September 21, 2021

How Activist Bill Ackman Finds His Targets—And Makes a Pile Off Them

The hedge fund honcho, who also has had his duds, combines a composed demeanor under fire and an appetite for enormous risk.

Reported by Larry Light

Where do activist investors discover their targets? How can they sniff out the corporate weaknesses, hidden behind a cloud of public relations and accounting obfuscation, that enable them to wage war with an avenging zest against entrenched management? How do they do so knowing they’ll be vilified, sued, and maybe even investigated? And might lose a bundle of money.

For answers, look at Bill Ackman, who could give a master class on the rough-and-tumble world of activist investing.

The term “chutzpah” defines activist investors, those brash souls who mount frequently hostile campaigns against companies they think need improvement, or whose flaws invite a short sale. Combining equal parts bravado and financial analysis, the most successful of these hardy combatants are able to thrive on the wild frontiers of risk. Among the roster of star activists—which includes the likes of Carl Icahn, Dan Loeb, John Paulson, Nelson Peltz , and Paul Singer—perhaps the most daring is Ackman.

Ackman’s hedge fund has seen highs and lows. He crushed it with a turnaround of railroad Canadian Pacific, and also by shorting bond insurer MBIA and the pandemic-stricken 2020 bond market. He suffered for his forays with drugmaker Valeant (a long) and nutrition supplement vendor Herbalife (a short). In the live-by-the-sword-die-by-the-sword arena of activist investing, small wonder that lawsuits and acrimony often seem to dog his endeavors.

Early on, just out of Harvard Business School, Ackman struck out on his own, which is less safe and more ambitious than signing up with a Wall Street powerhouse such as Goldman Sachs as a junior investment banker. He founded investment firm Gotham Partners in 1992 with a classmate. Ackman once asked storied investment manager Richard Rainwater if he was wise to start his own hedge fund right after graduating and recalled that Rainwater responded: “You don’t have to be old to be right.”

Then in 2004, Ackman opened his current firm, Pershing Square Capital Management, named after a place in Manhattan near Grand Central Station. And, despite some setbacks, he overall has been quite successful. His net worth is $3.1 billion, by Forbes’ count. Pershing has $14.4 billion under management, as of its most recent Form ADV filing.

The company maintains a batch of long positions in such companies as Chipotle Mexican Grill, Hilton Worldwide Holdings, and Lowe’s, According to a recent Pershing report, this portfolio had risen 7.9% in 2021 through mid-August, only half of what the S&P 500 had returned for the period.

The lushest returns, though, come from activist investing.

Media savvy, articulate, and self-possessed, Ackman likes to issue public condemnations of target companies’ perceived failings with a studied calm. His professorial delivery of these attacks suggests to listeners that he is a rational, clear-headed money manager whom it’s safe to invest with. A raised voice would undermine that perception.

One example: The academic manner with which he presented his three-hour, 342-slide lecture at a 2012 investor conference, painting Herbalife as a pyramid scheme and a worthwhile short. An even more telling example: How his poise held amid a 2013 CNBC-aired argument with Icahn, who had taken a long position in Herbalife stock. During the almost half-hour confrontation, the hard-charging Icahn, the dean of activist investors and no stranger to a raised voice, called Ackman a “crybaby,” a “liar,” “sanctimonious,” “arrogant,” and someone who “takes inordinate risks.” Unrattled, Ackman retorted in a matter-of-fact fashion that Icahn “has trouble with the truth” and “takes advantage of little people.”

As the Icahn episode shows, Ackman’s milieu is a battlefield. When he suits up for a fight, he wants to be sure he is right. So day in, day out, how does Ackman go about his activism business anyway? Although the hedge fund operator wouldn’t comment, we patched together his take on some of his major activist crusades, using his public statements and the views of people familiar with him, plus published sources. The object was to learn: 1) how he located these target companies, and 2) how he feels about the outcome of his efforts. Some of his biggest career highlights give the answers:

MBIA. Word of mouth from someone he trusts is one way Ackman hears about an opportunity. This happened in 2002, just after he conducted a victorious short strategy, netting $80 million, against the Federal Agricultural Mortgage Corporation, known as Farmer Mac, which he said was disguising its precarious financial situation. He asked a Lehmann Brothers salesman, who’d sold him credit derivatives to bet against Farmer Mac, if there was another company in similarly shoddy shape. The salesman pointed to MBIA, which stands for Municipal Bond Insurance Association.

The company provided coverage to protect municipal bond investors in the event their munis defaulted. Not believing its AAA rating, Ackman condemned MBIA’s insistence on both insuring bonds and running structured finance plays with thin capital. The two activities shouldn’t mix and the scant capital was dangerous, he declared. He promptly took out a large wager against the company, composed of credit default swaps against MBIA’s debt and short sales on its stock. This drama took six years to play out. He predicted that MBIA would default—and that crash happened in 2008 during the financial crisis. Pershing made $1.1 billion when the insurer collapsed.

Ackman viewed MBIA’s ruin as a good thing for the system and investors. At one point, he remarked that MBIA “was creating a lot of risk in the financial system. And we shorted the stock and we disclosed publicly our concerns about the company’s balance sheet and the risk it was creating for the capital markets.”

Canadian Pacific Railway. The catalyst for this involvement was a Pershing analyst’s brother, who believed that Canadian Pacific (CP) was the worst-run railroad in North America. Hearing about that from the analyst, he got in touch with the brother, who filled him in on the company’s shortcomings. Pershing amassed a 14% stake in the railroad and became its largest shareholder. A tough proxy fight ensured in 2012 against company management, and Ackman came out the winner.

With control of the board, he then brought in Hunter Harrison, the retired chief of Canadian National Railway, to helm CP. Harrison overhauled the lagging railroad’s operations. By the time Ackman exited from CP, his investment had expanded fourfold, to $2.6 billion. Ackman is pleased that the company has continued to prosper and even is in acquisition mode. The stock since has climbed to $67 per share, from $14 from when he got involved. Last week, CP won a bidding war to take over Kansas City Southern for $26 billion, creating the first direct railway linking the US, Canada, and Mexico.

Herbalife. Christine Richard, who followed the MBIA saga as a Bloomberg reporter and wrote a book about it, Confidence Game, was Ackman’s tipster for the nutrition firm. Richard, who now runs her own research business, Orion Research, told Ackman that Herbalife was a pyramid scheme that bilked its distributors. In 2012, Ackman began his years-long fight against Herbalife with his lengthy public presentation.

The crux of his case against the company: Herbalife’s network of independent distributors didn’t make much from the company’s nutritional supplements and personal care products—and many, particularly low-income folks who wanted to get ahead in life, lost money. Although Herbalife bragged that distributors could become millionaires, Ackman said, the real money was in recruiting others and taking a cut of their sales. Only a handful of distributors at the top of the pyramid prospered, he stated.

The Herbalife episode was a vicious tiff, as the televised set-to with Icahn demonstrates. Amid an outraged Herbalife’s protests, New York’s attorney general launched a probe of Ackman’s tactics. (No action against him resulted.) Eventually, Herbalife reached a $200 million settlement with the Federal Trade Commission (FTC) over what the agency alleged were unfair practices, with the money going to 350,000 distributors. Ackman, who departed his Herbalife involvement in 2018, ended up losing a reported $1 billion on his Herbalife campaign. But he takes solace that the distributors got some cash.

Valeant Pharmaceuticals. Not all of Ackman’s wagers are negative. Here, he became a big investor in an increasingly hobbled drugmaker in hopes of turning it around. That bet proved to be a disaster. Valeant had a controversial strategy of growing through mergers instead of developing its own products. The firm bought other pharma companies to profit from their innovations and jacked up drug prices. While it enjoyed a buoyant stock price and earnings for a while, this approach generated a lot of censure, including from politicians.

Ackman’s first step with Valeant came when its management enlisted him in an alliance for a buyout. At the time, Valeant’s stock and its prospects were doing well. Valeant executives asked Pershing to help it acquire Botox maker Allergan. In 2014, Ackman lent a hand by taking a multimillion-dollar stake in Allergan stock and pressuring the company to combine with Valeant. Allergan resisted and got sold to Actavis Generics. While his merger plan didn’t work out, Ackman bagged around $2 billion selling his Allergan shares. (Pershing and Valeant later settled a suit for $290 million from Allergan shareholders that claimed his teaming up with Valeant amounted to insider trading.)

From there, his association with Valeant deepened, as Ackman was impressed by the company’s brands. He purchased a 5% chunk of Valeant and eventually joined its board. But the company’s troubles mounted, as short sellers lambasted the company for price gouging on its drugs. The Securities and Exchange Commission (SEC) launched an investigation of the company, and Ackman helped engineer the ouster of Valeant’s CEO. Things kept worsening, however, and he sold off his Valeant holdings in 2017, for a reported loss of at least $2.8 billion. Ackman has told others that Valeant “became our mess” and was “a good lesson,” evidently in choosing poorly and then doubling down.

The Pandemic Bond Market. Pershing’s big score in the coronavirus pandemic’s initial days owes to an internal Pershing analysis. When large numbers of people in Wuhan, China, started falling ill to a quick-spreading new disease, Ackman figured it would go viral, reach the US, and wreak havoc in public health and on Wall Street. “Hell is coming,” he warned in March 2020. At the time, he recounted in a talk this past winter at Harvard Law School, he figured: “common sense tells me, this will be everywhere.”

Ackman, who had watched the 2011 movie Contagion, initially contemplated dumping Pershing’s entire portfolio, he wrote in a letter to investors. But upon further study, he changed his mind. As he put the matter, “After a careful review of the portfolio, we concluded that a hedging strategy was more consistent with our long-term ownership philosophy and would likely lead to a better long-term outcome than selling off all of our assets.”

To protect the portfolio, Pershing paid some $27 million for the hedges, buying credit protection on investment-grade and high-yield indexes. The hedges, in the form of credit default swaps, generated $2.6 billion in proceeds by the time Ackman got out of them on March 23, 2020. From early March to March 23, when the rescue effort from Congress and the Federal Reserve kicked in, investment-grade bonds slid 6.2% and junk bonds dropped 19.7%, data from Bloomberg Barclays Indices show.

Ackman has said he always knew he and Pershing were going to make mistakes. But in spite of some epic drubbings, he has come out ahead. “When I first started in business, I didn’t know when it was time to move on,” he once said. “But I learned a lot about what I call the return-on-invested-brain-damage calculation. If the return isn’t high enough to justify the brain damage, I won’t spend the time.”