Billionaire hedge fund manager Bill Ackman has confirmed a dark narrative about the stock market Wall Street was freaking out about at the end of last year.
Ackman’s fund, Pershing Square, had a terrible 2015, delivering a -19.3% gross return.
His biggest mistake, he said, was misunderstanding a certain kind of company — platform companies.”
“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.”
Platform companies are massive corporations that have taken advantage of low interest rates and a bull market boom to grow through acquisitions. Think: Valeant, Anheuser-Busch InBev, and Allergan, which is due to be acquired by Pfizer.
The thing is, the market is changing, deals are getting more difficult, and so the value of having a platform to do deals is worth less.
Wall Street was first introduced to this idea at the Grant’s Interest Rate Observer Conference in October of last year. A Chicago based hedge fund manager James Litinsky of JHL Capital put this argument in a presentation called “Conglomerate Boom 2.0: A Stable Platform?”, and everyone started freaking out about it — even guys who were around the industry to watch the conglomerate boom go down the first time.
“We’ve seen periods when conglomeratization went too far, and one of the reasons you’re seeing so many de-mergers, and split-ups, and so many activists are pushing for that, is we saw too much of that,” Evercore Chairman Roger Altman said in an interview on CNBC in November.
“Too many companies are just being big for the sheer sake of it. Too many CEOs thinking bigger is better. I think that has gone too far.”
You know what a boom/bust is, don’t you?
In his presentation, Litinsky pointed out that our current market looks a lot like another boom/bust cycle for big companies like the platforms — the conglomerate boom and bust of the 1960s.
Back then the companies were Leasco and International Telephone and Telegraph (ITT) — the players were legendary investor Saul Steinberg and ITT CEO Harold Geneen.
They built massive companies through mergers and acquisitions much as is done today, but they had their worlds rocked when the market turned on them — when interest rates rose from 4% in 1963 to 8% in 1968.
Earnings started to disappoint, stock prices fell, and all of a sudden companies couldn’t close the acquisitions they needed to grow and maintain momentum.
Litinsky created an index of companies that he thinks look like the 1960s conglomerates. It includes Valeant Pharmaceuticals, The Kraft Heinz Company, Danaher, Endo Pharmaceuticals, Allergan Pharmaceuticals, and more.
Which brings us back to Ack
Pershing Square’s biggest loser of 2015 was Valeant Pharmaceuticals, which fell 66% from January 22 to the end of the year.
Over the summer, while the stock was still riding high, Berkshire Hathaway’s Charlie Munger compared the stock to a 1960s conglomerate in a meeting with investors.
“Valeant, the pharmaceutical company, is ITT come back to life,” Munger said in November, according to Bloomberg. “It wasn’t moral the first time. And the second time, it’s not better. And people are enthusiastic about it. I’m holding my nose.”
In August, the stock started taking a dive when the government started criticising its aggressive acquisition, low R&D-based business model.
Then it really plunged in October, after accusations of malfeasance from a short seller.
In his presentation, Litinsky devoted two slides to why Valeant is a poster child for companies about to get crushed in our new market reality. Here’s one:
Though Ackman says he hasn’t given up on platform companies, or Valeant for that matter, he does express some regret about the investment.
“Our failure to sell stock wasn’t entirely an unforced error as we found ourselves largely restricted from trading during this period. During the summer, we were made aware of a large potential transaction that Valeant was working on, and as a result, we were restricted from trading at a time when it would have been prudent to take some money off the table,” he wrote.
“In retrospect, in light of Valeant’s leverage and the regulatory and political sensitivity of its underlying business, we should have avoided becoming restricted to preserve trading flexibility, or alternatively, we should have made a smaller initial investment in the company.”
Coulda, shoulda, woulda.