Bill Ackman On Why Using Debt To Buyback Stock Is Great And Much More: Full Q2 Investor Letter

Tyler Durden's picture

Now that everyone is finally focusing on the strategy of bloating any available company with massive leverage in order to use the proceeds to either buyback stock or engage in "synergy-creating" M&A (leading to countless pink slips), which is affectionately known as "activism", here is Bill Ackman's latest, Q2, letter with his take on this topic of how massive leverage which is great for shareholders now, but a disaster waiting to happen for employees and bondholders in the future as soon as rates rise, is the greatest thing since sliced bread.

There are Those that Argue Shareholder Activism Must Be Stopped


A few have argued that shareholder activism should be stopped or curtailed. Notably, the principal proponents of shutting down shareholder activism are not investors, but legal advisors who “defend” companies from activists and profit from this activity. The anti-activists justify their attacks against activism by conflating short-termism with activism. We are strongly in agreement that short-termism is bad for the long-term health of companies and industries, but successful shareholder activism is not short-termism. It is hard to argue that the changes we have wrought at Canadian Pacific, General Growth, Air Products, McDonald’s, Fortune Brands, Wendy’s, Howard Hughes, to name a few were those of a short-term investor. Our target holding period of four or more years is certainly not short term, and has increased over time as the quality of the managements and the businesses represented in our portfolio have improved.


Furthermore, the companies we have invested in, with extremely few exceptions, have continued to prosper even after we have exited, perhaps the best evidence of the long-term successful nature of our approach and its contribution to corporate America.




Activism has a “public good” problem for the activist in that all of the other shareholders who typically comprise 90% or more of a target can be considered free riders with none of the costs or the illiquidity, and with all of the upside. The only investors who don’t materially benefit from the activist’s involvement are those that sell out into the activist’s accumulation of its toehold investment in the target, a stake which is typically less than 10% of shares outstanding.


And even those sellers benefit, since they are able to sell at a price that has likely increased as a result of the activist’s purchases. The “public 

good” problem is a reasonable cost for the activist to bear because it is typically the largest shareholder of the corporation.


Because activism comes with large costs, the largest of which is the opportunity cost of time, an activist must be able to build a large enough stake to amortize his or her opportunity and other costs. If the 13D rules were changed and required immediate disclosure at 5%, only those targets where a 5% investment in dollars would justify the activist’s time would be suitable targets, narrowing the activist investment universe, particularly for small and mid-cap activism. This cost in reduced activism would be borne principally by the passive institutions and retail investors who own the substantial majority of every corporation on the stock market. For this reason, the last attempt to change the rules failed years ago as a large group of passive institutions voiced their concerns about the public costs of a change in the 13D rules that were designed to thwart shareholder activists.


A hundred years ago, the Carnegies, J.P Morgans, and Rockefellers of the world were large shareholders of corporations and acted like owners because it was their own money they were investing. When their companies underperformed, they did not need shareholder activists because they themselves replaced underperforming boards and managements to unlock value.

And nowadays "activists" can just pretend they are like the Carnegies, JPMorgans and Rockefellers thanks to trillions in zero-cost debt. What can possibly go wrong.

Some other observations from Ackman, first on the company in which he bought a massive call stake knowing, in what many have said is an illegal trade, a strategic is about to make a takeover offer, namely Allergan:

a CEO is incentivized to have his company’s stock price rise gradually enough to keep his job, but not so quickly so the amount of options and restricted shares he receives each year is maximized and granted each year at lower stock prices. Only until the CEO is ready to retire, in the last year or so of his term is he now incentivized to unlock hidden value and motivated to catalyze the sale of the company so he can receive additional accelerated change-of-control and other benefits along with a control premium. While by no means do all CEOs behave this way, traditional management compensation encourages such an approach.


Allergan’s management appears to be Exhibit A in this kind of behavior. While Allergan has fabulous products with growing market appeal, it has been criticized for a decade by its shareholders for its high expense levels (at 40% of revenues its historic overhead has been 12 percentage points higher than the average of its closest competitors), and wasteful and unproductive early-stage R&D spending.


Allergan management’s sandbagging approach to running a business is best evidenced by comparing Allergan’s 12% to 15% earnings growth guidance, that was expressed on the company’s 2013 fourth quarter earnings conference call in February of this year, with management’s statements, guidance, and new plan introduced after we and Valeant offered to acquire the business on April 22nd.


On May 12th, Allergan management held a conference call at which they increased February’s 12% to 15% earnings growth guidance to 20% per annum over the next five years. The increase in earnings guidance was not due to the discovery of any new products or due to a projected increase in revenues but rather magically appeared in response to the bid and is driven by a planned gradual reduction in excess costs over the next five years.


Successive increases in our and Valeant’s bid for the company have elicited even stronger predictions of superior performance from Allergan management. On July 21st, Allergan announced its first large-scale restructuring with an expected $475 million of cost savings from a 13% overall reduction in personnel including a one-third reduction in the R&D workforce. While one might have expected Allergan’s compensation committee to adjust management compensation targets upwards in light of recent guidance; instead, the board has kept the existing incentive plans in place and granted additional equity incentives including restricted stock and options for management achieving the new earnings targets.

There is the usual Herbalife bashing:

Since our discussion of HLF at the annual dinner in February, there have been a number of materially positive developments which are confirmatory of our thesis.


On March 12th, HLF disclosed that it had received a Civil Investigative Demand (CID) from the FTC. This is not simply an informal staff inquiry. Commencement of this type of proceeding requires a preliminary staff examination of the facts and legal issues, an application to the full Commission, and the majority vote of the Commissioners to initiate formal proceedings. This is the most significant FTC action on MLMs and pyramids in over 35 years, and you can expect it will entail a thorough examination of the practices of HLF.


According to press reports, the Department of Justice in the Southern District of New York and the FBI have commenced criminal investigations of HLF. The Southern District is one of the premier prosecution offices anywhere in the U.S. An investigation could include mail and wire fraud, money laundering, tax evasion, false health claims, and RICO (Racketeer Influenced Corrupt Organizations). A RICO investigation could look at the top distributors, many of whom we have profiled on our website, and trace their coordinated, parallel illegal businesses, which continue to be facilitated and promoted by HLF.


And perhaps the market top-ticking signal of the year: Pershing Square, a hedge fund, is going public.

Because we are an active, control and influence-oriented investor, we have avoided being fully invested because of the risk of investor redemptions. For example, during 2009, despite a relatively strong 2008 and a 41% net return in 2009, we had to keep a substantial portion of our assets in cash because of the large amount of investor redemptions we received. We will hopefully begin to address this issue with the initial public offering of Pershing Square Holdings, Ltd. (PSH), targeted for later this year, which will increase the amount of our capital that is permanent

full letter below

h/t @Valuewalk

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Squid Viscous's picture

Smug little POS... so concerned about Herbalife "victims" and hey, I got a fund to run as well...what a great coincidence

S.M.T.U.Q.I.'s picture

Bill Icahn and Obozo should be sent on slow boat too china.  We have ilegal immigrants that can do there jobs.

wallstreetaposteriori's picture

One of the most memorable things ever told to me the last 20 years was from my corporate finance professor in college.  "Leverage is your best friend when time are good and your worst enemy when times start to go bad".  So true.  As all these corporations change their capital structure, increase their leveage ratios, and buy their stock at all time highs, I wonder what will happen in the next recession when revenues fall off a cliff.  More bailouts?  I hope the fuck not, time to end the corporate moral hazard.

power steering's picture

Smarmy rat. What douche would invest with this theiving liar? 

Hal n back's picture

you have to admire his fee structure--clients have the risk, he gets the reward.

junction's picture

Ackman's missive is what happens when you have a criminal like Eric Holder as Attorney General working in tandem with bought off regulators at the SEC, FCC, FDA, ad nauseum.  Ackman used insider information to buy up millions of Allergan call options, betting the stock would go up.  When Allergan shot up in value, Ackman's Pershing Square fund made record profits.  There has been no more egregious example of insider trading ever, based on the profit made, than from Ackman's buying of Allergan options. 

But then, AG Holder is typical of Obummer's crew.  Obummer let PM Maliki get a second term as Iraqi PM in 2010.  The same Maliki who has yet to explain what happened in the Anbar province to those Abrams' tanks, the APCs and the trucks before ISIS attacked.  Why would Iraqi soldiers run on foot from ISIS if they had tanks and trucks available to drive away on?  Maliki's commanders were bought off.  At the same time ISIS was swarming across Iraq like fast moving, bearded homicidal roaches, Maliki was busy filing a lawsuit in California federal court to seize a Kurdish oil tanker filled with oil, oil from which Maliki and his henchmen did not get a kickback. 

Total corruption everywhere, with the Democrats and Republicans partying in August as the world burns.

toady's picture

You're all gonna die.

BLOTTO's picture

Salvation in death...who wants to live longer then neccessary on this perverted planet.


Im ready for the next chapter - where as a whole, we are vibrating at a higher density and hum along on another level...

huggy_in_london's picture

herbalife.... suck it up bitch

LawsofPhysics's picture

With an implicit guaranty from the Fed to steal from the productive class and backstop any and all risk, why wouldn't they?


Full faith and credit...

NOTaREALmerican's picture

Just another way the smart-n-savvy people use debt to win.   

It's impossible to keep the smart-n-savvy people from using whatever means they have to win.   

And, American society worships those who: "do whatever it takes to win" !

_________________________  (fill in all known "winning American sports cliches" here)  

NoDebt's picture

It just occurred to me, you would make a fantastic Herbalife distributor.  Fuck selling any product, just scream that at your prospective subs, slap the new recruit paper down in front of them and make them sign up.  Cha ching!  Dolla dolla bills y'all.

NOTaREALmerican's picture

I'm not saying the smart-n-savvy people are morally superior,  just genetically superior.    I couldn't sell an Eskimo a stove.

IANAE's picture

"Activism has a “public good” problem for the activist in that all of the other shareholders who typically comprise 90% or more of a target can be considered free riders with none of the costs or the illiquidity, and with all of the upside."


...a bit one-sided?  

NoDebt's picture

He didn't use Lloyd's famous "doing God's work" phrase, but you can just FEEL the attitude is there.  

This dude is way, WAY more important than you and me.  WAY more.

chunga's picture

That's how these people think.

Brokenarrow's picture

id like to play escaped convict and warden's wife with his pretty bride. the guys at Florence think "he's cute". One day this will all come to pass.......................

youngman's picture

They are all lemmings..doing the same thing...most Corps are buying back stock right now....its a trend...or should I say a fad.....the CEO cant double his salary right now with the heat from the they increase their stock option values......that is all...what is scary is the lack of Investment...R and D..that is what will kill the golden goose....

Rainman's picture

Here's another market top-ticking signal

JPM and BARC unloading their junk-rated CMBS ...circa 2007


NotApplicable's picture

The "C" stands for "Comical," right?

Seeing Red's picture

The stock-price-at-any-cost attitude is kind of sickening.  I wish companies were more dividend and long-term focused.  Part of this stems from the obvious loophole in the federal AMT tax, where long-term capital gains get special treatment.  Why?  Why not treat all income the same, and lower the AMT rate to a revenue-neutral number (from 26% to maybe 20 or 22%)?  The middle class would certainly be less gouged.  I'm sorry one-percenters, but if you get most or all of your income from long-term capital gains, I think you can afford to pay 20-22% federal tax.  This seems logical, so I'm expecting to get downvoted ....

Colonel Klink's picture

Die in a fire Ackman, please take your buddy iCON with you.

GernB's picture

Activism is wrong because it is fundamentally aimed at circumbenting the protectsion agains shareholders directly influincing corpororate actions. Such protections exist to prevent the corporation from bing inflluenced by majority shareholders to act to the benefit of the powerful shareholders at the expense of the less powerful shareholders.

For example, if I agree with Apple that retaining lots of cash is good in an economy that is so uncertain the Fed is pumping massive liquidity into it. I certainly don't want a more powerful shareholders with a false sense of security (because they watch to much CNBC,) using their influence to get their hands on that cash. And the corporate system has two layers of insulation (shareholders elects a board who appoiint corporater officers) between the shareholder and corporate officers specifically to prevent that kind of influence so the corporation can fulfill it's legal obligation to act in the best interest of all shareholdders.

It odd logic that says that just because you hold some positions for many years you are not actinging on your own short term interests. One does not necessarily imply the other there can be many reasons to hold onto positions long after you've wrung all the cash you can get out of a company.

NotApplicable's picture

If this activism was driven by hard-earned capital, rather than cheap and easy credit, there would be none of these issues.

Brokenarrow's picture

i hope bill has a heart attack

Mojeaux18's picture

How do I short his reverse ponzi scheme?  I mean fund!  How do I short his fund?