Chapter 6
The Activist Answer
William A. Ackman
This is not a black-box strategy. With most of our investments, we share our thesis about what’s going to happen.
—Bill Ackman, February 2011 interview
“What motivates people to succeed?”
That was the question posed by the 45-year-old hedge fund manager Bill Ackman to a roomful of students in a real estate entrepreneurship class at Wharton Business School. It was a sunny afternoon in October, the last class of an eight-lecture series, and the students had prepared by reading Christine Richard’s book Confidence Game, which details Ackman’s six-year battle with bond-insurer MBIA. But even after a few hundred pages on that struggle, and the subsequent fight with then New York Attorney General Eliot Spitzer, the students were still not prepared for Ackman’s answer.
“Sex,” he told them. “People don’t like to admit it, but it’s the primal driver.”
There was pin-drop silence. Slowly, a few chuckles began to break out from the back of the room. Ackman took off his suit jacket, rolled up his sleeves, and glanced up at the clock. Perpetually overcommitted, the founder and CEO of $11 billion fund Pershing Square Capital Management had been in meetings in surrounding Pennsylvania all day and, by then, was running low on energy.
Pershing Square’s goal is to work closely with the companies in which it invests to make their businesses more valuable by improving operational performance, selling or spinning off noncore divisions, recruiting new management, or changing the company’s strategic direction or corporate structure, among other approaches. In time, these changes should be reflected in the stock price. “We buy 8, 9, 10 percent of the company when we see long-term value in the investment, when the pieces are worth significantly more than the entire business or an operational change needs to take place,” he said. “We don’t predict when the stock market is going up and down or what’s causing that,” said Ackman. “So we’re not in a rush to get out.”
Ackman says that he expects most of the firm’s investments, particularly ones in which it takes an active role, will be owned by his fund for years. Pershing Square is typically the largest or one of the largest shareholders of a company, and therefore assumes a degree of illiquidity in taking such large long-term holdings. This strategy evidently worked. The fund has never relied on leverage and has averaged a 21.4 percent return since inception in 2004.
After taking a sip from the water bottle beside him, Ackman propped himself up on the desk at the front of the class and glanced at the clock once more. There was an hour and a half to go. “Fundamentally,” he continued, “what drives most human behavior is basically foreplay.” The students began turning to look at each other, not quite sure how to react. He trailed off as the room erupted in laughter and Ackman smirked goofily, sporting a slight blush.
His shock of prematurely white hair, dark black eyebrows, and light green eyes earned him the nickname “silver fox” by disgruntled employees of Target during his long and ultimately unsuccessful 2008 proxy campaign. To them, he looked dangerous and rich, yet there are facets to Ackman’s life that are simple—for example, he has had the same close friends for 25 years. Professionally, Ackman hopes to be known for creating value, not for arrogance, which he believes people who don’t know him confuse with confidence.
His friends agree. “Bill has an innate self-confidence that is a force of nature,” says Jonathan Gray, senior managing director and head of Global Real Estate at private equity firm Blackstone. The two met in 2000 through their wives at Temple Emanuel, their daughters’ nursery school. “It not only makes him a brilliant contrarian investor, but also the ultimate couples’ matchmaker and a philanthropist who can and will make the world a better place.” For example, he’s proud of his investment in shopping mall owner General Growth Properties and helping to make the company more valuable by successfully steering it through the bankruptcy process in 2009 and 2010. “I get thank-you notes from people who bought the stock at 50 cents who still own it. When someone buys something that goes up 40 times, it can actually make a big difference in his or her livelihood. I have letters from people who lost their job and then invested some of their IRA in General Growth, and it saved them,” he says.
Always energetic, Ackman morphs from aggressive, when dealing with stubborn executives of underperforming companies, to charming and benevolent when dealing with his partners and employees, whom he considers like family. But Ackman understands the dynamic between him and the embattled executives of the companies he targets. He likens a company’s board of directors to a club, to which he’s been reluctantly invited. “Do you really want to invite in the outsider who’s barging his way in the door because he bought a bunch of stock in your company? That’s how some directors think about it,” he explains. But that doesn’t stop him from doing his job with laser-like focus.
Ackman had gone to Wharton that fall day to give a lecture on failure—something the billionaire knows a thing or two about. The memory of his past failures keeps him grounded, as grounded as he could be at this point in his life. For all of his money, Ackman still drives a Volvo, although that is not to say he doesn’t make use of his private plane for business trips. Ackman also keeps a Ferrari, bought on a whim, parked in his upstate New York country home. After an almost 20-year-long career running his own hedge fund—first Gotham Partners and then Pershing Square—he had made it into the billionaire’s club, but not without his fair share of challenges and hardships along the way.
“Raising money for a start-up hedge fund is a lot like blind dating,” Ackman says. “You meet someone you’ve never met before, you have a limited time in which to make the pitch, and then you try to close the deal. Charm matters,” he says with a chuckle. “And sometimes people with the best ideas aren’t very good at blind dating. When I decided to run a hedge fund out of school, I’d meet with 100 people before one or two would finally agree to invest with me. In order to be successful, you have to make sure that being rejected doesn’t bother you at all. So for example, in college when I was dating and a girl didn’t like me, I didn’t get upset. I thought that if she didn’t like me, then she clearly wasn’t right for me. You should surround yourself with people that believe in you, in life, and in business.”
William Albert Ackman was born May 11, 1966, the younger of the two children of Larry and Ronnie Ackman. Raised in the affluent suburban town of Chappaqua, New York, Ackman was an ambitious, blunt, competitive, not to mention confident student at Horace Greeley High School. Ackman captained the tennis team and made it to the New York State quarterfinals. Ackman still managed to balance work with play and graduated fourth in his class. He even had a $2,000 bet with his father that he would earn a perfect score on the SATs, although his dad withdrew the bet the night before the exam for fear that he would lose. Though he didn’t get a perfect score, Ackman’s confidence and ability got him quite close.
His older sister, Jeanne, entered Harvard in 1983; Ackman followed her a year later. Jeanne would go on to Yale Medical School and then practice medicine in Boston after completing a fellowship at Brigham and Women’s Hospital. Her younger brother would come back to New York after school and follow a very different path.
“I was a pretty confident kid,” he admits, laughing as he remembers his time as an undergraduate at Harvard. “I’m an optimistic person, and I thought I would be really successful. I once made the argument that my net worth has really never gone up, because when I was younger, I assumed that I would do really well, and I have always had the present value of whatever I was expecting to earn over time. As each year goes by, my net worth accretes to what I expected it to be over time,” he laughs again. “I wanted to be successful.”
Already entrepreneurially minded, Ackman came up with an idea for a book while he was a freshman in college. Seeing firsthand how competitive the application process for Harvard College had been, Ackman wrote a book on how to write a college admission essay and included 50 or so successful application essays as well as interviews with admissions officers from Ivy League colleges. He presented the idea to an author friend of the family who attempted to sell it to several publishers, but he didn’t end up getting a deal. “I sent the book to seven publishers pitching my idea and came back with six rejections and a job offer from Workman Publishing.” Not long after, Ackman was surprised to find out two Yale graduates came out with a remarkably similar book, which ended up becoming a New York Times bestseller. “Two guys at Yale heard about the idea and copied it. I vowed then never to get discouraged into thinking my ideas weren’t worth pursuing,” says Ackman.
It was at Harvard that he met Whitney Tilson, who would become a lifelong friend. He would follow Ackman into the world of investing, launching his own fund, T2 Partners. Tilson met Bill when they were both teenagers, and they worked together as advertising salesmen for the Let’s Go series of travel books during the summer of 1986, when they were students at Harvard College.
“Bill was a hell of a salesman,” Tilson said. “He was very smart, very persuasive, and he was a very savvy businessman even as a teenager. He clearly had a passion for business and investing at a young age. It is a profession where experience matters a lot. There is no doubt he was at the top of the experience curve at a young age.”
Running his own firm is particularly satisfying for Ackman, who says the biggest driver of his early life was independence. “I wanted to be able to say whatever I wanted to say,” he recalls. “I wanted to be able to do whatever I wanted to do.” Nothing in particular inspired this desire in him; he was a typical kid, expected to obey his parents no more or less than usual.
“From the time I started investing, I’ve always been a fixer.” In fact, Ackman’s knack at rehabilitating troubled companies extends to his personal life relationships as well. He took an awkward college roommate under his wing, getting him contact lenses, taking him to the dermatologist to cure a bad case of acne, and prodding him to have a healthier diet and exercise regimen. “He was a character.” After the makeover, the friend became more confident. One night Ackman and a group of roommates took him to Wellesley, where he met a girl whom he eventually married, a story Ackman tells with a smile.
Ackman’s first insight into value investing came at a cocktail party at his parents’ Upper East Side apartment where he met a successful investor named Leonard Marks, who introduced Ackman to the investing world. Eager to learn, he followed Marks’s recommendation that he read The Intelligent Investor by Ben Graham, the book famous for having inspired Warren Buffett. For Ackman, reading his first investment book, he says, was like reading Jean-Paul Sartre’s Essays on Existentialism in college: “Either it inspires you or it doesn’t. And The Intelligent Investor made sense to me.” He was drawn to investing due to the frustration he felt in the real estate brokerage business. While he liked earning a fee for every deal he did, he couldn’t help but notice that the entrepreneurs did a lot better, and had more fun. Ackman thought he was at least as capable as the clients he worked for in the brokerage business, so he decided he would become the principal, the person making the investment decisions.
Ackman went on to read a library of books on investing while at Harvard Business School, including Seth Klarman’s Margin of Safety right after its publication. Impressed, Ackman contacted the author, the founder of the Baupost Group. “Hi, I’m a Harvard Business School student, and I just read your book,” Ackman recalls saying to Klarman. “I’m not looking for a job. But I’d love to learn from you. You mind if I come in and share some ideas?” The two established a relationship that lasts to this day. At the time, Ackman had about $40,000 saved from the real estate business that he considered “extra” money: his tuition in investing. If he lost those funds, he reasoned, it amounted to one more year of business school tuition, room and board. “I went to business school to learn how to be an investor. This is what I wanted to do as a career.”
Shortly after arriving at Harvard Business School (HBS), he opened up a Fidelity Brokerage account in October of 1990 and bought Wells Fargo, his first stock. Another early investment was Alexander’s, a department store chain that filed for Chapter 11 in 1992. At the time, Vornado Chief Steve Roth owned 27 percent of the company. When it filed for bankruptcy, Ackman bought 2,000 shares for $8⅜, an investment that made up about a third of his personal wealth at the time. While the company had closed all of its money-losing stores, it owned a number of very valuable real estate assets, including its crown jewel property located at 59th Street and Lexington Avenue in Manhattan. The company ultimately converted to a REIT and the stock eventually reached more than $400 per share.
Less than a year after he bought the stock, Ackman sold it for about $21, and it proved to Ackman that you can invest in the stock of a bankrupt company and still make money. He also learned that by selling early he might be leaving a lot of money on the table. He discovered that as long as a company was solvent—or had assets that were worth more than its liabilities—even in bankruptcy, you could create value for shareholders. The experience had a big impact on the young investor. “I made a nice profit,” he remembers. “Had I lost half my money, I might be a lawyer at this point.”
Two of the most influential, and what Ackman perceives as formative, experiences that he had at Harvard Business School were hearing Warren Buffett and Richard Rainwater speak to students. “I was expecting Buffett to teach us how he values companies, but he didn’t,” says Ackman. “He spoke to us about character. Buffett said one can immediately obtain the qualities that make for a good reputation by just making good everyday life decisions. He also reminded us that your reputation can be lost overnight and to therefore protect it with your life. I never forgot that,” says Ackman.
Richard Rainwater, however, gave Ackman the courage to start his own fund. An investing legend who had largely stayed under the radar, Rainwater had reportedly turned $50 million from the Bass family in Texas into billions of dollars in a relatively short time. Ackman stood in line to speak to Rainwater, and when he reached the front, the confident Ackman invited the billionaire investor out to lunch. There Ackman asked Rainwater if he thought it was a stupid idea for him to start his own fund right after graduating. “He said to me, ‘You don’t have to be old to be right.’” That was the only reassurance Ackman needed. From that point forward, he decided that he would start his own fund.
“Everyone told me it was a really stupid idea to start my own hedge fund right out of business school,” says Ackman of the idea. “That’s how I knew that it was a good idea.” His father was opposed to the idea and encouraged him to get some more experience before starting his own fund. It didn’t matter what anyone said, Ackman was going to do it anyway. He was “daring to be great.” Almost 20 years later, in 2011, he’d give Ron Johnson the same speech while convincing him to leave Apple and become JCPenney’s CEO in an effort to completely transform the retailer.
One of his classmates, David Berkowitz, an MIT-educated engineer, was always asking interesting questions and giving insightful comments during class, and Ackman wanted him on his team. They began a two-member investment club and began analyzing and investing in stocks after class. After working together for little more than a year, the duo decided to partner on launching their own fund.
As graduation approached, Ackman and Berkowitz started seeking investors. Marty Peretz, the editor-in-chief of the New Republic magazine and Ackman’s thesis adviser from his days as an undergraduate, became their first investor, with a $250,000 commitment. “From day one,” remembers Ackman. “I was always unafraid to ask someone to invest because, I thought that, while capital was a commodity, good investment ideas were rare assets.”
Ackman and Berkowitz continued to shop around for investors, using every contact and resource they could muster. They even landed a million-dollar client introduced by Ackman’s future mother-in-law, real-estate broker Marilyn Herskovitz. They eventually scrounged up $3 million and set up shop in a windowless office in the Helmsley Building that they leased from brokerage firm Furman Selz.
“Investing is one of the few things you can learn on your own,” says Ackman, explaining why he felt the need to go off on his own rather than apprentice for a well-known investor. “I felt I had the basic skills to be a successful investor, and if you think you’re Picasso, you’re not sure you want to learn from another artist. I had an unlevered strategy, doing plain-vanilla value investing—not something complicated or particularly risky. I thought, in the worst case, if I fail, I’ll be able to get a job,” he says. So Ackman started Gotham Partners in 1992, at age 26, straight out of Harvard Business School.
Prior to HBS, after getting his undergraduate degree, he had spent two years working for his father’s real estate brokerage firm, Ackman Brothers & Singer, as a broker arranging financing for real estate owner-developers. The sale of Union Center Plaza, an office complex in Washington, D.C., was Ackman’s first big deal shortly out of college in late 1988. It was a complicated deal and a formative experience for Ackman, where he learned to think about complex interests in real estate, knowledge that would prove invaluable for what lay ahead. “If I hadn’t worked on Union Center, I wouldn’t have been able to understand the first thing about Rockefeller Center Properties,” he says referring to his bid to take over and restructure the New York City landmark in 1996. Even though Ackman didn’t win control of Rockefeller Center, his active pursuit and brilliant plan put the young 28-year-old on the map in the eyes of the world’s biggest real estate tycoons and landed him a coveted spot on the Crain’s New York Business “40 Under 40” list.
Ackman still sees the Rockefeller Center deal as one of the most significant investments of his entire career. He spent many months analyzing the company, and the more he studied it, the more he admired what he calls the “brilliant” structure of the company. In the mid-1980s, the Rockefeller family wanted to take out a $1 billion-plus mortgage loan on the property, but there wasn’t a bank big enough to lend it to them. Instead, they set up a public company structured as a real estate investment trust (REIT) called Rockefeller Center Properties. That company then made a $1.3 billion mortgage on Rockefeller Center, with the mortgage the public company’s only asset.
The public company was complicated; it was financed with debt and equity. The mortgage was a participating, convertible mortgage with many additional fancy features to it. David Rockefeller was chairman of the board, and investors bought the stock largely because it paid a big dividend and they liked the idea of partnering with the Rockefellers. As the real estate market was falling apart in the early 1990s, the company was forced to cut the dividend. The stock price collapsed, and the REIT was under a lot of financial stress due to its high debt load and its inability to roll over its short-term financing.
Rick Sopher, Chairman of LCH Investments NV, the world’s oldest fund of funds recalls: “I was introduced to Bill in 1995 as I had been doing some work at Edmond de Rothschild Securities on the Rockefeller Center situation and hoped Bill might buy a few bonds through me. But I was overwhelmed by the energy with which he tore into this terribly messy situation; how he came back within days having done more research than I had ever imagined was feasible. He had literally paced out the buildings, scrutinized the leases and uncovered all manner of really complex issues which even the company had yet to fully appreciate. Later on, I was struck by his hunger and imagination; whereas a normal investor might have settled for buying a few undervalued bonds, Bill, even at that age, was staggeringly brave and ambitious, coming up with far more lucrative plans. I suppose that encounter with Bill in 1995 was one of reasons I became so enthusiastic about investing with external managers of this type.”
Ackman cleverly figured out that by buying the stock in Rockefeller Center Properties on the stock exchange, you could create an interest in Rockefeller Center at a very low price. “And if you could foreclose on that mortgage, you could own Rockefeller Center for a fraction of its long-term value. In addition to six million square feet of office space, it included some of the most valuable yet undermanaged retail space in the world, two million square feet of air rights, Radio City Music Hall which was rented for one dollar a year, and more,” says Ackman one cold January morning at his forty-second floor offices at 888 Seventh Avenue. Snow fell below as Ackman looked out on the afternoon New York City skyline from his office. He had a gleam in his eyes and seemed to get excited again just thinking about his long-ago plan.
“So I ran around town trying to convince another investor to partner with us so we could buy the whole company and own Rockefeller Center,” Ackman recounts. But no one seemed interested or understood what he was talking about. “I spoke to the smartest real estate investors I could find including Richard Rainwater and Steve Roth,” he says. Then his dad told him to call Joe Steinberg, President of Leucadia National Corporation, a publicly traded investment holding company. Steinberg agreed to meet, and their half-hour meeting turned into four hours of going through the deal. Ultimately, they ended up partnering on Rockefeller Center, and Leucadia bought a big stake alongside Ackman in the company. This was Ackman’s first high-profile active investment and the beginnings of an important relationship with Leucadia, with whom he would partner on many future deals including a $50 million investment from Leucadia that would help launch Pershing Square about 10 years later.
Ackman’s proposal to take ownership of Rock Center called for a recapitalization of the REIT through a $150 million rights offering backed by Gotham and Leucadia. The board turned down Ackman’s and Leucadia’s proposal, opting for a deal with a white-shoe group which included David Rockefeller, Tishman-Speyer Properties Inc. and the Whitehall Street Real Estate LP, a real estate investment fund managed by Goldman, Sachs & Company, who on October 1, 1995, offered to pay $296.5 million, or $7.75 a share, for the company. The investor group at the time would also assume about $800 million of the real estate investment trust’s debt, about $191 million of which was owed to Whitehall and a Goldman Sachs subsidiary.
Before the Goldman deal closed, Ackman received a call from Donald Trump who said that Goldman Sachs was trying to steal Rockefeller Center. “We have to do something about it,” said Trump. “I’ll come by your office.” Embarrassed by his sparse surroundings, Ackman quickly offered to hop a cab to Trump Towers instead. Trump’s idea was to convert 30 Rock into a residential condominium, but the tower had been nearly fully leased for many years into the future to multiple tenants, making the strategy unfeasible.
In July 1996, Goldman Sachs, Tishman-Speyer, the Agnellis, and David Rockefeller were awarded the deal and took control of the complex for $1.2 billion in cash and assumed debt. Gotham made a tidy profit on its investment in the REIT.
Though he didn’t end up owning the property, Ackman values the experience and relationships he made during the course of the investment. After the deal closed, Leucadia sent Ackman a check for a half a million dollars and four Concorde tickets to Paris.
Steinberg has gone on to do many deals with Ackman, and the two have become good friends who get together for boys-only scuba diving trips off the coasts of exotic islands. The experience also earned Ackman a letter from David Rockefeller and an invitation to lunch at the Four Seasons with Rockefeller and Jerry Speyer. In the letter, Rockefeller thanked Ackman for his restraint in not using his large shareholding to block their deal. Ackman still keeps the framed letter on his desk.
Despite the monumental experience, the deal still haunts him. “For years,” Ackman recalls, “I couldn’t walk by Rockefeller Center without getting butterflies in my stomach reminding me that I missed out on one of the greatest investments of all time,” he says. But he learned from the experience. “It taught me that you can make a lot of money as an equity investor in a near-bankruptcy,” he says. It would be a lesson he’d end up using to make the best investment of his career.
By 1998, five years after opening up shop, Gotham Partners had grown from $3 million under management to over $500 million. After the Rockefeller Center deal had closed, Ackman walked away with some powerful players on his side. Vornado’s Steve Roth told Ackman that to call him next time he had a good idea. According to public sources, Gotham attracted prominent, well-respected investors as its limited partners. Hedge fund legend Jack Nash gave Ackman $1 million to invest. Years later when Nash shut his fund, many of Nash’s investors turned to Gotham. Even David Rockefeller invested.
Return on Invested Brain Damage
Ackman’s first proxy contest for control of the board of First Union Real Estate did not end up being a good investment but was an important experience. Ackman credits the investment for helping him create his “return on invested brain damage calculation,” which taught him to consider time and energy required in the calculation of whether an investment made sense
On July 14, 1997, Gotham sent a letter to First Union’s board of directors voicing his concerns about the direction of the company and asking for a meeting with the board of trustees. Ackman had been building up a stake over the past year and was not happy about the current state of the company. But after many requests, First Union still refused to meet. “First Union was a paired-share REIT,” explains Ackman. “This was a company with a grandfathered corporate structure. It was a REIT ‘stapled to’ a ‘C-corporation,’” a traditional corporation that could own any kind of business. So when you bought stock in the company, you actually were buying interests in two companies. The structure enabled First Union to own real estate–intensive operating businesses that could not normally be held by REITs, thereby minimizing their corporate taxes. Since there were only four such paired-share REITS in existence, Ackman believed that the company’s unique structure made it worth well more than the value of its real estate assets.
So Gotham solicited proxies to replace all but three of First Union’s trustees up for election at the May 19, 1998, meeting, putting up Gotham nominees Ackman and David Berkowitz and seven other directors, including James Williams, chairman of Michigan National Bank, and Mary Ann Tighe, a highly successful leasing broker from New York. When Gotham got on the board of First Union, “it was a mess,” says Ackman. The previous board, in a scorched earth strategy, had triggered a change in control under all of the company’s indebtedness, including $100 million of public bonds. “So we negotiated a deal with the company’s bank lenders and borrowed $90 million in a bridge loan from a group of shareholders, paid off public debt, did a rights offering to pay back the loan, and then brought in a new management team,” says Ackman, who became chairman after the successful proxy contest.
During the proxy contest, the company’s paired-share structure was severely restricted by a change in the tax law due to lobbying by the Marriott Corporation and other hotel companies who felt the paired-share structure was an unfair competitive advantage.
After the Gotham directors were voted in with a landslide victory, they controlled a company that had lost nearly all of the benefits of its paired-shared structure. It was highly leveraged, with nearly $300 million of recourse debt in default or puttable as a result of the prior board’s not approving the new directors. It also had a jumble of different B-minus or worse real estate assets. Without a viable alternative, the board elected to largely liquidate the company, selling assets to pay down debt until it was finally reduced to assets that could not be sold, a pile of cash, and some contingent liabilities that were difficult to value.
These unsalable assets and complex contingent liabilities, however, prevented the liquidation from being completed within a reasonable period of time. The company then hired an investment bank to solicit interest in First Union’s public listing and cash assets. While nearly 90 potential companies expressed interest in signing a confidentiality agreement and learning more, none came forth with a proposal to merge with the company.
The board then approached Ackman about merging with a golf company held by Gotham Partners. After months of negotiation with the board, which included representatives from Apollo, the private equity firm, and Cerberus, as well as Bruce Berkowitz, now the manager of the Fairholme Fund, in September 2001, the company announced a deal to merge Gotham Golf and First Union. In late 2002, that deal would founder when a New York judge issued a temporary restraining order, which would later be overturned on appeal more than nine months later in September 2003.
In mid-2002, Ackman made his first publicly disclosed short position in a company called Farmer Mac. Ackman used credit default swaps (CDSs), which were just gaining prominence, to express the short position. Ackman believed CDSs were a more attractive way to short a company given their limited downside and potential for asymmetric returns. He had started researching the Federal Agricultural Mortgage Corporation, or Farmer Mac, earlier that year after his close friend from college, Whitney Tilson, recommended that Ackman take a look at the stock as a potential long investment.
As he took a closer look at the company, which was chartered by the U.S. government to create a secondary market for farm loans, Ackman got more and more interested. The company relied extensively on short-term financing to fund its business, making its viability highly vulnerable to its ability to access the capital markets. Ackman had concerns about the quality of the company’s loan portfolio and its leverage ratios. Even though the company was unrated by the rating agencies, its debt traded like triple-A-rated bonds with a very tight spread to Treasuries, and this contributed to Bloomberg’s mistakenly reporting the company’s debt as triple-A rated, due to confusion in the marketplace about the company’s connection to the U.S. government.
After Ackman met with and questioned the CEO, he confirmed the insights that he had gleaned from his research, and began to build a short position in the stock and debt of the company through the purchase of CDSs.
The only problem with this short idea, Ackman believed, was that unless somebody was willing to say that the emperor had no clothes, the game could go on for years.
On the advice of his lawyers, Ackman decided to write and publish a white paper about the company’s weak financial condition and failed business model. The market reacted quickly to the publication of Ackman’s first report on the company, entitled “Buying the Farm,” in which Ackman disclosed his short position in a disclaimer written by his lawyer on page one. “Buying the Farm” Parts II and III followed shortly thereafter when Ackman responded to a series of company conference calls that attempted to rebut his published reports.
The experience earned Gotham around $70 million after the stock sold off and credit spreads widened. Later, a report issued by the Government Accountability Office (GAO), in response to a Senate Agricultural Committee investigation, validated many of Ackman’s concerns. Shorting Farmer Mac later seemed prescient as mortgage lenders Freddie Mac and Fannie Mae, companies with a similar business model to Farmer Mac that Ackman also shorted through the CDS market in 2002, turned worthless during the financial crisis in 2008.
Pleased with the profits from his Farmer Mac investment and interested in the potential returns from purchasing CDSs on companies with undeservedly high credit ratings, Ackman began researching other potential short candidates in mid-2002. Michael Neumann, a salesman on the Lehman Brothers credit desk, who had sold him CDS contracts on Farmer Mac, suggested that Ackman look at the bond insurers.
Ackman zeroed in on MBIA. It was the largest of the bond insurers, the largest guarantor of municipal bonds in the United States. While MBIA had its origins insuring low-risk municipal bonds, in more recent years it had begun to move into the more lucrative business of insuring exotic and highly risky collateralized debt obligations (CDOs) and other structured products. Ackman believed that the company was underreserved relative to the risk it was underwriting, was overleveraged, and was engaging in various accounting devices to shield losses and accelerate gains. He believed that it was poised for a dramatic fall. Ultimately, Ackman concluded that the business, despite its triple-A rating, was likely insolvent. Ackman shorted the stock and built a large position in CDSs on the company.
As with Farmer Mac, Ackman wrote a detailed white paper on the company’s flawed business model and accounting failures. Prior to releasing it to the public, he shared the details of the report with Alice Schroeder, then the number one Institutional Investor–ranked insurance analyst. Schroeder sent Ackman’s findings to the CEO of MBIA, Jay Brown. Brown then contacted Ackman requesting a one-on-one meeting. At the meeting, Brown discouraged Ackman from releasing his report and suggested that MBIA would use its powerful relationships as the largest guarantor of New York State and City bonds to cause Ackman trouble: “You are a young guy early in your career. You should think very hard before releasing that report,” Brown warned.
Ackman published it nonetheless, and almost immediately, Ackman says, “a whole bunch of bad things started to happen to me.” To that point, Ackman had lived a charmed life. He was happily married to his wife, Karen, whom he had met at Harvard. He was father to two young daughters, had a sizable net worth, and had an eight-room apartment on Central Park West in the landmark Majestic apartment building.
A month or so later, in December 2002, a New York State judge issued a preliminary injunction, halting the merger between Gotham Golf and First Union, putting Gotham in an untenable position. Ackman and his partner, Berkowitz, had negotiated a deal with the Ziff family to buy out the Ziffs’ interest in the firm, and were in the process of negotiating a deal for a new investor to invest $50 million in the fund and own 15 percent of the firm. With some investors asking for their capital back and with tremendous uncertainty about the outcome of the Gotham–First Union merger, it became difficult to value Gotham’s assets for the purpose of admitting and redeeming investors.
“We ultimately decided the only fair way to treat investors was to wind down the fund,” says Ackman.
Then things got more complicated. After MBIA complained to New York Attorney General Eliot Spitzer that Gotham was spreading false and misleading information about their company, in January 2003, Spitzer subpoenaed Gotham, and the SEC began an inquiry shortly thereafter. Between March and June of that year, Ackman faced six days of testimony with the attorney general’s staff. He had no idea the battle would ultimately last for six years. He just knew that, eventually, the bond insurer’s house of cards would crumble.
Besides his sale of Gotham Golf to First Union being stopped by a New York Supreme Court judge, Ackman had to endure embarrassing public scrutiny. At that time, “there was an article in the paper seemingly every day about Gotham or hedge funds being [Eliot Spitzer’s] next target,” Ackman says. “It was not fun to take my daughter to nursery school. Sometimes it seemed as though other parents would pull their children away from me when I walked into the school lobby. When you have an aggressive regulator trying to find you guilty of something, even though you know you’re innocent, it’s a scary time.”
“It’s a very interesting experience to be accused of something in a country where you’re supposed to be innocent until proven guilty. I think regulators have a tough job. I think it’s an important job; they’re the police force of the marketplace. I just think they have to remember that the goal should be: is this man innocent or guilty? I think they are under pressure to prove guilt and that leads to some wrongful convictions.”
David Berkowitz left Gotham a few months later, in May 2003. After a decade of working together assembling Gotham, Berkowitz didn’t enjoy the stress and had no interest in going forward in the business. “David decided he had had enough and didn’t enjoy coming to the office anymore,” says Ackman.
With the overhang of MBIA still on his shoulders and his reputation dragged through the mud, Ackman felt an obligation to the investors. He worked unpaid in 2003, dealing with the issues and winding down the fund. Over the next few years, Ackman ended up returning to investors all of the liquid investments at market value and nearly three times the carrying value of the Gotham private investments.
Starting over wasn’t the easiest thing for Ackman to do, but it wasn’t the hardest thing he was doing at that time either. “The biggest challenge was when Eliot Spitzer, the most famous aggressive regulator in the world, had me in his gun sights and I was sitting across the table from three or four regulators who clearly didn’t care, in my opinion, whether I was innocent or guilty. They just wanted to find me guilty,” says Ackman. He did not let it affect his resolve. Ultimately, the SEC and Spitzer found no wrongdoing at Gotham or with Ackman or Berkowitz.
Despite a distressing year and without even a letter of acknowledgment from Spitzer’s office clearing his or his firm’s name, Ackman still wanted to stay in the game. Coincidentally, Ian Cumming, chairman of Leucadia National, happened to be vacationing at the same resort in Cabo San Lucas as Ackman and his wife in February 2003, and told the young manager that whenever he was ready to do something new, Leucadia wanted to be his partner. He had one stipulation: Leucadia had to be his sole partner, which meant he couldn’t accept money from any of his former investors.
In the fall of 2003, he did just that and ended up negotiating a deal with Leucadia to invest $50 million and launch his new firm, Pershing Square, with their backing. “So the only good thing I had going for me was that a very reputable investment firm with a track record better than Buffett’s from 1979 to the present agreed to put in $50 million,” says Ackman.
And so Pershing Square was born in January 2004, with Ackman vowing not to make the same mistakes twice: this time around, he would invest only in publicly traded securities.
After he made the deal with Leucadia, Ackman wrote a letter to all of his investors announcing that he was launching a new firm, but that the fund was not open to investors other than Leucadia. While Ackman always kept his investors informed even through the tough year winding down Gotham, he was surprised that the only angry calls he received during that time were from people who were disappointed that they were not permitted to invest in his new fund.
Ackman named the firm Pershing Square after the square in front of Grand Central Terminal, where his offices were located. The well-known café of the same name caused some humorous confusion for Ackman in the early days. He was having lunch at the Pershing Square Café one afternoon when the maître d’ told him he had a call from a very prominent businessman on the phone. When Ackman picked up and asked the man why he had called him at this number, he replied, “Well, I asked my secretary to find you and she just looked up Pershing Square in the directory and called.”
In June 2004, Pershing Square initiated a stake in Sears Roebuck & Company. “Sears was one of the first big investments we made,” says Ackman. “What attracted us to the company was that after they sold their $30 billion credit card business, the enterprise value declined massively. They used the money from the sale of the credit business to pay off their debt and to buy back a bunch of their own stock, yet the stock just continued to go down.”
“So we bought a stake in the company, but we were a tiny little fund without a lot of firepower. We believed the business had reached the end of its strategic life, and the pieces—the real estate, the brands Craftsman and Kenmore, Sears Home Services, the inventory, etc.—were worth a lot more than what the stock was trading. And we believed we could help unlock value by catalyzing a sale of the company to a strategic buyer—either a real estate investor or another retail company,” says Ackman. Remembering Steve Roth’s request to “come see me” with his next great idea, Ackman called him up. He pitched him and got him on board, and Vornado ended up investing about $400 million, giving Pershing and Vornado 4.9 percent of the company. Ultimately, they were a catalyst for the business being sold to Kmart in November of 2004.
Pershing also had a large position in Kmart when the deal was announced, and they made a lot of money when the two companies merged. “It was the best month in the fund’s history,” Ackman explained. That’s not the only reward Pershing received for their stellar investment; they also got a serious upgrade in office space.
Steve Roth’s Vornado owned a lot of premier office space across Manhattan, including the 888 Seventh Avenue skyscraper, which was the home to some of the world’s wealthiest hedge funds and private equity firms including George Soros’s Soros Fund Management and Dinaker Singh’s TPG Axon. The building, right across the street from Carnegie Hall, is now fully renovated with marble floors and sweeping views of Central Park. Roth gave Ackman a good deal for 10,000 square feet of space on the twenty-ninth floor. Ackman was happy. It was a big improvement from his first windowless office back in 1993.
In January 2005, Pershing was opened up to additional investors besides Leucadia. Rick Sopher, chairman of LCH Investments NV, who had been so impressed with Ackman’s dogged work on Rockefeller Center in the mid-1990s, jumped in immediately. “When Bill launched Pershing Square,” he says, “I was by then running Leveraged Capital Holdings, the world’s oldest multimanager fund. It was a rare case of it being totally obvious at the first meeting that we had to invest, and we received and subsequently subscribed on copy number one of the Pershing Square prospectus.”
Fast Food, Building Record Results
In mid-April of 2005, Ackman invested in Wendy’s, building an equity position through options, at which time he pushed Wendy’s to spin off the company’s Canadian Tim Horton’s subsidiary. “Wendy’s was the first high-profile activist investment we made at Pershing Square on our own,” says Ackman. “This was a company with a $5 billion market cap. We raised a coinvestment fund from a group of our investors, and we bought just shy of 10 percent of the company. We had started buying the stock right during the time someone supposedly found a finger in the chili at Wendy’s,” he recalls.
“That’s what helped create the liquidity for us to buy the stock,” he continued. “We were literally in the middle of our buying program when that happened. We were attracted to Wendy’s because they owned 100 percent of Tim Horton’s, a Canadian coffee and donut chain. At the time, Tim Horton’s was generating $400 million in operating income and we valued it at over $5 billion. Meanwhile, you could buy all of Wendy’s for less than $5 billion. So we figured that if you could buy Wendy’s and spin off Tim Horton’s, we would get Wendy’s for free, a company we believed was worth a few billion dollars,” says Ackman.
“The way the numbers worked is that we paid $38 a share and believed if you spun off Tim Horton’s, the stock would eventually double to $76 a share,” says Ackman.
In mid-July of that year, Pershing submitted a proposal recommending the spin-off of Horton, the sale of a large portion of the company’s restaurants to franchisees, and a share repurchase program. Despite his 10 percent ownership in the company, Wendy’s refused to discuss Ackman’s recommendations with him. “The CEO would not even meet with us.”
So Pershing Square hired Blackstone to write the equivalent of what some investors might call a fairness opinion. “We hired Blackstone to do an analysis of what Wendy’s would be worth if they implemented our plan.” We sent the Blackstone analysis to the board and filed it publicly in our 13D,” says Ackman.
Six weeks later, Wendy’s announced that it would sell 15 to 18 percent of Tim Horton’s in a tax-free spin-off during the first quarter of 2006.
In December 2005, Trian Partners, led by Nelson Peltz, Peter May, and Ed Garden, followed Pershing and announced that it had bought a significant equity position in Wendy’s. Trian also issued its own “white paper,” suggesting the company should spin off of all of Tim Horton’s as soon as practicable, sell-off ancillary brands like Baja Fresh and Café Express, improve margins at Wendy’s standalone restaurants through significant cost reductions and prudent revenue growth, and rethink previously announced strategic initiatives. Trian would later appoint representatives to the Wendy’s board in early 2006 about the time Wendy’s CEO was fired by the board.
In November 2006, it was reported that Ackman had liquidated his Wendy’s stake. From Ackman’s initiation in Wendy’s in mid-April 2005 to liquidation, Wendy’s stock appreciated from $38 to about $71.
“Wendy’s was a really good investment for us, making the fund a few hundred million, which was sizable as a percent of our total assets at the time,” says Ackman. “Wendy’s set us up for McDonald’s.”
In the late 1990s, Ackman’s Gotham Partners owned a small stake in McDonald’s and started looking into how the company could operate more efficiently. In the second half of 2005, Ackman invested in McDonald’s again, this time with a more involved plan. He viewed McDonald’s as three separate entities: a franchising operation (representing 75 percent of McDonald’s restaurants); a restaurant operation (company restaurant ownership of remaining 25 percent); and a real estate business (land ownership of nearly 37 percent of all restaurants and 59 percent of all buildings).
He would pick up with McDonald’s where he left off with Wendy’s and began building an equity position initially through options. His principal goal was to convince McDonald’s to sell or spin off its company-operated stores to the more entrepreneurial franchisees, who would materially improve the operating performance of the restaurants. This would have the additional benefit of improving the quality of McDonald’s earnings and cash flow as the assets that remained at McDonald’s would generate cash from rent and a franchise royalty stream from the franchisees.
“McDonald’s is what we call a brand royalty company, similar to what we worked to create at Wendy’s,” says Ackman. “The company collects about 4 percent of the gross revenues from franchisees for the brand name and franchise rights and about 9 to 10 percent in rent,” says Ackman. “When we initially attempted to convince the company that selling restaurants to franchisees would be a good idea, the push back was that the restaurants were profitable. Because McDonald’s owned the real estate and did not charge itself rent or franchise fees, the company’s operated stores appeared to be much more profitable than they were in reality.”
“Owning 13 to 14 percent of the gross revenues of every McDonald’s in the world is one of the greatest annuity streams of all time,” says Ackman. “Every time someone buys a Coke, McDonald’s get 14 cents right off the top. It’s an even better business than Coke. The problem was that McDonald’s had ‘deworsified’ their business by buying out a lot of retiring franchisees in the earlier years, so at the time of our investment they owned almost 30 percent of the restaurants. McDonald’s argued that it was important for them to have skin in the game by owning restaurants alongside their franchisees.
“The best franchisers in the world own very few restaurants. I would argue that Subway is one of the best franchisors because they don’t have to own any of their stores. The deal is a good one for the franchisee. And the franchisees are doing a good job. There’s little reason for a well-run franchisor to own any restaurants because the business of operating a restaurant is not nearly as attractive as the business of collecting a royalty in exchange for a brand,” says Ackman.
“We wanted McDonald’s to become more of a brand royalty company. We went to McDonald’s and we said, ‘Look, the entire business is trading at a discount to the sum of the parts comprised of the franchise business, the real estate business—together what we deemed the ‘brand royalty business’—and the company-operated business known internally as McOpCo. And the mistake you’re making is that the real business you want to be in is the brand royalty business, not the restaurant business. And the reaction to us was, ‘Well, you know, we’re earning a lot of money in our restaurant business. We make high- to mid-teens margins.’ We pointed out to them that they weren’t charging themselves rent or a franchise fee. And once you took off 4 percent in franchise fees and 8 or 9 percent in rent, and an allocation of corporate overhead and capital expenditures, they weren’t making any money operating restaurants.”
“So we said, ‘Look, if you sell these to the franchisees, you’ll collect the 14 percent royalty premium, and the franchisees will do a better job operating the stores which will grow the top line on which you get a royalty. The untold secret of McDonald’s is that when you sell a restaurant to a franchisee, sales typically go up a lot because the franchisees do a much better job managing the store.’ ”
“Now, McDonald’s didn’t like being told what to do by a hedge fund in New York and they tried to shut us down,” says Ackman. So a week after McDonald’s rejected Ackman’s updated proposal in November 2005, Pershing hosted a conference for McDonald’s shareholders to discuss potential options for the company. Ackman also flipped burgers at a McDonald’s with his eldest daughter to learn more about the business and to gain credibility with the franchisees.
In mid-January 2006, three months after Pershing’s original proposal and two months after its rejection, he revised his plan to include the sale of 20 percent of McOpCo in an initial public offering (IPO); the use of the IPO funds along with existing cash to accelerate store expansion in China and Russia; tripling the dividend to $2 per share, retiring all unsecured debt and expanding the share repurchase program; refranchising 1,000 stores in mature markets over the next two to three years; and providing more disclosure about the financial performance of company-owned stores.
McDonald’s publicly rejected Ackman’s second proposal, but, ultimately, the company quietly capitulated by beginning a process of selling restaurants to franchisees.
“They didn’t do it as quickly as we would have wanted but nonetheless the stock doubled over two years. That’s a big move for a large cap company. The company has continued to improve its operating and financial performance to this day.”
Borders and Target: A Couple of Clunkers
In November 2006, Pershing built an 11 percent stake in Borders, saying its shares were undervalued and could rise to $36 from $23.92. Ackman said at the time that fears of the threat from online retailer Amazon.com were “exaggerated.” Looking back, “We were wrong. We did our best to save the company, but it still failed,” says Ackman as his investment in the bookstore chain shriveled.
Calling it “the best retailer in the world,” in April 2007 Ackman began buying shares of Target Corporation for about $54 a share. Because of the size of the company, Ackman had raised a separate coinvestment vehicle totaling $2 billion from a group of other hedge funds and Pershing Square investors. While the main Pershing Square funds operated without leverage, Pershing’s coinvestment vehicles were leveraged single-stock funds that used options, margin, and total return swap leverage to enhance their returns. The first three coinvestment funds had generated high returns for investors as they coinvested with the main Pershing fund in Sears Roebuck, Wendy’s, and McDonald’s.
Pershing’s stake in Target, in its main funds and its fourth coinvestment fund, comprised of a combination of options and common stock, topped out at 9.97 percent of the company. Shortly after building its stake, in August 2007, Ackman met with Target CEO Greg Steinhafel and CFO Doug Scovanner to present his proposal for Target to sell its nearly $8 billion of credit card receivables, to transfer the risk of this business from the company, with the proceeds to be reinvested in the business and in share repurchases.
Initially, Target appeared to be heading in the right direction. In September 2007, Target announced it would review ownership alternatives for credit card receivables; later, it announced that it would buy $10 billion of its shares over three years. By May 2008, it announced a $3.6 billion sale of less than half of the credit card receivables to J. P. Morgan Chase. Unfortunately, Target had ignored the most important part of Pershing’s advice. The credit card transaction left Target with effectively all of the credit risk of the business, and half the funding risk.
While Ackman was disappointed with the transaction, he continued to press forward with a more extensive overhaul of the retailer.
In May of 2008, Ackman presented Target with a plan to create a publicly traded REIT that he believed would be valued at about $37 a share within a year. The Target REIT would own the land under every Target store, which would be triple net leased back to Target for 75 years. The lease rent would rise by the consumer price index and be payable twice yearly. The structure created a debt-free REIT, which would generate an extremely safe stream of growing dividends that was designed by Pershing to look as close as possible to a Treasury Inflation Protected Security; hence, Pershing named the company TIP REIT.
Pershing believed the benefits to Target from the transaction were substantial. It would allow Target to retain control over all of its buildings so it could maintain the flexibility of opening, closing, modifying, and moving stores while monetizing the large embedded value of its well-located real estate portfolio, a value that approximated 75 percent of the market value of the company.
Pershing’s TIP REIT was initially well received by Target’s senior management and its adviser Goldman Sachs. In September 2008, Target’s board considered the potential REIT transaction. Unfortunately for Pershing, the Target board met shortly after Fannie, Freddie, AIG, and Lehman failed, and the board did not have any appetite for what looked like a financial engineering transaction.
Rejected by the company, Ackman decided to go public with his TIP REIT proposal in a town hall format. Shortly after its November 2008 presentation, Target summarily rejected Pershing’s proposal, citing a number of concerns. A few weeks later Ackman made a second public presentation attempting to address Target reservations about the plan, but which Target again rejected. Then, after having bought back $5 billion of stock over the prior year on November 17th, Target suspended its share buyback program. The stock closed at $31.68, down substantially from Pershing Square’s more than $50 purchase price.
In February 2009, Ackman privately sought a board seat for himself and Matt Paull, the retired CFO of McDonald’s who had joined Pershing Square’s advisory board. As the stock market neared a bottom in March 2009, Target stock dropped to $25 per share as investors ran for the exits from retail stocks and the company’s large credit card business, which Pershing had pushed the company to sell.
Pershing’s leveraged Target coinvestment fund suffered with the decline in the stock. At the stock market low, the Target-only fund had declined by 93 percent leaving investors with mark to market losses of $1.86 billion.
In light of the severe losses, a number of the investors in the fund pushed for the right to exit despite the fund’s several-year remaining lock up. While Ackman told these investors that it was not a good time to sell, he offered everyone who wanted to exit the opportunity to do so, and committed personal capital to buy out exiting investors. Because he believed the opportunity to buy out investors was an attractive one, he offered all investors in the fund the opportunity to do so, although few went along. He also waived fees for all of the investors who elected to stay in the fund. Most significantly, he gave every investor in the Target-only fund a credit for any losses incurred that they could use against any future gains in the Pershing Square main funds. This so-called loss carry-forward meant that the fund investors wouldn’t pay any incentive fees on their main fund investment until they recouped the Target-only fund losses.
By March 2009, Ackman decided to push for a slate of five candidates, including himself, arguing for a 13-member board. Target rejected Ackman’s proposed slate, saying it supported reelecting the four directors on its 12-member board. Both sides made their case to shareholders in more than 20 regulatory filings but at the May 28 annual shareholder meeting, Ackman’s slate lost.
When Target’s stock ultimately rose back to more than $50 per share, the investment recovered materially from the lows, although no investors would become whole other than those who put up significant capital into the Target fund at the lows. Despite the losses in the Target fund, however, many investors were very appreciative of how Pershing handled the poor investment outcome, and they remained loyal to the fund. When the Pershing main funds’ investment performed strongly 2009 and 2010, many of the Target fund investors who remained with Pershing recouped their losses through fee waivers. By treating investors fairly, Ackman kept investors happy despite an investment that he deemed “one of the greatest disappointments of my career.”
Adam Geiger, CIO of New Legacy Capital, formerly invested with Bill Ackman right after Ackman and David Berkowitz split. At that time, Geiger was global head of investments at Ivy Asset Management, a New York–based fund of hedge fund manager. Geiger allocated at least $100 million to Pershing Square’s flagship hedge fund. “We made a conscious decision not to invest in the single stock funds including those dedicated to Target and Wendy’s,” Geiger said. “It wasn’t an efficient structure; i.e., to pay fees for exposure to a single stock while also being subject to the liquidity demands of others.” The main reasons Geiger allocated to Ackman were: value-added analysis, pedigree and relationships with legendary hedge fund managers, and credibility as an activist.
Even though his highly publicized unsuccessful proxy fight and hefty initial losses on Target garnered him a lot of negative media attention and lost him some investors, it served as a catalyst to win some over, too. For one thing, it got him noticed by one New York–based $600 million fund of hedge fund manager, which allocated between $25 and $30 million to Pershing Square in 2010.
After looking at Bill Ackman for a couple of years, the FOHF, who prefers to remain anonymous, realized Ackman was picking up steam after his Target failure. The FOHF believed that Ackman’s concentrated investment style of 10 to 12 positions was sensible, and it was complementary to the other funds in which it invested. The FOHF has a penchant for investing with event-driven funds, most of which invest in the entire capital structure. It argued that even though Ackman fit the bill as an event-driven manager, what distinguished him was that he was more equity focused. While the Target special-purpose vehicle proved to be a failure, the FOHF assessed whether Ackman’s ego interfered with his approach to investing and managing risk, ultimately concluding that he had the right balance between confidence and humbleness. The FOHF argued he was a good manager who really proved himself, and effects positive change in the companies in which he invests, while working well with boards of directors. The FOHF said it expects to up its allocation to Pershing Square to the extent it has capital to add to its position.
“Bill has created the most compelling business model in the investing world,” says his friend and fellow investor Whitney Tilson. “By marrying public and private equity investing, he has created a powerful model. With quite a high percentage of investments, he is able to effect change because he buys large stakes and he is willing to engage in proxy battles, but he usually doesn’t have to. He generally has good ideas and is very persuasive.”
Despite having to endure Spitzer and SEC regulatory investigations, Ackman did not give up on his MBIA short. He kept open a Gotham coinvestment fund that owned MBIA CDSs, and, shortly after launching Pershing Square, Ackman began to rebuild his MBIA short position through a large short-equity position and an enormous position in CDSs. For the first nearly four years of Pershing’s existence, the MBIA position was a loser. MBIA continued to counter Ackman’s public campaign, which laid out in incredible detail flaws in the company’s business model, its subprime CDO exposure, its inadequate disclosures, and its aggressive accounting practices. But by February 2008, the facts caught up to MBIA. Its shares had fallen more than 80 percent since the start of 2007. But as Ackman’s arguments proved themselves glaringly true, MBIA made yet another desperate attempt to turn the tables on Ackman.
In written testimony for a subcommittee of the House Committee on Financial Services, MBIA said that short-sellers like Ackman have worked hard to undermine market confidence in the bond insurers. Expressly targeting Ackman, MBIA wrote that the House Subcommittee on Capital Markets should work with the Securities and Exchange Commission to curtail “the unscrupulous and dangerous market manipulation activities of short sellers,” trying to undermine market confidence in MBIA to drive the company’s share price to nearly zero. But after having disputed MBIA’s AAA credit rating for more than five years, Ackman turned the tables on MBIA by getting the SEC, the New York attorney general and other regulators to investigate the company. The four-year investigation of MBIA resulted in MBIA agreeing to settle civil securities fraud with the SEC and attorney general’s office, and to pay a substantial fine.
MBIA’s share price collapse and skyrocketing CDS—CDS spreads went from 15 basis points (bps) in early 2007 to about 2,000 bps less than two years later—enabled Pershing Square to deliver strong returns to its investors in 2007, and to help mitigate losses in the portfolio in 2008.
“If we want to say that the emperor has no clothes and write a 66-page white paper about it, that’s a healthy thing for the capital markets,” says Ackman. “It’s also good for the market when Jim Chanos says, ‘Here’s why I think China’s a bubble,’ or when David Einhorn says, ‘Lehman should have to recapitalize because it’s overlevered and it’s going to go down.’ I think that stuff’s really important.”
At the end of 2008, Ackman closed out his investments in MBIA. After 6 years of battle, he made over $1.1 billion in profits, with his personal take over $140 million, a sum he publicly committed to give away to the Pershing Square Foundation.
Months later in May 2009, 18 financial institutions would file a suit against MBIA including Merrill Lynch, J. P. Morgan, Citigroup, and UBS, claiming the bond insurer transferred away assets that would be needed to cover claims on securities backed by mortgages to form a new municipal bond insurance company.
While MBIA was a fabulous investment, it would not turn out to be the most profitable investment of Ackman’s career. His early experience as a precocious young investor with the bigwigs of real estate on Rockefeller Center was about to come in very handy. He just had to take care of a few other things first.
In March 2008, Borders put itself up for sale, and though it received an indication of interest from Barnes & Noble, it never found a buyer. As a 3 percent position, Borders was a small investment for Pershing, but Ackman did his best to save the company. “A member of our investment team joined the board, we lent the company money, hired a new CEO, put the company up for sale,” he says. But when the sale did not happen and Barnes & Noble walked away, Ackman decided to move his focus elsewhere.
When Bennett Lebow expressed interest in buying control of Borders in 2010, Pershing was delighted to have someone else invest capital and work to fix the company. Lebow was ultimately unsuccessful and Borders was forced to file for bankruptcy in 2011. In total, Pershing lost about $200 million, which amounted to a couple of percent of capital. But Ackman isn’t beating himself up about it. “We’re going to make some mistakes,” he says. “Borders was a mistake on the buy. It just didn’t meet our criteria of the kind of businesses we like to own.”
“When I first started in business, I didn’t know when it was time to move on. But I learned a lot about what I call the return-on-invested-brain-damage calculation. If the return isn’t high enough to justify the brain damage, I won’t spend the time.”
In November 2008, five months before the company filed for bankruptcy, Ackman bought a stake in General Growth Properties, a REIT that owned 140 million square feet of shopping center real estate across the country. Pershing added to its holdings gradually over the next several months. Soon, all of the experience he had amassed beginning with his Alexander’s investment in business school, his Rockefeller Center investment, and the failed First Union deal at Gotham would come to bear on the greatest investment of Ackman’s life.
Ackman had had his eyes on the company since 1998. “When we were restructuring First Union, I sold a property to General Growth,” he says. “I met Joel Baer, who was the company’s chief investment officer, and we stayed in touch.” Ackman had followed the stock ever since and began to focus on it when the stock price dropped, in late 2008 and early 2009. It eventually plummeted from $60 to 30 cents, as the company was unable to roll over its debts in the midst of the credit crisis. It was time for Ackman to swoop in. He knew that if the company could restructure its debts through a bankruptcy, this could be one of the greatest comebacks in investment history.
Ackman thought that despite the company’s being in bankruptcy, it was potentially a good investment because its assets were worth far more than its liabilities. “Malls historically generate high stable cash flows,” Ackman explained in a news article interview with Infovest21, written on May 29, 2009, when he spoke at the Ira Sohn Investment Research Conference. “[GGP has] the second highest occupancy of any mall company. It has 73 Class-A Malls including high profile names. Fifty of the 200 malls create 50 percent of the NOI. The likelihood of a forced liquidation by a court is reduced because of the extreme pressure it will place on the commercial real estate market and other REITs.”
Ackman had also met Madelyn Bucksbaum, a cousin of one of the company’s founders, at a charitable event in the 1980s. After Ackman amassed a position of 25 percent of the company, he got a call from Maddie reconnecting after almost 20 years. She offered to do anything she could if he ever needed help.
After buying a stake in the company, Ackman began to lobby the management. He advised GGP that the best way to restructure the company was in bankruptcy and talked them through how it could done, providing a few examples of other companies that had done it successfully. “I tried to convince them to put me on the board, but they were represented by Goldman Sachs. And Goldman Sachs didn’t like the idea, saying, ‘No you don’t want the fox in the hen house,’” says Ackman. “I’ve got a good relationship with Goldman Sachs, but they have a business that is based on ‘defending’ companies from me. They might think it is bad for them if I join the board of a company they represent. They’re supposed to ‘protect’ companies from people like me,” he explains matter-of-factly.
While Goldman was fighting to keep Ackman off the board, Joel Baer lobbied GGP that Ackman was the right man for the job. Ultimately, the board decided to vote on his joining the board. Ackman was shocked to learn that it would be a close vote. “I can’t believe this,” he says. “Here I am, I own 25 percent of the company. I’m offering to help. Their stock is trading for pennies and they won’t let me on the board?” So he called Maddie Bucksbaum to take her up on her offer to help. She convinced her cousin, John Bucksbaum, to vote for him, and his was the deciding vote that put Ackman on the board in June 2009.
Once on the board, Ackman worked with management and the company’s advisors to restructure the debt of the company. “Brookfield was interested in doing something but they made an initial proposal to the company which was not attractive,” he said. So he went back to them with an idea for separating GGP into two companies. “Ultimately, that’s the structure that became the basis for Brookfield’s proposal,” said Ackman.
By April of 2010, GGP still needed more capital. Bruce Berkowitz, who owned $2 billion of GGP debt and had been telling Ackman that he wanted to be involved, became enraged when the Brookfield deal was announced. Ackman explained that he had designed the Brookfield deal with room for Berkowitz, as they would need much more than $2.5 billion. Ackman told him, “We need $7 billion and you can help.” Berkowitz hopped a flight from Miami while Ackman prepped Brookfield for the meeting. He said, “He’s going to come in, and I’m going to make a suggestion. We’re going talk about it. If Bruce thinks it’s fair, he’s going to agree. He’s going to shake hands. And then it’s going be done, and we don’t have to worry about it anymore.”
Despite Ackman’s confidence in Berkowitz, Brookfield was very skeptical of him from the word go. “He came in with Gucci loafers, casually dressed, no jacket. Just straight from Miami with his partner Charlie Fernandez,” remembers Ackman.
And the meeting proceeded exactly as Ackman had said: “Bruce Berkowitz and I sat down and discussed a potential proposed transaction. Once we had terms that Bruce was satisfied with and that I agreed to do as well, we went back into the room with Brookfield. Bruce then said, ‘Here’s what we’re prepared to do.’ We all shake hands, Bruce is gone within 35 minutes. It was the quickest deal of my life.” The Brookfield guys still didn’t know if Berkowitz could be trusted. “He just committed $2.7 billion. I told them he was real,” and Ackman was right.
In November 2010, GGP exited bankruptcy and spun off a new company called the Howard Hughes Corporation which held certain GGP assets that Ackman had identified that generated little or no cash relative to their underlying asset value. Today, Ackman chairs the Howard Hughes board.
As GGP rose from 34 cents to its current value of $23 per share (now represented by stock in three companies, GGP, Howard Hughes, and the Rouse Company), Ackman netted $2.6 billion for his fund thanks to his investment in the struggling mall operator. The investment brought much recognition from the industry as well, including the HFMWeek U.S. Performance Awards for 2010, where Pershing Square won in the long/short equity category for funds over $500 million.
“What attracted us to JCPenney?” Ackman asks rhetorically one winter afternoon in his office. He leans back in his chair and toys with one of the knickknacks on his desk. His personal sanctuary is pristine with a large off-white sofa in the corner and crystal chess set on the coffee table, facing the floor-to-ceiling windows that look out over Central Park. Behind his large wooden desk and Bloomberg screen is a long row of drawers overcrowded with pictures and mementos of his days as co-captain of the Harvard Business School rowing team, black-and-white pictures of a young Ackman and his beautiful wife, Karen, at their wedding, and then special moments from his life like fishing trips with his father and some of his closest friends including Paul Hilal, whom Ackman went to Harvard with and who is now a senior partner at Pershing Square.
“We have done a lot of department store retail over the years,” he starts. “JCPenney is a 108-year old iconic brand. They own a big percentage of their real estate or they rent it at very low cost. The cost of the platform is very low. It’s not considered a great brand, but it’s not like Sears; it’s not considered a bad brand,” says Ackman. “But the company has underearned its potential in terms of its margins. Its revenues should be meaningfully higher and its expenses should be lower. So there’s lots of operational opportunity in the company. That’s what we thought on the way in.”
In October 2010, Ackman went to talk to Steve Roth about it, his partner in the 2005 investment in Sears, and Roth liked the idea. Together, they bought 26 percent of the company. In its 13D regulatory filing, Ackman disclosed that he planned to hold discussions with JCPenney and other investors about possible changes to strategy or management at the company. JCPenney then put in place a poison pill, an antitakeover defense, to prevent an investor from amassing more than 10 percent of its outstanding stock, or to block existing large stakeholders such as Ackman from buying even more shares.
At that point, Ackman and Roth approached the company about joining the board. “And they thought about it and they came back and welcomed us on,” says Ackman. In January 2011, JCP said it would add Ackman and Roth to its board. “We get along well with the other directors and we have made good progress together.”
Since Ackman’s stake, the company announced a plan to improve profitability by closing underperforming stores, winding down its catalog and outlet operations, and streamlining its call center and custom decorating business as part of a cost-cutting drive.
Maybe it’s his can-do attitude that also convinced the board to welcome him. “When he takes a large stake in a company, Bill does tremendous due diligence and his eyes see things others don’t see,” says friend Mark Axelowitz, managing director of investments of UBS Private Wealth Management, who also serves with Ackman on the Executive Committee at the Boys and Girls Harbor in Harlem. “That is the mark of a genius. Observing how he operates in board meetings and seizes opportunities, Bill can’t help himself but to take charge when he is in a meeting, not because of ego but because he enthusiastically sees the opportunity to make a difference,” says Axelowitz. “Within a short period of time he became president of the Boys and Girls Harbor. It was an easy decision for the board to engage his leadership capability. Bill offers creative ideas and he makes thoughtful, wise decisions. Before the end of the day, Bill takes action, gets the job done, and that’s why people listen to him.”
“One of the other things we were able to help with is the CEO’s succession plan,” says Ackman. “Mike Ullman was in his mid-60s and he was not going to be there forever,” says Ackman. “So we went out looking for the best retail CEO in the country. And Ron Johnson’s name came up, so I gave him a call. Initially, we had the right to appoint a third director to the board. So we told Ron, ‘Look, we’ll put you on the board so you can get a sense of the company. And when Mike steps down, maybe you can become the CEO.’ But it was hard for him to be on the board of JCPenney while he was at Apple. He said, ‘Look if I’m gonna do this, I’ve got to do it all the way.’ And so then we began a process for the transition of Ron from Apple to JCPenney. The entire board was involved. Everyone interviewed him. Mike Ullman spent a lot of time with him. The directors spent a lot of time with him,” says Ackman.
“This guy, I’m telling you, I think he’ll be the best CEO of any company ever. He’s going to completely transform it.” Ackman says excitedly.
In October 2011, Ackman acquired a 12.2 percent stake in Canadian Pacific Railway, which Pershing views as an “undervalued” and “attractive investment,” according to its SEC filing. Shares of Canadian Pacific rose in premarket trading on the news of Ackman’s stake but then petered out throughout the day on the New York Stock Exchange.
Ackman has been adamant that Canadian Pacific’s current CEO, Fred Green, needs to resign. His proposed replacement: Hunter Harrison, the former CEO of Canadian National, Canadian Pacific’s largest rival. With an operating ratio (or O/R, a railroad industry metric that measures expenses as a percentage of sales) in the mid to upper 70s in recent years, Canadian Pacific materially lags its large, Class I North American peers on every performance measure. Ackman feels that there is no structural explanation for this elevated ratio and that by bringing in Harrison as CEO, who has engineered numerous similar turnarounds at Illinois Central and Canadian National, Canadian Pacific can bring down its costs significantly and achieve an O/R of 65 by 2015, thereby boosting the earnings power of the company considerably and the valuation it receives in the marketplace.
CP operates on a 14,800-mile network that extends from Vancouver to Montreal and to U.S. industrial centers including Chicago, Detroit, Philadelphia, New York City, and Minneapolis. It ships bulk, including grain, coal, sculpture, and fertilizer; merchandise, which includes forest products, industrial and consumer products, and automotive. It also has a passenger rail, which is limited to the luxury railroad experience provider, Royal Canadian Pacific. Pershing Square plans to hold discussions about business, management, and operations, among other topics with Canadian Pacific’s management, board, and other stockholders, Pershing’s initial filing states.
On January 24, 2012, Ackman announced his slate of proposed directors to be nominated to the board of Canadian Pacific at the May 17 annual meeting and that he would be holding a shareholder meeting in Toronto to discuss the company’s performance the first week of February. His nominees for the board were himself; Gary Colter, president of Corporate Restructuring firm CRS Inc.; Paul Hilal, partner at Pershing Square; Rebecca MacDonald, founder of the Just Energy Group; and Anthony Melman, chairman and CEO of strategic advisory firm Nevele.
Ackman says of his investing style: “I don’t care what other people think. I invest based on what I believe the opportunity for profit is compared with my estimate of the potential for loss.”
Despite the high stakes and high-profile nature of his investments, Ackman says he rarely feels stress on the job. Ackman is more concerned with the health and well-being of his family and the world. He is emotional about life, but not about investing. “I cry when I watch the Olympics,” he admits, laughing. “I’m part of the one percent of the people in the movie theater crying. So I’m an emotional person. But about investing, I’m not emotional. Emotion is a very bad thing to mix with investing.”
But Ackman is emotional—and activist—when it comes to his charitable work. “If I cry, I give,” he confesses. In 2006, Ackman and his wife, Karen, established the Pershing Square Foundation, whose mission includes addressing poverty, education, the environment, health care, and human rights. To date, the Foundation has committed over $130 million to various causes in the greater New York area and around the world.
In his philanthropy, Ackman seeks to support smart, talented people who create life-changing solutions to intransigent problems. Some of the Foundation’s significant investments in the nonprofit world have included the One Acre Fund, which is transforming the lives of tens of thousands of subsistence farmers in East Africa through training and access to better seeds, technology, fertilizer, and farming techniques; the Foundation for Newark’s Future, which, with Ackman’s long-time friend Mayor Cory Booker, and in partnership with Facebook’s Mark Zuckerberg is changing the educational opportunities for Newark’s 45,000 children and their families; and the Innocence Project, which uses DNA evidence to exonerate the wrongly convicted.
Before funding any charity, Ackman does his homework, as he would for the Fund’s investments, and he typically backs those ventures that promise the greatest leverage for his charitable dollars. Often, Ackman jumps in to help an early-stage organization weather the proof-of-concept phase and to grow to the next level of operations and impact. He wants to back ventures that other charities can’t or won’t consider, or cannot fund soon enough, but where Ackman sees long-term charitable value and can move quickly. And, naturally, Ackman is not shy about asking tough questions and offering his own insights and suggestions, just as he does with portfolio companies.
In part, the Foundation is making good on Ackman’s pledge to donate to charity his personal gain from the MBIA investment, but more generally it reflects Ackman’s belief that those who are fortunate enough to garner large financial benefits from the world have an obligation to redeploy those gains for the greater good.
One of the reasons Ackman can separate his emotions from his work is because he’s financially secure independent of his business. “I wouldn’t invest with someone that has all of their money invested alongside you because they’re under too much pressure if they make a mistake,” he says. “Why would you want to invest with someone that risks everything they have? That’s not a prudent approach. You want someone who is financially secure on his or her own, but who has the substantial majority of their liquid assets invested alongside you,” he explains.
It seems investors agree. HFMWeek wrote an article that in January 2010, New Mexico Public Employees Retirement Association added a fourth hedge fund portfolio, allocating $20 million to Pershing Square. Reports from the end of March 2011 stated that NY Investment Council plans to add another $100 million to Pershing Square.
J. Tomlinson Hill, CEO of $45 billion Blackstone Asset Management, Blackstone’s fund of hedge fund portfolio that has invested in Pershing Square since 2005, sees a unique ability is Ackman to sniff out inconsistencies and remodel companies. “The real secret here in the private equity business is that companies welcome us with their open books,” he explains. “The real genius of Ackman is he is able to analyze companies better than the companies can themselves and he is restricted to whatever information is in the public domain. He creates value in a way no other manager can,” Hill says.
The future of Pershing Square may involve an IPO. Ackman addressed the possibility in a May 25 letter to his investors that was leaked publicly. “We have spent a few months earlier this year examining alternatives for creating permanent capital for the funds,’” he wrote. “We are closer to identifying a solution, but have postponed pursuing such an alternative until the timing is right.”
The letter added: “The only truly permanent capital today in the funds is that of our long-term employees and other affiliates, which today represents approximately 8 percent of our capital. If we could increase the amount of our capital that is permanent, it would enable us to be more opportunistic during times of market and investor distress, and would also enable us to take larger stakes in a greater number of holdings.”
Ackman also explained in the letter that his activist approach could work best with capital that couldn’t be withdrawn, saying it does not “help our cause to be forced to liquidate a holding to meet investor redemptions at a time when we are publicly pushing for corporate change due to the undervaluation of a company” adding “capital stability is important for the long-term success of the strategy.”
Ackman’s personal goal is to have one of the best investment records of all time, but he understands that the industry often judges investment managers a year at a time. After a spectacular year, Ackman is reminded that, “Every year I start over from zero!”