are normally in agreement. At first glance it appears that they are on different sides of the trade this time around.

However, if you drill down their respective theses, they aren't necessarily betting against each other. Tilson is betting that the spill cleanup costs are overstated and that BP would be able to stop the leak, sell assets to raise cash, and meet even the worst case scenario estimates of clean up costs. While he is a value investor, this is more of an event-driven play with a shorter timeframe.

Ackman, on the other hand, seems to be wagering against BP's long-term creditworthiness. Some of you may be wondering why Ackman didn't just short the stock and there are two possible reasons for that. Firstly, as just mentioned, he is betting against the creditworthiness of the company rather than the fundamentals of the business itself. Secondly, as detailed in our profile of Pershing Square, Ackman prefers to use credit default swaps for exposure on the short side of the portfolio.

Their latest positions come in addition to Pershing acquiring a recent Citigroup (C) stake and we previously covered why Ackman bought Citigroup as well. Check out Ackman's full commentary in Pershing Square's second quarter letter to investors embedded below:



You can download a .pdf copy here.

To learn more about Bill Ackman, he is the subject of Christine Richard's book, Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff. For more great hedge fund manager commentary, check out the latest letter from Dan Loeb's Third Point as well.