The ideal investment for uncertain market conditions would be a trust with a great performance record and a strong chance of preserving value in a bear market, yet one whose shares trade at a significant discount to net asset value (NAV). That’s a lot to ask for. Trusts usually have to sacrifice upside to protect the downside and the successful ones trade close to or above net asset value.
Yet Pershing Square Holdings (LSE: PSH), the £5bn fund lead-managed by Bill Ackman, trades on a discount of nearly 30% despite having returned 70% last year. First listed in Amsterdam in 2014, it switched to London last year. Though classified as a hedge fund, the fund hasn’t shorted any investment since 2017. Instead, it runs a highly concentrated portfolio of companies, mostly in the US, and often seeks to influence their management. The top five holdings typically account for over 60% of the portfolio and the top ten for 80%.
Getting the pandemic right
Over half of last year’s return was accounted for by Ackman anticipating long before others that Covid-19 would spread from China around the world and cause deep dislocation in financial markets. PSH bet heavily that the spread between corporate and government bond yields would rise significantly at a time when the downside was limited. At the height of the panic, PSH covered its bets and reinvested in equity positions.
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PSH’s investment portfolio was initially affected by the sell-off but then recovered sharply. Lowe’s, the home improvement store chain, adapted quickly, gained market share and saw significant growth in sales and margins. The shares now trade over 50% above the pre-pandemic high.
Hilton Hotels is only modestly higher, but Chipotle Mexican Grill has more than doubled over the same period (and tripled since its March 2020 lows). PSH sold out of Starbucks in January 2020, reinvested in March 30% lower down, and sold out again earlier this year, the share price having nearly doubled.
Ackman is optimistic about Restaurant Brands, which owns Burger King, but the shares are unchanged since early 2020. Agilent, a scientific instruments company, was little affected by the pandemic and has seen its share price double since early 2020, though PSH recently sold out. Howard Hughes, a property company, is expected to strongly recover in 2021 after a difficult few years.
A big bet on music
Performance this year has been slower but PSH has matched the S&P 500 on average in up months while losing just 1.8% against 3.8% in the index’s down months. Much of the year has been spent on manoeuvring to acquire a significant stake in Universal Music Group (UMG) prior to its flotation but PSH’s strategy was frustrated by a legal challenge to the listed special purpose acquisition company (Spac) it set up last year for this purpose.
Ackman claims that the challenge is spurious, intended by its proponents to frustrate the Spac route to market, but does not have the time to pursue the case through the courts. Instead, funds managed by Ackman, including PSH, bought a 7.1% stake in Universal from its controlling shareholder Vivendi for $2.8bn and have now exercised an option to buy another 2.9% for $1.15bn. PSH’s investment is $2.5bn, as it is limited to investing 25% of gross assets in any business.
Following the acquisition of EMI in 2012, Universal became the world’s largest music company with an estimated market share of 32% in recorded music. The purchase price values Universal at $39bn compared with 2020 revenues of $8.7bn and profits of $1.56bn although a report by Goldman Sachs values it at $53bn.
Streaming is expected to see double-digit growth for the foreseeable future and live performing is recovering strongly. “We believe that UMG has the potential to be one of our most successful investments with a minimal risk of permanent loss,” says Ackman.
This makes PSH’s high discount to NAV puzzling, especially given Ackman’s record of protecting against the downside. In addition, PSH bought back 6.6% of its shares at an average discount of 32% last year and 21% at an average discount of 26% since inception. There can be few more anomalously undervalued trusts in the market.
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