AVI – an Angry, £1B Fund Manager – “We are writing this open letter to you following the outrageous decision by the Board to sanction the issuance of $400m of twenty-year debt without, as far as we are aware, any consultation with shareholders unconnected to the Investment Manager. The issue of such long-dated debt materially constrains the Board’s ability to manage PSH’s persistently wide discount to NAV, at a time when doing so should be their primary focus. We are staggered that the Board has decided to further tie its hands in this way.”
Bill Ackman had the idea to raise a permanent capital vehicle a few years ago via a closed end fund (CEF). Without getting too much into it, many times a CEF’s stock will trade at a discount to its net asset value (NAV). This can happen for several reasons: (i) the fund has a high concentration of illiquid assets, (ii) it may have an outsized amount of leverage within the vehicle, (iii) it may just be a function of the yield / distributions, etc. Many times when the discount persists, funds will use cash flow to buy back stock, close the discount gap and keep investors happy. Bill Ackman is not doing this. He has instead decided to raise $400M in new debt and ante up, which has rightfully pissed off investors. Their argument is essentially:
“Look – we understand using leverage to increase returns for equity investors, but there are two ways to do that. Instead of raising new debt to purchase additional assets, why wouldn’t you just buy back a bunch of stock to reduce the discount to NAV? You could’ve easily done that and gotten your leverage ratio to the same levels as you did by borrowing the new money and forcing additional free cash flow to interest and principal payments.”
I’m not gonna lie, either – they’re right. It really doesn’t make any sense, when you have two options for levering up, to choose the option that is less advantageous for your shareholders – unless you understand Bill Ackman. AVI alludes in the following quote that Billy Boy is motivated by one thing only – greed:
“We note Bill Ackman’s comments in PSH’s annual report on buybacks and leverage: “Buybacks have other drawbacks as they reduce our shareholders’ equity and increase our leverage. We would not be surprised to find that a higher leveraged PSH trades at a greater discount to NAV when compared to a less leveraged PSH”. Given gearing was at 20% when this report was written and the new debt issue will see this increase to 25%, it seems Bill’s aversion to an increasing leverage ratio could more accurately be described as an aversion to shrinking the assets on which management fees are earned.”
While true that Ackman would lose fee revenue by shrinking the equity float, this isn’t why he’s chosen to forgo that strategy. Anyone who has been following Ackman throughout his career knows he isn’t motivated by greed – he’s motivated by his insatiable need to prove how great an investor he is. The real reason he’s decided it’s better to lever up with new debt vs. shrinking the float is that he believes he has a real, long term winner lined up and needs some capital to play with. In his mind, he is going to out gain any short term stock improvement from buybacks with good old fashioned alpha generation.
You have to remember, though, that Bill Ackman is the best, but he’s also the worst. He’s the guy that correctly called the subprime crisis and made a killing on his MBIA play. He’s the guy that parlayed a $60M investment in General Growth into a $1.6B stake post-turnaround. He’s also the guy that blew up his first fund, Gotham Partners, by piling capital into a portfolio of illiquid investments and golf courses. He’s the guy who lost, quite publicly, billions of dollars on a poorly executed bet on Valeant. Lastly, he’s the guy who picked a fight with both Herbalife and Carl Icahn, only to lose more money and his own dignity, on national TV, in the process.
That’s why I have zero sympathy for this rinky dink fund that is upset with this atrocious allocation of capital. Ackman is undoubtedly smart. Ackman is undoubtedly smug, as well. You pay him to manage your money, not the other way around. So don’t sit there and be a backseat driver while he’s out here picking winners (or massive losers). That’s always been Billy’s style and your diligence team should’ve picked up on that. Regardless, you’re about to make a lot of money or lose it all. The only thing you can do is sit back, enjoy the ride and just:
