Investment company Pershing Square Holding’s (PSH) shares continue to trade at a steep discount to NAV (net asset value).

This discount stands at 29.73% at last count according to the AIC (Association of Investment Companies), one that perhaps reflects the hedge fund’s high fees and complexity.

Yet the discount looks overdone as the FTSE 100 fund, run by famed US investor Bill Ackman, continues to flourish by making concentrated investments in quality large cap North American companies and as such it would suit investors with a reasonable tolerance for risk.

The company’s annual investor presentation (11 Feb) provided a fascinating peek under the bonnet of Pershing Square, which delivered another strong year in 2021 driven by new investments, existing portfolio holdings and its hedging strategy.

Shares also notes Pershing Square’s strategy also proved to be defensive during last year’s more volatile market conditions and notes there are a number of catalysts in place that can help to grow net asset value (NAV), including an interest rate hedge, a potential future transaction for portfolio company Pershing Square Tontine.

This SPAC, or special purpose acquisition vehicle, an entity with no commercial operations which lists on the stock market with the aim of making an acquisition, remains on the lookout for deals. Plus there is the potential upside from new holding Netflix and a stake in an as-yet-undisclosed new position.

ANOTHER BANNER YEAR

At the annual investor meeting, Wall Street titan Ackman outlined the two big contributors to Pershing Square’s outperformance over the long term. ‘One, we own these very well capitalised, dominant high-quality businesses where we are an influential shareholder’, he explained, and two, ‘we’ve also been very effective at hedging what we would call Black swan-type risks’.

In 2021, Pershing Square Holdings performed ahead of most market indices, delivering NAV appreciation of 26.9%, beating the total returns from the FTSE 100 and the MSCI World, though it fell just short of the S&P 500. Curiously, the discount to NAV widened by 5.3% from 23% in the beginning of 2021 to 28.3% as of December 31 2021.

Performance drivers included the company’s interest rate swaptions (a financial product linked to movements in rates) as well as stocks ranging from home improvement retailer Lowe’s to Universal Music Group, hotels giant Hilton Worldwide and fast casual restaurant star Chipotle Mexican Grill to name a few.

Portfolio holding Pershing Square Tontine, the US-listed SPAC which failed to consummate a deal to buy Universal Music due to regulatory actions, detracted from performance.

For reasons Shares outlined here, Tontine pulled out of its proposed acquisition of a minority stake in Universal Music and instead, Tontine’s Universal Music share purchase agreements were assigned to Pershing Square Holdings, which today is a shareholder in the Euronext Amsterdam-listed music powerhouse.

NEW POSITIONS, BIG POTENTIAL

Ackman recounted that since the start of 2021, Pershing Square Holdings has added four new holdings and also exited two highly successful investments in coffee house colossus Starbucks and life sciences-to-diagnostics firm Agilent. 2021’s new positions were pizza delivery leader Domino’s Pizza, Universal Music and a new position which remains unnamed given that the stake is still being built.

Waxing lyrical about Pershing Square’s 10% stake in Universal Music, Ackman said ‘we fell in love with Universal in terms of the characteristics of the business’, which he described as ‘the best positioned company’ in both the recorded music industry and the music publishing business with a decades-long runway for revenue and earnings growth.

‘The transition to streaming has been one that is very favourable for really all participants in the music ecosystem from the artist to the publisher to the record label and that transition is well underway and inevitable,’ explained Ackman, palpably excited by the ‘enormous embedded growth in that part of the business’.

Although Universal’s share price including dividends increased 37% from Pershing Square’s average cost up to the end of 2021, the shares are actually down year-to-date with Universal ‘sort of learning its way to be a public company’ according to activist investor Ackman.

‘We think some of the weakness in the share price this year relates to some confusion on the part of shareholders and their understanding of the business and we expect management to do a good job in telling the story when they announce their results for the year in the next few weeks,’ he explained.

At these levels, Ackman calculates that Universal Music is trading at a ‘very deep discount’ to intrinsic value and believes it ‘ultimately belongs on the NYSE or Nasdaq’, and will receive ‘a much higher valuation when that transition takes place’.

As for Domino’s Pizza, ‘a very high-quality business’, Ackman explained that ‘we had the opportunity to acquire a meaningful stake at an attractive valuation in a business that we know well’.

For those tuning in to the investor meeting, Ackman also provided further details on how Pershing’s highly profitable interest rate hedge was unwound to fund a new position in the new year, namely streaming company Netflix.

 NETFLIX’S WIDE MOAT

Amid a volatile market backdrop in 2022, hedging gains provided the capital to fund a new position in Netflix. This followed a share price plunged in January after the US-listed company issued lower than expected short term margin and subscriber growth guidance.

In the investor presentation, Pershing Square Holdings pointed out that despite more than a 50% surge in revenue, over 800 basis points of margin expansion and improved free cash flow over the last two years, Netflix’s share price has nearly returned to pre-pandemic levels.

Led by ‘visionary’ management according to the Pershing Square Holdings investment team, the streaming subscription video-on-demand company’s powerful competitive moat stems from its investment in an industry leading content library, with pricing power derived from a superior value proposition compared to alternatives.

As Pershing Square investment team member Bharath Alamanda explained: ‘Our investment thesis really starts with their enormous growth potential – we believe as broadband penetration increases, Netflix’s ability to penetrate broadband households increases over time and we see no reason why that subscriber number can’t more than double over the next ten years.’

TONTINE TARGETING OPPORTUNITIES

Ackman described Pershing Square Tontine as ‘the biggest disappointment of 2021’ due to the SPAC’s failure to consummate the Universal Music transaction. Undeterred by this setback, the Pershing Square team is working on a couple of potential targets, though a July deadline to complete a merger (albeit with the option of a six-month extension) is now looming.

Regarding the timetable for the launch of the Pershing Square ‘SPARC’, which stands for special purpose acquisition rights company and is a new structure which is ‘a much better version of a SPAC’ according to Ackman, the New York Stock Exchange is shortly expected to file a revised rule change that would facilitate the listing of this opt-in SPAC.

Despite having compounded NAV performance at a superb 50% per annum over the previous three years, Pershing Square’s shares trade at a wide discount that the board views as ‘unacceptable’.

However, the unchanged message from the investor meeting was that the board and manager are unwilling to take action that would impair the fund’s longer-term returns and the board is relying on NAV performance and a renewed marketing effort to help address the discount.

One facet of this marketing push has seen Pershing Square Holdings reclassified by the AIC from the Hedge Funds sector to the North America sector, and the board continues to believe that ‘the most powerful driver of long-term shareholder returns will be continued strong absolute and relative NAV performance’.

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