The Alpha Masters: Unlocking the Genius of the World's Top Hedge Funds (27 page)

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
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U.S. Performance Awards for 2010, where Pershing Square won in the long/short equity category for funds over $500 million.

A Penney for His Thoughts

“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.

Canadian Pacific on the Rails

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.

What Makes an Activist

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.
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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!”

Chapter 7

The Poison Pen

Daniel Loeb

Third Point

A manager that has become overconfident by using a bad process is like somebody who plays Russian roulette three times in a row without the gun going off, and thinks they’re great at Russian roulette. The fourth time, they blow their brains out.