Part of the reason why history repeats itself so often is that it’s so rare for grown people to change, especially if they are Masters of the Universe accustomed to being right.
It is with that in mind that we examine the tragedy that is hedge fund billionaire Bill Ackman’s portfolio. He lost $1 billion on Valeant Pharmaceuticals on Tuesday when the stock was chopped in half.
But instead of turning his back and cutting his losses, he sent his investors a letter reaffirming his belief in the company’s value, telling them that he has a vision beyond what Valeant’s own management can see.
In particular, management shocked the market with revenue and earnings guidance for the next twelve months (Q2 2016 to Q1 2017) which does not appear to foot with continued favourable prescription trends and management’s commentary on the call about the strength of the underlying businesses…
We continue to believe that the value of the underlying business franchises that comprise Valeant are worth multiples of the current market price.
Valeant is Ackman’s biggest loser — no question — and he’s admitted that it dragged down his entire fund in 2015. It’s worth saying here that nobody is suggesting that the drugmaker is going to mean the end of his hedge fund, Pershing Square.
But what’s going on now does seem familiar if you’ve followed Ackman’s career, and the hedge fund that did blow up in 2001: Gotham Partners.
Gotham Partners 1993-2001
Like Ackman’s current drama, the Gotham Partners mess was covered closely by the press. How could it not be? Ackman and his partner, David Berkowitz, were vanguards of the hedge fund pitch to the public — of putting their secretive industry in the spotlight, and on their website, sharing ideas with the world.
Now the practice is more common, and not derided as an investor “talking their book.” Back then, however, the practice not only captured the attention of the entire market, it also caught the ire of former Attorney General of New York, Eliot Spitzer. Uncomfortable, to be sure, but not fatal to the fund.
No, Ackman’s fund failed when Gotham Partners morphed from a diversified hedge fund to a holding company with a “portfolio of private companies and thinly traded public ones,” as the New York Times wrote in 2003.
“An examination of Gotham’s activities in recent years shows a series of ill-timed bets, a surprising lack of diversification and a dangerous concentration in illiquid investments that could not easily be sold when investors wanted their money back,” the Times wrote.
One of those companies was Ackman’s obsession. It was called Gotham Golf, and it swallowed Gotham Partners whole.
Gotham Partners started buying Gotham Golf, a golf course operator, in 1997. As time passed, the value of its assets declined, but Ackman and his partner kept buying up more golf courses. The company got bigger and deeper into debt. Ackman, then in his mid-30s, devised a plan to save the company. He tried to merge it with cash rich First Union Real Estate Equity & Mortgage.
But First Union’s minority shareholders sued. They would not allow the merger to go through. Ackman ran out of time. Gotham Golf was going bankrupt, the rest of his positions were illiquid, the timing was all wrong.
He shut his hedge fund down.
Ackman started his current fund, Pershing Square, in 2004. Wall Street raised an eyebrow, and some of his original investors never got over the blow up at Gotham. Still, by 2010, Ackman had $7 billion under management. In 2015, it had around $20 billion under management.
Right now, it’s managing something like $12 billion. Valeant Pharmaceuticals is responsible for a big chunk of that decline. Ackman’s initial contact with the company was strange. In 2014 he made a deal to help Valeant purchase Allergan Pharmaceuticals without owning any Valeant stock. Instead he bought Allergan, and as with First Union, pushed the other shareholders to accept a merger.
They did not. Being swallowed by Valeant, a so-called “platform company” which had a business model based on slashing research and development spending, hiking prices and growing by acquisition was not attractive to these shareholders.
After that Ackman bought some Valeant stock in early 2015, and it became his fund’s biggest position. Things were great until, in October, accusations of malfeasance from a short seller combined with government scrutiny over drug-price gouging brought the stock to its knees.
Valeant was forced to change its business model — it would have to sell more drugs at lower prices. Its distribution channel for high margin products, a mysterious pharmacy called Philidor, was dismantled by January.
Pershing Square was down 20% in 2015 in large part because of this disaster, but Ackman was unmoved. In a letter to investors he blamed those with thinner skin for following him into trades and selling when they lost conviction. He said the market was wrong.
“Our biggest valuation error was assigning too much value to the so-called ‘platform value’ in certain of our holdings,” he said in his year-end letter to investors.
“We believe that ‘platform value’ is real, but, as we have been painfully reminded, it is a much more ephemeral form of value than pharmaceutical products, operating businesses, real estate, or other assets as it depends on access to low-cost capital, uniquely talented members of management, and the pricing environment for transactions.”
The value is real, the environment is wrong. So Ackman held on.
All signs point to Ackman being wrong on Valeant.
The platform that the company created is worth a fraction of what it was even months ago. Government scrutiny alone prevents it from returning to its former business model, to say nothing of the fact that investors in the company’s $34 billion debt pile probably wouldn’t allow it. On Tuesday management guided 2016 revenue down to $11 billion to $11.2 billion from $12.5 billion to $12.7 billion. The stock is down 68% just this year.
Yet again, Ackman is defiant. He says he will take on a greater role at the company. He’s managed to secure some board seats and floated the idea of selling key parts of the business to pay down borrowings.
But that doesn’t make Valeant’s stock a buy, and until it is Ackman is stuck holding and forced to make of the situation what he can.
Of course, investors in Pershing Square will also have to remain patient if they can, luxury Gotham investors were not afforded. Eventually a court overturned the Gotham Golf, First Union decision. Ackman’s merger could’ve gone through if he’d had more time.
“It was very instructive in many ways,” fellow investor Whitney Tilson told Reuters in 2010. “(Ackman) learned lessons from this.”
Perhaps. Or perhaps not.