2015Q3 Pershing Square Holdings, LTD., Q3 2015 Earnings Call, Nov 09, 2015

CONTENTS
CALL PARTICIPANTS
PRESENTATION
Pershing Square Holdings, Ltd.
ENXTAM:PSH
FQ3 2015 Earnings Call Transcripts

Monday, November 09, 2015 4:00 PM GMT
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S&P Capital IQ Estimates**
**Estimates Data not available.
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COPYRIGHT 2015, S&P CAPITAL IQ, A PART OF MCGRAW HILL FINANCIAL.
PERSHING SQUARE HOLDINGS, LTD. FQ3 2015 EARNINGS CALL NOV 09, 2015
Call Participants
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EXECUTIVES
Ali Namvar
Senior Analyst
Brian Welch
Charles Korn
David Klafter
Jordan Rubin
Paul C. Hilal
Partner
Ryan Israel
Director, Member of Audit
Committee, Member of
Compensation Committee and
Member of Nominating & Policies
Committee
Unknown Executive
William Albert Ackman
Chief Executive Officer and
Portfolio Manager
William F. Doyle
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Copyright 2014, S&P Capital IQ, a part of McGraw Hill Financial.
Presentation
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Operator
Good morning, everyone. Welcome to the Pershing Square Capital Management quarterly conference call.
I will now turn the call over to Bill Ackman, Founder and CEO of Pershing Square Capital Management.
Chief Executive Officer and Portfolio Manager
Thank you, operator. Welcome to the call. As usual, we distributed the legal disclaimer, which we
encourage you to read. We're going to have Q&A at the end of the call. We've gotten a lot of questions in
advance. Feel free to send questions to ir@persq.com. If we don't cover your question during the call, feel
free to contact the IR team directly. We'll make the call available for replay for 2 weeks until November 23,
midnight. If you'd like to access the replay, please contact ir@persq.com.
So the purpose of this call is to give you the information we would want. We sat in your seat as an
investor. We obviously won't give away information that we think would create a competitive disadvantage
for the firm that would include what we're buying and selling or have plans to buy and sell in the future.
I've gotten some feedback from some investors that our calls have been, at least, a little more too
detailed from a quantitative point of view. So what I encouraged the team to do is focus on kind of the
high-level developments during the quarter with respect to investments in the portfolio. If you have
more detailed questions, feel free again to contact IR or to contact the underlying companies themselves
directly. We don't think of ourselves as the IR department for the companies we own. What we're really
trying to help you with is your investment in Pershing Square.
With respect to performance, we're going to update performance. We do so each week based on Tuesday's
close, and on Wednesday, we will provide that detailed information. Our last performance report was as
of the end of the month, last month. Obviously, it's been a pretty interesting period performance-wise,
interesting in a negative way performance-wise for Pershing Square as a result principally of decline in
Valeant stock price and then some decline in holdings, actually also a platform, which we'll talk briefly
about today. And I think there's been a bit of what I would describe as people betting against Pershing
Square, the assumption that as a result of recent events we're going to be forced to dump various
investments and you've seen an underperformance of a number of our, particularly the smaller less, liquid
positions, with the expectation might be that we intend to -- we're going to be forced to sell shares.
So just a couple of thoughts on that, so our investors understand. Number one, we probably have the
largest base of permanent capital of any investment fund of our type and that approximately half of
our capital is comprised of either permanent capital in the form of a publicly traded entity, 7-year bond
offering proceeds that we issued in the public markets as well as a fair amount of internal capital. That
provides a very good anchor for our capital base. The balance of our capital, a substantial majority of
which is committed on a 1/8 a quarter basis, which means you can redeem your money 1/8 each quarter,
and that gives us a lot of visibility in terms of capital flows in the future. We've been fortunate in having
done well for our partners over the last 12 years. We've erred on the side of transparency. I think the
press picked on the 4-hour duration of our Valeant conference call that we held for investors. Again, we
made about an hour or so presentation then we proceeded to answer literally every question we got
from investors. We're prepared to accept a fair degree of snide comments from the press in exchange for
providing you with the information that we would want with respect to, particularly, an investment that
has declined in value, at least, in the market price by about 2/3 over the course of the quarter.
I'm going to jump in and just walk through the portfolio and we'll address questions at the end. I'd like to
start with Mondelez and Ali and/or Anthony, why don't you go ahead and explain what happened during
the quarter?
Ali Namvar
Senior Analyst
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Sure, thanks, Bill. So Mondelez, our newest and largest position is really a classic Pershing Square-type
investment in that we own a business that's very simple, predictable, very high quality, with attractive
long-term growth and multiple opportunities to create shareholder value. And as an update, since that
announcement of the investment in August, we've had highly constructive meetings with CEO, Irene
Rosenfeld, and other members of senior management. And while the nature of these discussions are -they're essentially private, what I can say the key takeaway from the meetings is that we remain ever
convinced that the opportunity for productivity improvement and margin expansion remains vast and we
consider to be the largest in the industry.
As a reminder, Mondelez's operating profit margins were only 12% last year, and this year, they're
estimated to be about 14% for -- this is for 2015 and that's well below what we think they should be given
the company's categories, the brands and its scale.
In terms of recent performance, on October 28, Mondelez reported third quarter results. Organic growth
for the quarter was up 3.7%, driven primarily by pricing actions to offset currency headwinds. Volume
growth was negative for the quarter, but we're confident that volume growth will return as the company
lapsed through many of these pricing actions.
Gross margins and operating margins expanded very nicely, over 200 basis points, driven mostly by the
-- what we've called the base productivity programs that Mondelez has. What's important here is that this
increase in margins does not yet reflect the company's massive investment in its supply chain and the
supply chain reinvention should boost margins in 2016 and beyond significantly. So we're looking forward
to a pathway to more margin expansion and that pathway is basically set up nicely.
In conjunction with the quarterly results, Mondelez also announced the newly created role of Chief
Commercial Officer. Now we think it makes tremendous sense to have a senior executive overseeing the
company's commercial execution including the optimization of trade investments and the rationalization
of the company's portfolio SKUs. And we believe that trade spend optimization opportunity at Mondelez is
immense and represents what we say as a new powerful initiative for achieving more productivity.
And I'd say, lastly, we look forward to continuing a very constructive dialogue with Irene Rosenfeld and
other members of management team and the board and we'll keep you updated as that progress evolves.
Thank you, Ali. Brian, Air Products?
Brian Welch
Sure. So Air Products announced great quarterly results in late October. These quarterly results were
actually a record high for the company by a substantial margin. The organic revenue growth in the quarter
was about 1% and the margins were up over 300 basis points to about 21%. This led to earnings per
share growth of 10% despite FX headwinds of about 9%. So the earnings per share growth, excluding the
FX headwinds, would have been about 19% for the quarter.
Importantly, this quarter's results marked the end of the company's fiscal year and also the end of the first
12 months under the new CEO, Seifi Ghasemi. And the progress that he's made over the 12 months is
very spectacular and impressive.
For the year, the company produced earnings per share of $6.57, which was an increase of about 14%
year-over-year. Now this was despite a 7% headwind from foreign exchange movements within the year.
So excluding that headwind, earnings per share growth would have been 21%, but importantly, despite
that headwind, the company actually exceeded its initial earnings per share guidance set out last fall
under Seifi's initial prognosis on the business. So the performance has been quite good, and in fact, has
been so good that they've managed to surmount some of the unforeseen foreign exchange headwinds that
the company has faced.
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For next year, the company has called for guidance, which has earnings per share growing 10% to 14%.
We believe the company can achieve most of that year-over-year increase simply due to the cost savings
that are continuing to roll through the P&L. As a reminder, we've discussed in previous calls the 2 different
buckets of cost savings the company is focused on. They've taken majority of the actions to reduce the
corporate infrastructure of the business and to extract cost savings out of the SG&A and many of those are
rolling through the P&L in the coming quarters.
The other material development for Air Products for the quarter was their announcement that they are
spinning off their Materials Technology business, this is a noncore business that Air Products has owned
for a number of years. We think the announcement of a spin-off of this business makes great strategic
and financial sense. We think spinning the business off will allow each of the 2 businesses to focus more
appropriately on their own operations. More importantly, it will allow each of the businesses to allocate
capital in a way that best suits their business. You can imagine that a small noncore business like this has
not had the freedom or leisure to invest in transformative capital allocation decisions historically and we
think some of that can change now that the business is its own stand-alone entity.
The other key development on the spin-off of Materials Technology is really just that this business was sort
of an underlevered segment within Air Products. As you'll recall, Air Products has to maintain a very high
credit rating when it's selling on-site contracts to its customer base and the...
I would say it believes it has to.
Brian Welch
It believes it has to maintain a very high credit rating to service its on-site customers, and this business,
held within the corporate parent at Air Products, has effectively been underlevered relative to its enormous
free cash flow generation. And they've announced that with the spin-off, they will put more leverage
on this business at approximately 4.5x EBITDA, which will free up about $1.5 billion of capital for the
remaining business to either invest in the core industrial gas business or to repurchase shares.
Brian, you said that you believe that Air Products could make most of its earnings on the basis of cost
initiative, this 11% to 14% growth. The balance comes from growth or explain what you meant by that.
Brian Welch
Sure, so I can be a little more specific on the earnings bridge. The business did $6.57 this year in earnings
per share. The company has announced that they -- of their $300 million corporate and SG&A savings,
they believe they achieved about $150 million of that in the $6.57 a share, but that the other $150 million
will come next year. They've also said that on the productivity side, they expect to get $300 million of
savings with $75 million of that coming per year. So if you take the $150 million plus the $75 million,
you get $225 million of EBIT improvement next year from the cost savings. And if you tax effect that and
divide it by the share count, it's basically $0.75 a share in earnings improvement. So you can get to sort
of the lower-middle portion of the company's guidance range for next year solely on the cost savings that
the company is forecasting.
The other 2 variables would just be contributions from growth CapEx, which is a little more lumpy and
challenging to predict. But recent performance in Asia and other parts of the business where that CapEx is
going into the ground has suggested that there's enormous opportunity there as well.
The company did say that, with their guidance, they're being very cautious about global growth at the
moment given the slowdown in various different markets and given the uncertainty. So they have said
that next year's guidance effectively assumes no global growth. And we think that's probably appropriately
conservative, but hopefully things are better than they're assuming.
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I note that Air Products' stock down 6% for the quarter along with many industrial -- other industrial
companies. How sensitive is Air Products business to kind of industrial GDP or kind of the economic
environment?
Brian Welch
So it's relatively not very sensitive to macroeconomic outputs despite the stock price reaction, as Bill
mentioned. If you look at the Industrial Gas business, for instance, for the quarter, Industrial Gas
revenues, excluding Asia where all the growth CapEx investment has been, had been up slightly on
basically flat volumes and 1% to 2% price growth. If you look at Asia where they've been spending a
majority of their CapEx in recent years, the volumes were up 15%. And again, as a reminder for our
investors, this business is extremely high quality. Almost half of the company's Industrial Gas business
is in the on-site variety where they build a large plant on a contracted basis for the customer and those
contracts include take-or-pay terms where the companies are paid regardless of minor fluctuations in the
end users' underlying demand. So it's a very high-quality, resilient business and we've seen that in the
results that they continue to post.
Thank you. Paul, update on CP.
Paul C. Hilal
Partner
Thanks, Bill. The global macro softness that's been plaguing the rail industry over the course of the year
continued through the fall -- throughout the third quarter. It's not only the slowdown, it's also the supply
chain destocking that continues. And this environment presents a challenge for railroads. Railroads have
real operating leverage, and as volumes come down, the operating leverage works against them, so they
struggle to maintain margins in this kind of environment. Broadly speaking, the rail industry has seen
about 3% volume declines, both in the U.S. and Canada.
CP has managed very well through these headwinds. In the face of a 4% revenue ton-mile, which is a
measure of volume, decline year-over-year for the third quarter, they improved their margins a full 3%.
The question is how does this management team do this? Well, they do this through continuing to increase
the productivity of labor and continuing to increase the productivity of their physical assets. These -- the
results of these efforts are seen in the operating metrics and they're also seen in the financial metrics.
Financially, CP was able to move these reduced volumes, about 4% reduced volumes, with 9% fewer
people, a very big increase in labor productivity. And there's reason to believe that the labor productivity
of the firm will continue to increase based on the company's announcement in the past quarter of the
restructuring of the Brotherhood of Locomotive Engineer work rule contract to allow those workers to work
not on a mileage a basis, but on an hourly basis. Hunter, on the recent earnings call, expressed hope that
the same kind of arrangement could be achieved with the Canadian unions.
So we've seen labor productivity improve. We've also seen improvements in asset productivity. These
have led to a reduction year-over-year in the number of railcars in the network by a full 15%. So the
company with 4% fewer volumes with 15% fewer railcars. They also have 400 locomotives, high-powered
locomotives, specifically in storage. This is a result of greatly increased locomotive productivity. What this
means is that unless volumes increase materially, Canadian Pacific is not going to need to purchase any of
these high-powered locomotives until 2018. They can just draw upon this reserve of stored locomotives.
Originally, when the company embarked on this venture, they thought that they'd be able to defer
locomotive purchases for 3 or maybe 4 years. It's looks like it's going to be closer to 7 and possibly 8. At
$2 million apiece, this is a meaningful savings for the company.
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Prospectively, the company explained on the earnings call that if volumes don't increase, because of the
great work they've done upgrading and improving the network and the rolling stock, they'll be able to
reduce the capital expenditure budget for 2016 from the $1.5 billion level where it is in 2015 down to $1.1
billion.
On a cash flow basis, the company's cash flow -- free cash flow for the year so far has been great. The
company generated $1 billion of free cash flow year-to-date -- or sorry, 9 months ending September 30.
This compares very favorably to the $600 million of free cash flow they generated in the 9 months a year
earlier.
The company issued $2.7 billion of U.S. dollar-denominated debt this past quarter. The proceeds of
that raise and some of the cash flows that were generated over the past 9 months contributed to the
retirement or the early repurchase of some covenant-restrictive debt that had been outstanding. It
was also used to fund repurchase of approximately 5% of the company's shares outstanding over
the past quarter at attractive prices. The company has an additional 1 million shares left in the board
share repurchase authorization. The authorization permits the company to repurchase up to 8% of the
company's stock. That authorization can be -- has the possibility to be expanded to 10%, which is the
ceiling of the normal course issuer bid rules in Canada.
The management was upbeat on the call concerning next year. Hunter explained that even if volumes
do not recover next year, he sees an opportunity to improve labor productivity and asset utilization even
further, translating to 200 to 300 additional points of margins for 2016.
Thanks very much, Paul. Bill, Zoetis down 14% during the quarter and largely this is sort of an interesting
phenomenon that you see where you have a stock in a sector group, specialty pharma or just kind of
health care. Generally, those stocks were down a lot during the quarter driven initially by a tailored Clinton
tweets and follow-on questions about drug pricing. But of course, Zoetis is not a human health company,
it's an animal health company. So maybe you can start there, Bill. What are the implications for Zoetis
from some of the politics around drug pricing, does it have any impact on the business. Just very high
level.
William F. Doyle
Yes. Sure, Bill. So you're exactly right. The stock traded down basically in sympathy with the human
pharmaceutical stocks in the quarter. It's often grouped in that same category, but it shares almost
nothing in common with those products, how they're distributed, how they're paid for. The Zoetis business
is a highly diversified global business supplying medicines to ranchers for the production of protein and
to vets for the betterment of pets. In the case of the ranchers, this is a B2B business where the prices
are negotiated between sophisticated players. In the case of the veterinary market, this is a take-or-pay
self-pay business, again with no -- essentially no third party or government reimbursement. So it -- well,
the stock trades or has historically traded with this group. Management is spending quite a bit of time
educating the analyst community and the investor community in general that this business, other than the
fact that they're drugs, has very little in common with the human health business.
That's in the same ETF, though. So it does trade with, to some extent, but that does create an opportunity
for -- so I'm going to think through the short-term technical factors.
William F. Doyle
I think exactly right, and it creates an opportunity for management again to educate the shareholder base.
And case in point, the company announced last week another outstanding quarter. They saw operational
revenue grow 9%, operational adjusted net income grow 30% -- 31%.
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This is an extremely diversified business. As I mentioned, it's diversified globally. It's diversified by
species. It's diversified by products. Growth in Q3 was driven primarily by the U.S. livestock business;
the integration of products on the veterinary side from their Abbott Animal Health acquisition, which they
acquired in Q1; and growth in newly launched products in the veterinary market. This is a business that
has a highly productive R&D engine that continues to launch new products.
Notwithstanding very strong FX headwinds, the company reported $1.2 billion in revenue that was equal
to reported revenue in Q3 2014 and EPS that increased 15% compared to Q3 2014. Their adjusted net
income, which excludes certain onetime adjustments, was $0.50. This was an increase in 22% compared
to Q3 last year and it significantly exceeded the Wall Street consensus of $0.40 per share.
This is a very disciplined management team. They're focused on growing revenue faster than expenses,
and again, delivered another quarter where that was the case. As I mentioned, operating revenue was up
9% while operating expenses grew only 3%. And management reaffirmed their commitment to meet or
exceed the $300 million expense reduction target that was previously announced by 2017.
And finally, one of the big news items during the quarter was the company announced the acquisition of
PHARMAQ. The fastest-growing segment of animal health is the fish farm or aquaculture business. This
is a segment where previously Zoetis did not participate. It's basically the only segment where they did
not participate and PHARMAQ was the leading manufacturer of aquaculture medicines. This business is
a natural strategic fit with Zoetis and we expect this to be a real platform for future growth and will also
take advantage of not only the R&D capacity that they're acquiring in the acquisition, but we expect that
the R&D capability at Zoetis plus Zoetis' global sales and marketing capability will also contribute to longterm growth.
Thank you, Bill. So next is Valeant and we've been going through investments in order of size. This was
our largest investment. Mark to market today, it's roughly 12% of total assets of Pershing Square. A few
thoughts. Obviously, we spent a fair amount of time on this very recently on the conference call. That call
is still available for replay and a number of transcripts have been done by Bloomberg and others. What
we've been focused on is what are the implications for the company of sort of the very, I would call it,
reputationally damaging media and various assertions that people made about the company and how do
we think about the value of this business. And like any other business, we think about it based on the cash
we expect the business to generate over time. And so we've looked at the various products and product
lines of the company and asked ourselves and done some due diligence. Beyond that, what is the impact
of the shutdown, for example, of this Philidor specialty pharmacy distribution channel on the cash flows of
the company going forward, what are potential reputational implications. And I think what's interesting, if
you think about Valeant's business, first of all, number one, the only business in Valeant that is Valeantbranded is the dermatology business. We spent a fair amount of time in the last week or so doing some
kind of physician-based due diligence, which I'm going to ask Jordan to talk about.
But if you think about the cash flows from Bausch + Lomb, are people going to buy more or less Bausch
+ Lomb contact lenses or solution or equipment or otherwise as a result of the noise around Valeant,
the answer is, we think, no. We don't think there'll be any impact on the Bausch + Lomb franchise
as consumers are not going to switch contact lenses on the basis of an accounting-driven short seller
afforded by Valeant. If you look at Valeant's branded generic business, which is in Latin America and
Middle East and Russia and markets around the world, these brands -- I can't even name the brands,
but they're not Valeant's and they're not even brands that are known to us. They are very much local,
established brands in these markets and we expect sales to continue as they normally would and be really
unaffected by recent events.
Now their acquisition of Salix and the associated Xifaxan and other products. Again, these are products
that treat specific diseases that have gotten FDA approval and we expect doctors will prescribe them to
patients because -- to treat various disorders and we expect the growth of this -- of these products to
continue really unaffected.
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And if you go product-by-product throughout the portfolio of the company, the only real question in our
mind was the Valeant-branded product, the dermatological products that are prescribed by a subset of
doctors, with all the press around Philidor with the impact, and we did some interesting work and I'm
going to turn it over to Jordan to explain what we've done in terms of research and what we've learned.
Jordan Rubin
Sure. Thanks, Bill. So as Bill mentioned, we thought it'd be helpful to cut through the noise and bring the
conversation back to the business. And in the last week, myself and a colleague, Charles, who's going to
also share his thoughts on this research, did some diligence on Valeant's dermatology business. We spoke
to 10 dermatologists in the last several days and we surveyed over 40 dermatologists online about their
use of Philidor, specialty pharmacies in general and their thoughts on Valeant.
And the high-level takeaway from this research is that the most important thing for doctors is that their
patients have access to the right drug at the lowest possible cost and doctors recognize very broadly
that specialty pharmacies help make that happen. So a little bit of headline, what else did we learn? We
learned that doctors who prescribe Valeant drugs generally like Valeant products, and in many cases,
see clear differentiation between a Valeant product and alternatives. Doctor generally not hesitant
to use specialty pharmacies. They're a partner with manufacturers. In fact, it's very common -- they
recognize it's very common any issues for these partnerships to exist. Many doctors even see insurers
as an adversary and they view specialty pharmacies as necessary ally against this adversary. The doctor
we spoke to saw 60 patients a month. And they don't have time, their staff don't have time to fight with
insurers for access to this medication for their patients.
Actually, if I could just jump in for a second. I was only able to sit in on one of these calls, but one of
the things I found most interesting when you talk to dermatologists and you ask me why you prescribe
this product, the branded product versus a generic version of the product, and the answers they give are
interesting. In dermatology, in particular, the -- what the doctors talked about was sort of the cosmetic
quality of the product actually has an impact on whether or not the patient uses the product. So for
example -- if you have acne, for example. Compliance, i.e., do you use the product every day, do you put
3 different ointments or whatever on your face depends on whether the patient, or the consumer in this
case, is willing to actually have this product on their face. And if it looks greasy or if it has a tactile feel
that's not appealing, the patients won't use the product and won't cure the disease. And so the doctors
think very carefully about which particular ointment or treatment that they want their patient to use.
And they also -- they want it to be affordable for their patient, which is why they want to make sure that
whatever the co-pay requirement is, it's something their patient can afford in light of their particular
health plan. And a lot of people that go to dermatologists are -- the particular person we spoke to was a
young -- a lot of our patients are young women, in their mid-20s. They don't -- they are on the kind of
gold-plated sort of health care plans, but they're very sensitive to the quality and cosmetic quality of the
product, again where the Philidor or the specialty pharmacy comes in very handy. Everything we heard
that was interesting is the fact that Valeant has a very broad portfolio of products that can be dispensed.
You can get them at one -- it's just helpful. The existence of Philidor was quite helpful in that the doctor
could be very confident they would prescribe, for example, 3 particular ointments to be used to treat a
disease, some kind of skin problem, and they were confident the patients could get those drugs filled at
very low costs and very low co-pays. So there's a real industrial logic behind specialty pharmacies, which,
of course, raises the question, what's going to happen next. But why don't you keep going through on the
other...
Jordan Rubin
Like what Bill said, as with any -- so acne is probably the portfolio in Valeant's dermatology business that's
the least differentiated, but they do have a number of products that are combination products where each
of the individual component is available as a generic. But if you think about it, actually, acne, just like any
other disease, you have to use the drugs to treat the disease. The disease won't go away without proper
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compliance. And if you have a 16-year-old boy, the probability that he compliantly applies 2 separate
creams a day versus 1...
And sometimes 3.
Jordan Rubin
Sometimes 3 is much lower. And then you think about our product like Retin-A. Retin-A Micro is available
as exclusive to Valeant's type of product. Retin-A is not, but that Micro makes a difference. The Micro
product is much gentle on the patient's skin. And...
Actually, one of the doctors talked about how the generic version of the drug is a 5% concentration where
the branded version is a 0.5% concentration. And if you have mild acne, you don't want to put on a very
caustic. . .
Jordan Rubin
Yes -- so yes, Solodyn is a product, for example, where there are generic versions available but in
different strengths. And the patient takes 3 pills in 1 day, 2 pills the next day, 1 pill the day after that
and it just becomes challenging to get a patient to take the medication if the regime is complicated and/
or the product causes them rashes or other issues beyond their acne. So getting back to the -- to what
I was saying before. The doctors that used Philidor loved it, and for the most part, they send the vast
majority of their prescriptions, their Valeant prescriptions through Philidor. And these doctors reported
overwhelmingly 9 out of 10 that they will not change their prescribing habits so long as Valeant can
replace Philidor with another specialty pharmacy that can help them with co-pay assistance and prior
authorizations.
And the last thing I mentioned that we learned that was very interesting was that dermatology generics
have become extremely expensive and this is something you heard from almost everybody that we spoke
to. It was also reflected to me in the online survey. A high percentage of doctors report that high co-pay
requirements and prior authorization requirements were very common, particularly in acne. And unlike
branded manufacturers, the generic manufacturers don't provide any assistance to the physicians to get
through these barriers to patient access. So with that, I'll kick it to Charles and he can share some of his
perspectives.
Charles Korn
Yes, I think I agree with kind of all that sentiment. Summing up some of what Jordan's saying, I think
Valeant and others are increasingly selling a product portfolio, but also they're selling a product with a
valuable service and I think that, that came through when we were speaking to doctors.
Two other things worth noting. One, on the co-pay assistance. So co-pay assistance has been going
through the retail channel for years. These coupons that the manufacturers will give out, that's not new.
But we found that, that was ineffective in the retail channel for a variety of reasons. So one is patient
compliance. The patient themselves has the co-pay coupon and they may lose it or they may not actually
bring it to the pharmacy. And then we also heard that there's somewhat misaligned incentives at the
pharmacy where the pharmacist has an incentive to prescribe the generic perhaps and so they may
make it difficult for the patient at the retail format in order to administer that co-pay coupon, or it's
in the specialty channel that co-pay coupon dovetails nicely with the claims adjudication and the prior
authorization assistance. So we're hearing that increasingly the incentive of pharmacies are perhaps
misaligned -- retail pharmacies, I should say, are misaligned with the incentives or the needs of doctors
and patients.
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And then the last point I'd make is there is a point here on product penetration. So of the doctors that we
surveyed, 2/3 use Philidor -- 2/3 who script Valeant use Philidor. They tend to write more Valeant scripts
on average and it's simple. There's better access in the specialty channel. Of the 1/3 of doctors who we
spoke with who write Valeant scripts, but do not use Philidor, they generally hadn't heard of the specialty
pharmacy channel. But importantly, they're all intrigued by the service offering and thought that it was -could be quite valuable for a subset of their patient population and they tend, on average, to script fewer
Valeant scripts. So one would assume that if they are indeed interested and they were to begin using
specialty pharmacies, that may rise over time and so there could be a volume benefit here over time. So
those are the 2 other observations on that.
Yes, the other thing I would add is -- at least the doctor I spoke to talked about how specialty pharmacies
were not a unique channel for Valeant. They were used by all of the -- many of the manufacturers that she
recommended products from, and she had said they little pads with little coupons that she would give to
her clients and her patients that they would use.
So I think what's interesting in terms of recent developments, this morning, Valeant announced a
conference call to be held tomorrow at 8:00 a.m. They said the call will discuss transition plans for Philidor.
They also mentioned they're going to have an Analyst Day later this year. I don't know if it's too quick
for Valeant. I don't want to raise expectations, but my guess is fairly soon they will have identified a new
specialty pharmacy channel. It will be one that will likely be owned by someone else. And again, this is a
fairly large volume, call it, $800 million worth of product being sold through the Philidor channel. That's
an attractive piece of business for an existing specialty pharmacy to bid on and our assumption would
be that they're -- they probably contacted a multiple large-scale specialty pharmacy divisions of some
maybe the bigger PBMs or maybe some stand-alone specialty pharmacies and we hope to hear tomorrow.
Ideally, they've identified a new partner on terms to allow a seamless transition and that, that will happen
in relative short order. But we thought it very positive that they're holding a call and also they're going to
take questions from analysts. I expect it will not be a scripted call. I think it'll be a probably likely to be
a more traditional Valeant call where they answer questions. And I think that will get -- I think half the
problem here has been the way this has been managed from a PR point of view. Up to this point in time,
I don't think this management had received subpoenas or have been really the focus of congressional
attention. And with all the lawyers and crisis PR folks you hire during a period of time like that, very often
a company will, at least in this case, we think they mismanaged certainly the communication message.
The fact they're holding a call tomorrow, we think, is a very positive step in the right direction.
Let me make another kind of overall comment. Our expectation for the future cash flows of Valeant have
not materially changed in terms of the next, I'd call it, 10 years. There's been a disruption with respect
to Philidor. If they can manage that seamlessly, we don't expect a huge impact on the company's cash
flows. There's certainly more heightened sensitivity around drug pricing. I think Valeant is not the only
company to have received subpoenas. Just last week, I think, Friday, Merck and Lilly, I think, were also
subpoenaed with respect to drug pricing. So I do think the issue of drug pricing is going to be one that
will create sensitivity on drug companies about being a little too aggressive on price. We do not believe
that Valeant needs to be aggressive on price in order for this to be a very attractive investment for us
at materially higher prices than where it is. But obviously, at the current share price, we think it's very
attractive.
I have to kind of predict the next several months, I think what you'll see is, one, we have a call tomorrow,
so beginning of little more transparency, update for shareholders, I think that will be calming to investors.
There's a -- Valeant will be testifying December 9, along with several other pharmaceutical companies,
about drug pricing. There'll be a fair amount of, we think, typical shaming and theatrics, to some extent,
that occur in congressional hearings, but I expect Valeant will have very good answers to the questions
that they're asked. And they're going to have an Analyst Day before the end of the year, they mentioned
yesterday, where they will give a chance for people to have a better understanding of the business of the
company. In January, the company announces -- typically updates its guidance for the upcoming year. And
then the company will file its 10-K probably sometime, I would guess, in the February-March time frame.
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I think each of these events will be a confidence-inspiring event for the shareholders of the company.
And what's happened, in my mind, is you've had really a panic caused by a collection of not directly
related events, but the combination, I think, caused the marginal investor to sell, and selling begets
more selling and panic and all kinds of rumors. And then on Monday, there's going to be more dramatic
information, the short seller says. And just people -- our last call was held on a Friday, mid-call, the kind
of most public short seller here came out and said, "On Monday, I'm going to release the most damning
information. I believe it's much dirtier than I thought." And then Sunday night, he withdrew his plans to
release that information. So I think it's been largely a victim of fear and panic, and we think the -- just
the combination of more disclosure and management sort of facing their shareholders and answering
questions, a lot more information about specialty pharmacies. These are not unique animals to Valeant.
They use it very wisely. We heard very good things from the physicians about the service quality and
their patient experience with Philidor's. We hope they can replicate that with a third party. And so I just
think the combination of these things will ultimately cause a revaluation on the stock price. The company,
of course, is doing an investigation of Philidor. If there are members of management that are somehow
involved in something inappropriate, I'm sure that will be addressed by the board. We think they're
handling it largely the right way. And those are some basic thoughts with respect to that investment.
So we -- one other thought, I think, again, a lot of mischaracterizations on the press. In our call, we -- I
compared -- I was trying to come up with an analogy in the investment world to the Valeant experience,
and I made an analogy to American Express in the so-called The Salad Oil Scandal. And the point I made
there is that well-known company, well known for its credit cards and travelers' checks. No one really
knew anything about this warehouse division that was relatively small part of the business. But they woke
up one day to find out that American Express had lost a ton of money, caused a loss of confidence. The
stock price dropped, call it 50%. Warren Buffett stepped after doing some field research, much the same
kind of research that Jordan and Charles have been doing in terms of talking to the ultimate users of the
product, concluded that this would not have an impairment on their core business. It would have a cost in
terms of a write-off, but that the business will ultimately recover. I was not comparing myself to Warren
Buffett because we were -- if we didn't own the stock and we bought it after it collapsed, I would say we
-- it's an apt comparison owning the stock from $193 to $250 and then $275. We are not making new
Warren Buffett comparison from that perspective. So why don't we continue with the restaurant brands.
Ryan?
Ryan Israel
Director, Member of Audit Committee, Member of Compensation Committee and Member of Nominating &
Policies Committee
So restaurant brands had another really good quarter recently. I think there are 2 things to focus on from
the quarter. The first would be the continued improvement at the Burger King U.S. store base. Same-store
sales, which is a measure of the increased sales that occur each of Burger King stores, was up 5% from
last year, which was actually the second quarter now that Burger King has led the industry in terms of
sales by a significant margin. And it's the eighth consecutive quarter where the Burger King U.S. stores
have delivered positive performance.
If you recall, this is really the last leg of the 3G turnaround at the Burger King business. They had
substantially reduced cost. They had refranchised stores, made it a more capitalized business and really
expanded their units, our stores around the world at a high degree, but hadn't been able to turn around
the same-store sales at Burger King. I think we're now seeing consistent trends where that last leg of
the investment piece is playing out. What's interesting is, despite the improvement in same-store sales
recently, there are still a lot of opportunity to come. The sales that occur at each of the Burger King stores
in the U.S., significantly less than the key competitors of Wendy's or McDonald's. And so we think there's
turnaround, which has gotten legs recently, has a long way to run and could be the next leg of growth at
the Burger King brands in the U.S.
Secondly is the continued cost reduction at Tim Hortons, how the company reduced overhead costs at
Tim Hortons by more than 40% this quarter, which is actually an acceleration from the first 2 quarters of
this year, which when they bought the Tim Hortons brand at the end of last year. And what I think what's
important here is the company is certainly increasing the efficiency with which Tim Hortons operates,
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which is an improvement to the earnings. But at the same time, this isn't at the cost of growth. In fact, it
may be accelerating the growth of Tim Hortons, both shorter and longer term. It shows that, I think, that
company under 3G's management can both make businesses more efficient from a cost perspective and
still maintain top line growth as well.
So in summary, the quarter was very good. EBITDA was up 6%, and earnings per share were up about
33%. And this occurred in spite of a very significant headwind from the strengthening U.S. dollar, so which
impacted results negatively by about 12%. So excluding the change in foreign currency, EBITDA would
have been about 20%, and earnings per share would have been more than 45% above last year's levels.
Thanks very much. So Howard Hughes has not yet reported earnings for the quarter. I'm Chairman of the
Board of the company. Obviously, we are insiders here. So I can't really comment on anything particular
to the quarter. I'd make an overall comment. The stock was down 20% for the quarter. I think that had
absolutely nothing to do with the performance of the business. The company has continued to perform
well. The only weakness that Howard Hughes has shown at all is lot sales and new leasing is down slightly
somewhat in The Woodlands development that is a meaningful but still small minority percentage of the
value of the business, and that really began earlier in the year with concern about the price of oil. What I
would say is this really fits into -- I would say this, I think that there is a phenomenon with respect to our
-- particularly our less liquid investments, where people are betting against Pershing Square, assuming
that we're going to dump our position in Howard Hughes, our position in platform or Nomad. It can even
-- maybe even carry it to Canadian Pacific, cases where we have a large stake and we on many days of
trading. We have no plans to sell any of these investments at this point in time. We think that we will own
-- expect to own these investments over the years. Now of course, I have to make a comment that of
every day, we reassess every investment in the portfolio, but we do think that these are very long-term
positions, and they get much more interesting as the prices get lower. So Howard Hughes is a much better
investment, down 20%. The same thing is true for Valeant, for example. And Canadian Pacific, we think is
a bargain at current levels. And the good news here is we get to take advantage of it even without buying
the shares ourselves. Our interest in CP has increased meaningfully in the last quarter just by virtue of the
company retiring shares. The lower the stock price goes, the more profit we will ultimately -- we expect to
make from this investment.
Now there is one investment during the quarter where there was some impairment in the value of the
business, and we distinguish between a mark-to-market decline of the stock price versus a -- some of
the impairment of the business. Platform reduced guidance during the quarter. It tells you that cash
flows are lower than were expected, so that is an impact, certainly, in the short term on the value of
the company. We are quite limited in what we can say about Platform because it's still in the midst of
a pending acquisition, Alent. And as you can tell from most of these calls, we -- I insist that they are
unscripted. I do have to -- since this is important, I'm going to read this, and this is a script, but I'll be
short.
During the quarter, Platform's share price declines 51%. The U.K. Takeover Code requires are comes to
be derived from publicly available information. In this context, we have noted the companies would share
some similarities to Platform's business model or compete in the agricultural chemicals industry have also
experienced significant share price declines in the third quarter, for example, highly acquisitive companies
such as XPO Logistics. LTs [ph] and ColPac [ph] each exhibited share price declines between 35% and
47% for the quarter. And addition, the share price of Platform's closest agricultural period declined 35% in
the third quarter.
There have been 3 key developments that have occurred since our last call. First, the company has
undergone a leadership transition in several key roles. In the last several months, Platform announced the
resignation, hiring and promotion of several key executives. In August, Wayne Hewett, former President
and Head of the Agricultural Services business left the company. In October, Dan Leever, former CEO
of Platform, resigned. Dan stated his resignation arose due to disagreements with Chairman, Martin
Franklin, regarding management style and cultural integration of the acquired companies. Platform also
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recently hired a new CEO, Sanjiv Khattri; and promoted its former Head of Corporate Development, Ben
Gliklich, to COO. In an investor call in October, Martin reiterated his commitment to Platform, explained his
involvement with the company will be even greater than it has been in the past.
Second, the company reduced its EBITDA guidance for 2015. In August, the company reduced 2015
EBITDA guidance $620 to $650, which was a 5% reduction at the midpoint from its initial guidance of
$660 million to $680 million. In October, Platform further reduced its 2015 guidance $550 to $570, an
additional 12% reduction. The company has explained that the primary drivers of the guidance reductions
are worsening foreign exchange rates and the change in distribution strategy in the Agricultural Solutions
business to realign inventory levels to more closely match underlying demand.
Third, the company provided the additional details regarding the financing for the pending acquisition of
Alent. In October, Platform reiterated that it has an underwritten commitment for long-term debt financing
what it believes to be a competitive market rate of $1.8 billion cash portion of the purchase price. In
addition, the company clarifies it does not need to issue additional equity to finance the closing of the
Alent acquisition until this transaction closes, which is estimated to be, Ryan?
Ryan Israel
Policies Committee
December 1, the company has said.
December 1 according to the company, at which point, I expect on our next conference call, we'll be able
to talk more fully about this particular investment. I want to make a general comment about so-called
Platform companies and then also comment about Pershing Square and our -- how we think about trading
and so on and so forth.
So if you think about Valeant, for example. When Valeant stock was trading at $250 a share, there were
some value. It was trading at a price that reflected the value of the existing asset base but really no value
for their ability to make attractive acquisitions, to take advantage of their competitive operating model,
their lower tax rate and their ability to do transactions. We held the stock at that price, believing that
likely that Valeant could continue to deploy capital on attractive terms and continue to grow the value of
the business.
With the collapse in the stock price, with the widening spreads of its debted issue, today, we do not think
it is likely that Valeant can -- certainly in the short term, for probably the next 18 months, they will do
very few in the way of acquisitions, and they'll take probably the -- nearly all of their free cash flow used
to delever the company, either through a combination of just paying down debt or the opportunistic
repurchase of debt that's trading at a discount to face value in the marketplace. But at $80 a share, our
assessment of intrinsic value in terms of the existing core asset of the company has not meaningfully
changed. So we think there's something approaching 3x upside in the core assets of the company,
assuming they don't make another acquisition in the business.
Now the -- you can look at Platform in a somewhat analogous fashion or Nomad and these other
businesses. We are not -- by virtue of being a large investor and owning a meaningful percentage interest
in these companies, we do not have the ability to trade these investments the same way someone
would -- who owned 0.5% stake in these companies. With 20% of Platform or a similar percentage for
Nomad, to a greater extent, we have -- certainly have more flexibility in Valeant because we're just a 6%
shareholder, and it's quite a liquid stock. But we generally don't take advantage of kind of what we believe
to be short-term rises in stock prices. Where a company approaches our estimate of the intrinsic value,
we won't sell if we believe there are events that can take place to make intrinsic value grow at a much
faster rate. Maybe the best example I can give you is about -- call it, a year ago, we had a lot of debate
internally about our investment in the then Burger King Worldwide because at the stock price where
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to a great extent, reflected the value of Burger King. We elected -- yes, there were still some upside in the
business. It was still attractive, but our return requirements are higher than a typical investor. So for us,
it was becoming a lower-return investment absent another transaction. And the company was looking at a
potential for a capital return in the form of adding additional leverage and buying back stock. We elected
to hold that investment at that time because we believe that we had a management team that was -- and
a strategy led by the folks at 3G, where we believe that they would find other opportunistic things to do
with their capital. In fact, we had pitched them on the idea of acquiring Tim Hortons, although they had
not really given us any visibility as to what progress they had made. And then, lo and behold, we got a
call from them and where they told us they were days away from completing or announcing a transaction
with Tim Hortons. And the -- we've continued to hold that investment, and it got cheap again, really, the
day after they acquired Tim Hortons. While the stock price has gone up somewhat, we think there is -continued to be a very significant opportunity for the company to increase the value of both the Burger
King franchise and the Tim Hortons franchise.
My guess is there will come a day where the stock price of Burger King and Tim Hortons, again, our
restaurant brands, starts to reflect the the potential of those 2 acquisitions. And we don't think we're there
now in the -- certainly in the mid-30s of the share. And we'll have debate internally again, do we hold this
investment? Or do we think it's likely they're going to find another smart place to deploy capital and make
a decision as to whether to continue to hold it, sell some, et cetera.
The same approach we applied to Valeant. At the $250 share price, with a brief moment, it was at $250
a share, we felt the stock price was -- reflected a large amount of the value of the existing asset base
of the company. But in light of management's track record for doing transactions, and in particular, in
the pharma space where they're a much, much larger -- there are only so many restaurant companies
that restaurant brands can acquire. There are trillions of dollars of market cap, public and private, of
potential acquisitions for Valeant. And we elected to hold the investment at that time because we are
confident in the management's ability to deploy capital. We've not lost that confidence in management,
but there was a period of time, I would guess for the next 15, 18 months, we don't expect a lot of
business development or acquisitions to take place at Valeant. And that's just fine because we think it's
still a very, very attractive investment. I would say it's a more attractive investment and probably a lowerrisk investment than it was at $250 a share. What the public dialogue around Valeant has missed, and
what's interesting about the media is when Herbalife was at $81 a share, people said the probability of a
government investigation is de minimis. The company's growth is going to continue at very high rates for
a long period of time. Pershing stock is going to double and triple. Pershing Square is going to be wiped
out. Our view was that, eventually, they would have difficulty, running out of people to recruit in the world.
All of the scrutiny around the business would affect their ability to continue to mislead people. It would
have an impact on the underlying performance of the company, and then ultimately, the government
would take real interest in the company. And 3 months later, the FTC announced an investigation, the DOJ
announced an investigation. And then shortly thereafter, the company's results started to deteriorate.
So with that -- the point here is we're at sort of an Herbalife moment at $81 a share, with Valeant at $80
a share, except the situation is reversed. There's a huge amount of public perception. The market tends
to -- people -- the media tends to believe something is true based on where the stock price is in the short
term. And the only thing the stock price tells you in the short term is what short-term traders view of
value is. It doesn't tell you anything about long-term value. And our job as stewards of your capital is to
kind of look through the noise, focus on the underlying drivers of the value of the business, what's going
to cause cash flows to go up or down over next year and the next 50 years and make an assessment
as to whether the current price is interesting relative to those future cash flows. And on that basis, we
think Valeant is an extraordinary bargain. If there are facts that we don't know that could cause us to
reassess that, we reassess every one of our investments every day, as we do Herbalife and as we do all
of our investments. But based on what we believe the most likely answers to questions are, based on the
research we've done, based on the dermatologists we're talking to, and I'm not just going to talk to 10 or
40, we have -- we do a very broad review. But we think we've actually talked to a statistically significant
enough number of them, and we're getting very consistent answers that gives us a lot of confidence. In
the portion of Valeant's business, about 16% of revenues that's most at risk from all of the publicity.
With that, let me go to Nomad. Brian?
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Brian Welch
Sure. Thanks, Bill. So Nomad is off to a very strong start. It's a newly formed company. Importantly,
economic conditions in Europe remained rather weak, and that has led to some softness in the business
and very modest revenue declines in our existing Igloo asset, which is the leading frozen food business in
Europe. Importantly, though, the business remains quite resilient, and for the first half of the year, EBITDA
for the business was flat.
The team is hard at work in trying to identify and execute on additional opportunities to improve
performance of the base business, the most notable of which is looking very closely at the trade spend
that the company spends with its kosher customers. And the trade spend has been called out as -- by
the company at EUR 1.1 billion per year. And notably, this is more than 3x the existing EBITDA base of
the company, which is about EUR 305 million. So it's a very, very large bucket of spend. I think it's fair to
assume that most of that is quite productive. But if there are areas of it that are not productive, surely,
the company will be looking at that and looking to extract as much value for shareholders as possible.
The most material development within the quarter was the company has announced and completed
acquisition of the non-UK assets of Findus. Findus was a leading frozen food competitor of Igloo. And the
non-UK assets of Findus are highly complementary to our existing Igloo business at Nomad. As you'll
recall, Igloo had a leading market position in the U.K., Italy and Germany, and the non-U.K. assets of
Findus that we have purchased provide us with leading market positions in the Nordic countries and in
France. So it's really filled out our European footprint. Pro forma for the Findus acquisition and putting
these 2 great leading frozen food businesses together, we will be 3x the size of the next largest branded
competitor in European frozen foods.
Now obviously, the acquisition made great strategic sense, but we also think it made great financial
sense. The GBP 500 million purchase price represented about 7.5x EBITDA pro forma for the announced
synergies. And given the low CapEx requirements and the modest cash tax rate, this equated to about
12x unlevered free cash flow, which we think is attractive. Pro forma for the acquisition and the expected
synergies, the company has said they expect to earn about $1.30. And on that basis, with the recent
decline in the stock price to about $14, the business trades at just under 11x. The company remains
relatively moderately levered, and we have about 3.7 turns of net debt to EBITDA and that leaves us with
some flexibility to do value-enhancing acquisitions if such opportunities arise.
One other point I'll make about so-called Platform companies is I think you can expect their stock prices
to be more volatile in the short term because the market tends to overvalue and/or highly value, and then
the opposite, undervalue, their ability to do transactions. And if you can accept that degree of volatility,
however, I think you can make very, very attractive returns. At, call it, early August, we were on the high
end of the band in terms of valuation for Platform and Nomad and Valeant and even restaurant brands.
And today, we are at the absolute low end of the band. The -- in each case, that stocks are trading at what
we believe to be meaningful discounts to their value based on the existing assets they own, attributing
negative value to their ability to do transactions. We think some of this is technical factors, even related
to the fact that Pershing Square is a significant shareholder as people, if you will, bet against us or that
we're going to dump our position in each of these various companies. That's I think relatively kind of
transitory in nature and likely to go away. Some is business related because of economic weakness or
issues particular to Platform, which we discussed. But in the -- and certainly, in the case of Nomad, the
company is conservatively -- relatively conservatively financed and with plenty of additional capacity to
do transactions. And the business is doing well, and we have very strong management team in place,
whereas, by contrast, the Platform, there's clearly some turmoil at the top of the company. There a -- you
got a search underway for a new leadership. And so there are particular issues there that could account
for some decline in the value.
Brian Welch
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The only thing I would add to that is there's a perception that Platform companies are worth more in
better economic times or when the capital markets are more robust in frothy. Obviously, there's some
truth to some of that, but some of the best Platform companies that we have saved, Berkshire Hathaway
being an example, AB InBev being an example, have done very attractive acquisitions during economically
tumultuous times. Obviously, Berkshire Hathaway bought the largest railroad in North America at an
extremely attractive price when the rest of world was in panic mode. And so assuming you have the
financial flexibility to pull these things off, obviously, the volume of transactions tends to go down as
market conditions change, but some of the best asset purchases of all time are obviously done at lower
prices. Many of the assets that we would be looking at, at Nomad, for example, would have private equity
competitors looking at the same assets. And so changes in market conditions do not necessarily reduce
the Platform-value opportunity of these companies.
And so what we focus on is finding so-called Platform companies that own very, very high quality cashgenerative businesses. So even if they are fully invested at a particular time in a cycle, just with the
passage of time, they delever. I mean, Valeant is a classic example of this, and that this company will
delever very dramatically. We expect over the next 18 to 24 months, putting them in a position to be an
active acquirer of relatively decent-sized businesses in relative short order.
So what we like also is that since the value of the company is not entirely dependent on the existing
assets, these are investments that we can own, we believe, for many years and earn very attractive
returns because of their ability to constantly -- we have a very talented management team, and the team
has done a great job fixing an existing asset. What you want to do is you want to get more assets under
their control, so that they can continue to create shareholder value. And this business model is one we
believe in. There's going to be more volatility. Certainly, we have seen a dramatic amount of that in the
last, literally, 90 days. But we don't think that is a permanent one. We think it is a temporary one.
Ryan? Fannie, Freddie.
Ryan Israel
Policies Committee
Yes, 3 quick points this quarter. First, the company has reported earnings last week. The underlying core
business is the single -- the family guarantee portfolios of both Fannie and Freddie continued to remain
healthy. However, the reported earnings declined significantly from the prior quarter due to losses on their
derivative portfolios. And to explain that, the derivative portfolios relate to hedging interest rate risk on
the fixed income arbitrage portfolio. So what they do is they enter into derivative contracts, which pay
off if interest rates rise in order to offset the economic loss that would occur on the assets in the fixed
income arbitrage portfolio. However, due to the way that the accounting works, you actually recognize a
loss from the derivatives when interest rates decline, and that goes through your P&L. However, the assets
in the fixed income arbitrage portfolio, while they increase in value, economically, when interest rates
decline, there is no corresponding accounting treatment in the P&L for those items. So what happens is,
economically, you're neutral. But in terms of your P&L statements, your income statement, you actually
report a large loss. And so the company is reporting significantly lower net income this quarter than
last quarter due to the losses and accounting sense on the derivatives. One thing that's interesting that
we would note is the Net Worth Sweep, which prevents the companies from building capital to offset
against economic or accounting losses can't happen because they have to pay their income in terms of the
accounting income they earn every quarter to the government. And then when they have noneconomic
losses, which are happening right now, there's a risk that if the losses are large enough, they would
actually have to draw money from the government. We think this further highlights one of the reasons
why the Net Worth Sweep is extremely problematic.
The second point I'd make is that there seems to be, to us, an emerging consensus that the GSEs should
recapitalize themselves, retain capital and exit conservatorship. There have been a variety of articles
in the press over the last quarter which have called for this. Just last week, there were 2 trade groups
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that represent the community banks that wrote a letter to the White House asking the administration to
release them from conservatorship, allow them to retain capital and potentially recapitalize.
Earlier in the month, there was a research firm in D.C. that put out a report stating that the administration
was actually evaluating all of its options, including allowing the GSEs to exit conservatorship and
recapitalize or retain capital. Several officials of the government have since said that, that wasn't
happening, but we find those research reports very interesting in a broader context of what seems to be
a consensus building that the GSEs shouldn't persist under the current Net Worth Sweep and the current
conservatorship.
And then quickly, the third item is that there was a lawsuit filed in the Kentucky court by a common
shareholder at both Fannie and Freddie stock at the beginning of October, and we think this provided just
yet another legal avenue to overturn the Net Worth Sweep.
Thanks, Ryan. So on Herbalife, as we are a short seller here, in the short term, the business fundamentals
and the company are relevant because they really relate to the risk of being short. The company is
growing at a high rate. Earnings are going up every year. They're buying back a ton of stock, and
everything is wonderful. It meaningfully increases the risk the stock price rises and we lose money while
we're waiting for what is likely largely to be a regulatory event. So actually, I want to start first on the
financial side in terms of what happened in the quarter. And I guess Charles, why don't you go ahead and
update what happened this quarter?
Charles Korn
Sure. Thanks, Bill. So in the quarter, the first thing I'd talk about is total members. So arguably, this is
Herbalife's most important metric. They declined from 4.1 million in Q2 to 4.0 million in Q3, which means
that in excess of 0.5 million members churned through in the quarter, I think this is the first time where
the rate of member churn...
Wait, help me. How does 4.1 million to 4 million explain the 500,000?
Charles Korn
Sure. So the company reports the gross new members, but they don't obviously highlight the magnitude
of the churn. And then quarterly, in the Q, they note the absolute net members at the end of the period.
So if we know that total members went from 4.1 million to 4.0 million, they recruited 525,000 new
members. We can then infer the total churn was somewhere between 525,000 and 725,000, and there's
some rounding that prevents us from having a precise number. But importantly, this is the first time where
the rate of member churn has exceeded their ability to find new victims.
So it's -- basically, you're saying you're running on a treadmill, and now the treadmill is running faster
than the person running.
Charles Korn
The treadmill has started going backwards basically. Also this quarter, the company began using a new
term, which they call active members.
The treadmill is always going backwards.
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Charles Korn
Well, yes, accelerating.
The runners -- the runner is about to fall off the treadmill is what you're saying.
Charles Korn
Potentially, yes.
Okay. You got to be careful with our analogies, but go ahead.
Charles Korn
That's fair. The company began using a new term on the conference call, the active members, this quarter,
suggesting that they can see that a proportion, and we expect a large proportion, are actually inactive. So
it's interesting change in terminology for them.
Actually let me just -- very high level. This company has 4 million -- they used to call them distributors,
and these are people who have signed up to become an Herbalife distributor, paid $70 or $100 kind of
a minimum initial fee. You've got to enter into some form of a confidentiality agreement and all other
kinds of restrictions. We pointed out the failure rate was something approaching well over 90%. They said,
"Well, these are not really distributors, they are members, and they're just signing up to get a discount on
the product. Because if you sign up, you get a 25% discount on the product." Now of course, the product
is sold at a 50% discount including free shipping or 40% discount on the web or you can go to one of the
distribution centers and the various distributors or members will sell you the products at discounts. We
think this is a lot of -- kind of a fictional account. But the fact that you have a business, maybe an analogy
to Costco, they said this is really like a Costco membership. Well, Costco, 95% of the members renew
every year. In Herbalife, what you're telling us is they're losing somewhere between 500,000 or -- and
700,000 of these -- actually, this quarter, it's 600,000 to 700,000 people left during the quarter, and they
recruited approximately 500,000.
Charles Korn
That's right.
People during the quarter. Think about this as a business, how loyal a business is it if you're -- if you have
-- on an annual basis, you're losing 2.2 million of your 4 million members. So more than half of your
customers are quitting every year, and this is why we believe -- and again, there are a lot of people in the
world that you can swindle, but the fact that their -- the treadmill is running faster than the company, I
think, is a very significant sign. Go ahead.
Charles Korn
So high level on the -- on Q3, the business posted weak top line results, but tight cost controls and certain
project deferrals drove a meaningful EPS beat versus guidance. On revenue, on a consolidated basis, the
company reported net sales of $1.1 billion, which is down 12% year-over-year, knew that was worse than
Wall Street expectations and below management guidance, and that negative variance that was largely
attributed to FX headwinds, which have been very substantial for the company.
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On a constant-currency basis, excluding the impact of FX headwinds, the company reported net sales
growth of negative 1.4%, excluding China. China had another great quarter. They grew 27% year-overyear on a constant-currency basis. And so when you look at the total company, including China, the
business realized positive constant-currency growth of 2.8%. So similar to last quarter, as I mentioned,
China continues to be the key driver of growth here. And while year-over-year, growth was robust at 25%,
it actually declined sequentially 5% Q3 over Q2.
An interesting narrative I want to quickly touch on is South Korea, which is a large and important market
for Herbalife. Historically, that has been their third or fourth largest market. It is one of their most
profitable margins -- markets, excuse me. It has 56% contribution margins versus 43% for the rest of the
business. At least 6 members of Herbalife's Founders Circle or Chairman's Club are from South Korea, and
it is...
instead of 50%?
Charles Korn
Yes.
Okay.
Charles Korn
And it's a large nutrition club market. So starting a year ago, this market began to inflect, and the
deterioration notably accelerated this quarter. It was down 39% year-over-year on a constant-currency
basis or down 46% on a reported basis, including FX headwinds. While management continues to blame
the impact of changes to the business model to us, this looks like the classic pop and drop, which they've
seen and experienced in other markets around the world.
The reason why Korea is a great market to launch a pyramid scheme is because it's a very tight culture. I
mean, everyone speaks the same language. Everyone looks the same. It was kind of ethnically -- Iceland
was another great example. Maybe not all Koreans look the same, but to a Caucasian, they look similar.
The point here is people don't like my comments in this regard, but my point here is that if you look at
Iceland, which is another analogous market, where you've got a very tight community, very small sort of
geographic concentration, you've got most -- the Iceland market was Herbalife's best market ever, and
then it collapsed. You got Korea where most Koreans live in Seoul. So you've got people within a very tight
geography. They're the same ethnic group. It's an ideal market to grow a pyramid scheme. The reason
why Herbalife has done so well with the Hispanic community in the U.S., again, is people trust people from
their own.
Charles Korn
Affinity fraud is one term people have used to describe positive -- that prey on closely -- close-knit
communities like those you described.
The more PC way of saying what I was trying to say is that the -- when you have one ethnic group in a
tight geographic area, that's an ideal market to grow a pyramid scheme. And that's why Korea has shown
fabulous growth. The problem is when it goes in reverse, it also collapses very quickly. Herbalife no longer
talks about the growth in Iceland. And the growth in Iceland is incredible because, again, it's an island, a
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very tight community. And I think one of the best evidence that involves a pyramid scheme is you look at
the Icelands of the world and the South Koreas of the world.
Charles Korn
Malaysia is another good example of that for them.
Turning to the company's guidance, which they released on the quarterly call, the company communicated
expectations for low single-digit volume growth, mid-single-digit revenue growth but adjusted diluted EPS
growth of negative -- sorry, negative 7% to positive 1%. So the range there is $4.35 to $4.75, signaling
an expectation of negative operating leverage in 2016, which we thought is interesting.
On the balance sheet, the company paid down $39 million of debt in the quarter, and the May 2015 credit
facility amendment requires them to further delever by $255 million through March of 2016.
Bottom line is as business performance deteriorates, we want to make it less risky, to be short, it also
makes it more probable we can make money just on the deteriorating fundamental of the business. David,
what's the regulatory update?
David Klafter
In mid-August, the FTC filed a complaint against another MLM, called Vemma Nutrition. It was structured
very similar to Herbalife's. The FTC began with a preliminary injunction which was confirmed by the court.
In mid-September, court found, and I'm quoting here, "There's little doubt that the FTC will ultimately
succeed on the merits in proving that Vemma is an pyramid scheme." We published the detailed sideby-side comparison of Vemma and Herbalife. We think they are structurally identical. You can find that
comparison on factsaboutherbalife.com. At the end of October, a New York State Senator, named Jeff
Klein, working with the public advocate, Letitia James, and a not for profit, called Make the Road, released
a report on Herbalife. The report's called, The American Scheme: Herbalifes Pyramid Shakedown. The
report is available on Senator Klein's website. It concludes that Herbalife's distributors are running an
illegal pyramid scheme and it proposes changes to New York state legislation to better protect New York
State residents. In preparing the report, the researchers called data from 56 victims who had lost on
average $20,000 a piece and as high as $100,000, which is a devastating loss to a low income participant,
and a steady 60 nutrition clubs. And at the same time that the report came out, they published a short
video clip, showing some of the outrageous claims that are made in nutrition club training session about
medical products, medical traits of the products and about key complaints. We posted a video on our
YouTube channel, called Facts about Herbalife. We think the report from Senator Jane and public advocate,
James -- Klein and public advocate, James, corroborates our work on the nutrition clubs and training
system. At the end of October, a video clip of CEO, Michael Johnson, appeared on YouTube. It was
hosted by someone else, not by us, and in the clip, Mr. Johnson says, "The company has built its whole
reputation, its whole life on recruiting, which is precisely a key factor in determining if something is a
pyramid scheme." Not surprisingly, the clip was taken down because Herbalife protested that it's protected
by copyright. While the video is a number of years old, we think the underlying sales and marketing
plan and the incentives that drive that kind of behavior remain the same. Relating to the investigations
of Herbalife, its disclosure and its 10-Q has not changed from the past. The Department of Justice and
several AGs are still seeking information about the company. The company has now spent a total of $101
million, defending itself and responding to government, and in the last quarter, its clause for responding to
government increase were $7.6 million, up from $5.8 million in the quarter before.
So bottom line?
David Klafter
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Bottom line, the company is still under pressure both financially. The business continues to weaken, and in
terms of regulatory increase, we think as the regulators get in there, the more they learn, the more it will
corroborate the fact, how we think the Vemma case provides a blueprint for how the FTC could be thinking
about Herbalife.
So we'll go to Q&A. This is not going to be a 4-hour conference call, but I think because we've developed
a reputation for answering every question, we're getting a lot more questions from investors, including
people who may not be investors actually. And in some cases, I think people just like to have their
questions read so that they can make a particular point or not. So what we try to do here is organize the
questions by category. With respect to questions on Valeant, my recommendation is Valeant's going to
have a call tomorrow. They're going to update people about what's going on with Philidor, and so we defer
to Valeant on those question.
So let me just go through these quickly as possible, and we'll give this call 20 minutes or so, so that
people don't feel obligated to stay any longer on the call.
How do you allocate your time between portfolio management and analyzing prospective investments?
And the answer is that it really depends on what's going on at that time, and it depends on person to
person. With respect to myself, I'm responsible for overall portfolio management. But when there's an
issue or a problem, that's where I'm generally going to focus my attention. I spend a fair amount of time
on Valeant, for example, in recent weeks. Given what has happened with Valeant, we review change to
approach the concentration and the corporate position limits. This is -- we do not have hard position limits.
We've allowed Valeant to get to be one of our largest investments. And one of the takeaways from this
experience is what's different about Valeant versus other large investments we've had historically is the
company's more leveraged than businesses we've owned historically. And I think in retrospect, in light of
the underlying financial leverage of the company, I think we -- this could have been a smaller investment.
We certainly could have shrunk it as it became a large investment, and that's something that we're going
to think about certainly more carefully going forward. Given current generally lofty equity valuations,
we're putting greater focus on the short side. The answer is we'll shorten very few stocks because of
the inherently unattractive risk rewarded being a short seller. We do always like asymmetric ways to bet
against problem credits. We have been in a generally improving credit environment, although I do think
things, certainly for some non-investment grade companies, have gotten meaningfully. It's an area we
spend some time on, but it's, I would say, not a place we spent a lot of our time looking for short ideas.
What's the most important attribute of a leader to you? Who's your favorite CEO from the outsiders
aside from Buffett. I don't know if I have a favorite CEO. I would list the most important attributes of a
leader are character, intelligence, energy, and then depending upon the business, just overall, obviously,
leadership skills. If you're a railroad executive, meaning, a CEO for a railroad company really needs
specific domain expertise. Other industries, you can -- just good leadership and experience is enough.
What is the most interesting industry that Pershing Square is not invested in? There are lots of really
interesting industries we don't invest in because they're a little too interesting. I find it -- a lot of the
technology, what's going on in early-stage business is fascinating. We try to follow what's going on in
early-stage investments simply because it can have applications for more established companies, but it's
not an area that we -- we don't invest in private businesses and we don't invest in businesses where it's
hard for us to predict the future of cash flows with a reasonable degree of confidence.
Which is the most frequently mispriced risk that can negatively impact an investment?
This is sort of a new one, which we haven't really though about before. I would say Valeant's susceptible
to an attack from a short seller is never a factor that we thought about in choosing or sizing an
investment. And I think because it's in a regulatory sensitive industry because it's a levered company,
because the company has not -- focused a lot of energies on telling their story, et cetera, I think it made
it a very vulnerable company for a short attack. That's an interesting attribute that we had not previously
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thought about. It certainly has an impact on the short-term trading price of the stock, and it can have
an impact on the fundamentals of the business and that perception can become reality. And if you're a
publicly traded -- interestingly, think about Valeant. Valeant were a private company. This would be really
largely irrelevant to the private owners of the business. I think they would look carefully into what was
going at Philidor. They'd investigate. They'd obviously cooperate with the government to the same extent,
but they wouldn't be in the public eye constantly having to -- where people condemn them based on what
the stock price does as opposed to what's really going on with the business
Why haven't you invested in financial companies? Simply because it's difficult for us to predict the cash
flow, the inherent uncertainties, the black box nature of the business. You see problems with other hedge
funds following your ideas, many of your names have high hedge fund concentration. This push prices
up in the short term, making it more expensive for companies to buy their shares. When there's market
volatility, the hedge fund redemption of your stocks get impacted by a lot of selling pressure. For better or
for worse, we can't control who owns the stocks that we own. And so whether they're owned by shorterterm traders or long-term investors, it's not something we spend a lot of time on. For sure, the platforms,
the Nomads, maybe even the Howard Hughes and the Valeants of the world suffer from having a lot of
shorter-term hedge funds type of investors as opposed to large index investors who are more permanent
holders, and that leaves some more volatility in their stock prices. Volatility generally has been a friend of
the firm. It could make you look silly in the short term. It can make our results look bad in the short term,
but it does create opportunities. For example, CP stock price declining and people being concerned that
Pershing is going to sell has enabled CP to buy back a big percentage of the company at a lower price.
This one [indiscernible] to our benefit over the next several years.
For each portfolio company, what are the businesses' competitive advantages moats? Are these moats
depending mostly on management. But for each of our businesses, the moats are everything from market
position to brands to long-term contracts to unique assets, like real estate to patents to some extent with
some of our businesses. And we generally in each of our businesses, we like the person running it, but we
believe we can find someone else to run it if we were -- they were -- die or become disabled or resigned
for some other reason. We don't want change in the vast majority of the companies we own, but we're
always thinking about who could run the business internally or is there an external choice that could be
helpful.
Will you commit to adjusting your fee structure if Pershing underperforms for an extended period rolling 5
to 7 years? We've kept our fee structure the same from the beginning of time. What we focus on is, and
what we think investors should focus on is the net to them. If we do not deliver attractive return net to
you adjusted for risk, then you should take your money elsewhere and we'll run a smaller capital. We have
other entities that offer lower fees, which we've opened -- we have a public entity that has a lower fee
structure, for example.
In terms of platform exposure, so any concern around access to capital markets, we did discuss this
already. Well, Pershing will make changes for now for future investments with perhaps an enhanced
focus on risks and doubts, and including issues that could to successful short attacks. I think it's certainly
something we'll think about in terms of sizing a position. I've had -- the biggest regret I have with Valeant
is that we're not in a position to buy a lot more. Have we owned less at a higher stock price, had we taken
some of our profits at $250 a share, that would have freed up capital for us to be a bigger buyer at $75 a
share, but it's certainly something that we should think about.
Again, however, I want to just point out that we do have less -- well, pretty much most -- the vast
majority of the portfolio is in liquid investments. There are periods of time where we can't sell because we
have access to inside information or we choose not to sell because we think it would be in the short term
damaging to the company, perhaps, in the middle of doing something strategic, and we can't suffer some
short-term consequences, but long term, we think the relative -- the trade-off from a long-term strategy
and being an influential owner are ways that cause the short-term trending limitations that we have.
There's many damage to Pershing Square's reputation because of recent events, and if so, what might
that mean going forward for at least in the moderate term? So we are -- I mean, it certainly presents
lots of opportunities for -- we seem to attract a fair amount of media attention. Let's put it that way. We
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always -- always look better when your results are stronger, and you look worse when your results are
worse. We are not -- just to be clear, we don't run Valeant. We're not on the Board of Directors. We're an
important shareholder. We certainly are not shy about sharing our point of view, and -- but I think the -our reputation depends on our doing what we say we're going to do. I think it's helped by transparency,
and it's helped by a very strong long-term record. We've said many times that maybe -- the guarantee
is there will be periods of time where we vastly underperform the market or other investors, and there'll
be periods of time where we vastly outperform the market or other investors, and what matters this is
meant to be a bumpier long-term [indiscernible] to achieve higher rates of return [ph] and that's what
-- we don't know how to make a smooth [indiscernible] close to the kind of returns we've earned over
time. So we give up smoothness, and therefore, we're much more likely [indiscernible] that criticizing
Pershing Square for being down 16% [indiscernible]. This is the best strategy designed to not be down
and just only making money. I don't know of a strategy like that, that would [indiscernible] the kind of
returns that we earn. What we're focused on is the underlying intrinsic value of the businesses we own.
In the past 30 days, the intrinsic value of the businesses we own has not changed meaningfully. For 90
days, over the same period, peak to trough, the market value of our holdings has declined 25% or 26%
or even more than that. What that means to me is that Pershing Square is very cheap, and perhaps, the
cheapest it's been relative to the assets we've owned. This is not a case where we had a -- some kind
of derivative strategy where we lost 26% in a road trader impairment, right? We still own all the same
businesses we own 26% ago. In almost every case, you've heard the team talk about what's going on
with each business. The businesses had become more valuable, have generated more cash, have made
more progress on strategic initiatives, and the stock prices are down. So the gap between intrinsic value
and where you can create the portfolio at today's share price or effectively, the [indiscernible] of Pershing
Square, has widened very substantially. And what's interesting is we see that phenomenon with our
investors. At early part of this year, we saw a fair amount of redemptions from investors as the -- we
had a very strong year last year, up 40% or so, 37% to 40%, depending on fund. And by outperforming
other funds, we became overweight for many investors who trimmed their investment in Pershing Square.
And most recently, the most recent redemption period, we had one of the smallest, less than 100 basis
point of redemptions because I think investors realize that the portfolio is cheap today, and yes, our
underperformance makes us maybe underweight to other funds that they're investing in, but I do think
this is a very good time to own Pershing Square for that reason.
Herbalife, what's our time horizon, how much is the cost per year from negative performance? The
position today is about 6% of capital. It cost us, let's call it, 5% including all costs, including VaR cost, and
otherwise, to keep the position of market value. So that 30 basis points per annum for the overall firm,
some a little more than that in terms of options, but call it 5 or 6 percentage points based on the current
market value.
What's our time frame? I think it's hard to judge, but I think we're getting a lot closer. Business is
deteriorating. Regulators have been working now for years. The SEC has been at it for 3 years. The
FTC has been at it, approaching 2. The DOJ and other regulators, I do think this comes to some kind of
resolution. We hope for resolutions similar to Vemma, where the judge said, "We'll let you continue to
operate, but you can no longer pay commissions based on purchases of products." And that was enough
to wipe the company out, and if the -- what happens here is Herbalife have to pay distributors based on
actual third-party sales, to people outside the system, the company will go bankrupt, and that by the way,
would be the best evidence that it's a pyramid scheme.
Let's see. Herbalife reports annual revenue greater than $4 billion. It's supposed to have 2 million
distributors. This implies the average purchase -- it actually has 4 million distributors. The average
purchase price will be 1,000. This amount should be much greater to either fuel the pyramid or subparts
to real customers. Can you explain the discrepancy? The answer is probably an average of 1,000, but you
have top distributors with down lines of 250,000 people buying millions and millions of dollars of product
from the company, and people who pay $100. Charles?
Charles Korn
Yes, if you look at their statement of average gross compensation in the United States, about 20% of
their distributors are sales leader or higher, which is roughly a $3,000 purchase, point being that the vast
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majority of the distributors never even achieved that level, but probably fell out the pyramid before they
load that much inventory, and so you kind of a weighted average -- if you have 4 million distributors,
and then you also need to consider the gross sales number, is actually $7.5 billion net of all the different
allowances that's closer to $5 billion. So there's a couple of numbers there that are off.
Recently, the FTC, SEC, DOJ have a full video of Michael Johnson that was posted to YouTube. Yes, we
generally -- I don't think we know exactly, but my supposition would be, whoever provided it probably
provided it to the government.
Fannie, Freddie, any comments about on Bethany McLean's new book about Fannie and Freddie, Shaky
Ground? I think it's a great book. I think you should read it carefully. We're actually thinking of sending
it to our investors because one of the problems with Fannie and Freddie is that these are companies that
are not well understood by the average person. So maybe we'll have copies at our Annual Dinner that we'll
hand out if you'd like a copy.
What are the repercussions for Fannie and Freddie? They need to draw more money from the treasury.
Will that affect the lawsuits in any way? I think that the repercussions are it will remind people that
the current status quo is not a good outcome. The government is booking the profits in terms of the
dividends that Fannie and Freddie have paid into the government's income statement. I think that gives
the government -- it makes the deficit look lower. The money has to start going back in. It's a reminder
that these entities have no capital, and that this is not a stable situation.
Senator Corker can be reprimanded anyway for telling American public the short GSEs, and that's up to
the SEC. Out of all cases, which one will -- the appeal, CFCD [ph] which one will stop the network suite
first, in your opinion? I don't know if we have a point of view.
What's your opinion on the Delaware case winning [indiscernible] filed a [indiscernible] in Delaware, the
former Supreme Court Justice of the Delaware -- the Delaware Supreme Court judge filed a case. I don't
think we can do any better than he.
Would you like -- we'd like to know the progress in setting of shadow board to represent shareholders.
Are you considering it? This is something we thought about -- we've had other things focus on -- the idea
here is that set up -- the Board of Directors of Fannie and Freddie are not fiduciaries. We're shareholders
and we thought it might be interesting to set up a quasi shadow board that would represent the owners. I
think it's a good idea. It's just a question whether -- the time and energy required.
New forensic accounting improvement to bill was not necessarily a one-off challenge. The 2008 deal
also tried to cancel the warrants or the next ones -- 2012 network suite that's canceled that you foresee
considering?
Look, Fannie and Freddie were bailed out. Clearly, there was a market competence issue at the time.
The government stepped in. The government was the only game in town and they struck a very, very
expensive bargain. We're not fighting the original deal, like Hank Greenberg was fighting the original AIG.
We're fighting -- is 4 years later, after both companies have become -- restored to profitability, after the
$150 billion reserves they took were -- they took $150 billion of reserves that were unnecessary. The
government stepped in and took 100% of the profit of both companies going forward, and we think that is
illegal and will be found to be illegal by the courts, and that's a much easier road of trying to challenge the
original agreement.
I'm going to move from Fannie and Freddie because it's a little too detailed. Air Products. We decided to do
with the material technology business when we spun off. Shareholder increased their position. The answer
is no. Like any other investment, we'll look at it. Once it's a public company, we look at the price, we look
at relative to other opportunities. When we may buy more, we may sell it. What are the catalysts for the
stock in your recent announcement, spinoff? I think the catalyst here -- I think the spinoff will be helpful
actually, and discontinued business performance.
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Mondelez, are you concerned about any long-term top line detraction from a strong dollar? Not really. I
mean, we've managed a lot of our kind of our euro exposure in Mondelez. The emerging market currencies
have declined very dramatically. Could they decline more? I guess they could. I will be -- I think it's less of
a risk today, obviously, than it was a risk a year ago. Ali, you have a point?
Ali Namvar
Senior Analyst
Yes. I would say that -- look, this is the de facto way doing where you have emerging markets exposure.
What these companies do is you have great brands, you participate in great categories. Initially, currencies
devalue in emerging markets, and then you price through because you invest in your brands and you
offset that currency headwind. You also have global peers who run the similar position as you. So
basically, it's a way of doing business, and most of the participants understand. What it does is it creates
short-term volatility, but over the long term, it neutralize itself. What you have to really ask yourself is,
do you want to participate in emerging markets, and the answer I believe is absolutely yes. This is where
snacks as a category has incredible growth opportunities from a volume perspective, and it's -- the way to
think of the currency issues is it's sort of a small shorter-term risk to pay for the opportunity to participate
in the emerging markets. And finally, and we saw a lot about this issue, with respect to Mondelez, and in
general, when you're investing, you want to own the company that has the greatest cost savings in this
type of situation. So they are the ones that have the most flexibility to deal with commodity changes,
currency changes and Mondelez certainly has that because as we said, we think it has the greatest -- one
of the largest cost savings opportunity in the industry, and thus, giving it the most amount of flexibility.
Not just cost savings. I mean, these are brands that have enormous pricing power. And what you see
Mondelez do is when the currencies have gone against them, they generally raise prices, and the market,
with a little bit of disruption, has taken the price. There are a bunch of questions from one person that
really about the comparisons to Heinz and how much progress was made there, and I think we believe
that 3G has set its standard of what's possible in the packaged food industry. And I think Mondelez aspires
to improve their business, and obviously, is aware of the progress that's been made at Heinz and Kraft,
beginning progress at Heinz and Kraft, and so I do think that's motivational for the company.
Ali Namvar
Senior Analyst
Yes. I'd just add that -- exactly just add that we very closely studied what 3G was able to accomplish at
Heinz, and we're taking these learnings and bring that to the company. I think the senior management,
Irene, they've been very appreciative of some of these studies, and I think it's well -- it's been wellreceived.
QSR, which hasn't received nearly as much press as Valeant, thank god, recently, despite announcing
a solid first quarter, because you addressed your point of view and extensive analysis, what challenges
Tim Hortons would have to overcome in the U.S. in order to succeed in the long term. Could you please
address these potential challenges, opportunities for the business model? I'll just make a comment that
Tim Hortons has been successful at this point largely on the northern border with Canada. It's really
just about exposing the brand more broadly in the market in the U.S. and there has been success, and I
think management is quite bullish, not just on Tim Hortons' ability to grow in the U.S. but we think it's a
very attractive concept without a lot of competitors globally, and they've had a lot of interest from their
franchisee partners globally.
Okay. 30 questions on Valeant, we're going to table those until the Valeant call. And if you have questions
after the Valeant call, feel free to ask Valeant. And if you questions that relate to our investment and
Valeant, feel free to ask the IR team.
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CP, a few questions we can't answer because of our board representation, but here's one, given the
considerable amount of costs already taken out, is there much more room for cost cutting? Paul?
Paul C. Hilal
Partner
Hunter addressed this on the call, on the last earnings call, he expects that given the opportunity he sees
from here on labor productivity and asset productivity, there could be 200 or 300 basis points more of
cost opportunity. In his words, that assumes that there's no recovery in volumes. In his words, if volumes
recover, we have to buy a bigger safe because we're going to need a place to store all the cash that's
going to come in.
Excellent, buy a bigger safe. Have you considered swapping Zoetis for Valeant shares. The answer is
we think we have an appropriately sized position in Valeant. And could we buy more? We could, but we
like Zoetis, and we can't just easily swap one for another. So we have no plans to do that. On the Q1
conference call, you mentioned you primarily saw upside in Zoetis in an M&A scenario, where Valeant
stock down, unable to buy Zoetis and Allergan being purchased by Pfizer, who is a potential buyer, if you
think now there's more value in Zoetis as a stand-alone company. I'll just leave it to say that we think this
is a very attractive stand-alone business with significant top line growth, a big cost opportunity, and we do
think it's a valuable strategic asset. We think that about most of the companies we own, and I'll leave it
there.
Explain your agreement with Sachem Head and its purpose. Scott Ferguson of Sachem Head brought us -pitched us on investing in Zoetis. This is a company that we had previously analyzed and have considered
an investment in, but we're in the middle of Allergan and Valeant, and did not, at that point, wish to
pursue it. Scott informed us he was going to go ahead and pursue it, and we thought it was an attractive
opportunity that he wanted us to do it with him. He had proposed to raise outside capital from one of his
investors. We thought it was in the best interest of Pershing Square for us to have a larger position in the
investment, and so we proposed to Scott that we would in effect -- instead of his raising a co-investment
vehicle, we would give him the economics on the portion of the capital he would raise from third-party
investors, so that he would be made whole for the period up through the end of this year because we will
make a payment to him equal to, I think it's a -- I don't remember the precise terms.
Unknown Executive
I think it's 10% of our profit...
$500 million
Unknown Executive
[indiscernible] $500 million, but we've accrued for that in our returns.
So we gave him 10% of the profit we earned versus our average cost on $500 million of capital. We've got
about $2 billion of capital invested in the investment. So in effect, it will be something in order of a 2.5%
promote for the period from the time of our investment late last year through the end of this year. I think
the stock we acquired is around $37 a share. Today, it's around $45 or $46 a share, and that would be the
provision. We could have allowed Scott just to raise the outside capital, but we thought it was better for us
to make the investment directly.
WWW.SPCAPITALIQ.COM
27
Platform, we can't comment. How do you calculate the intrinsic value of Howard Hughes? What it is
currently? The way I'd calculate the change of value of Howard Hughes, I look at all their assets, and I
formed an assessment. The company has not published an estimate of NAV. I think the outside investor
can look at the net operating income from the existing asset base projected for that NOI can show based
on the lease-up of the existing portfolio and have put an appropriate cap rate on that, cash flows and then
look at the other assets, like condominiums in Hawaii versus our cost and what the profit will be. And then
one by one, you've seen a number of analysts come out with estimates for their fairly boutique-y firms,
but each of these estimates are materially above -- as much as 100% above the current share price.
Last call, you indicated you would coordinate a call to allow you to talk about Howard Hughes and give
us an update. I don't know that I said that. I think what I've said was at some point, Howard Hughes will
decide to do an analyst call or an Analyst Meeting. I think they're enjoying their privacy, if you will. They
don't do conference calls. They just focus on running their business. They're not really focused on driving
the stock price. The stock price has done well at four-fold in the last 5 years. At some point, they choose
to do so, but I don't know when that point is.
Investor's attention has been focused on a few key properties since Howard Hughes over the past few
years. Are there any notable updates for [indiscernible] or et cetera. I'd call Howard Hughes on that, but
nothing material to disclose.
A few more questions. I guess I'm more -- I'm beyond my 20-minute limit, but let's see if I can cover
these rest very quickly.
Okay, this person asked about 12 questions, so we're going to pass on this one. I'm not going to get
through all those. Platform, we can't comment. CP has declined 20% this year. The management vastly
underestimated the impact of low oil prices. On the shipping volume and it's revised its guidance, what
role does the board play when CP provides multiyear guidance, how to prevent management from
providing too aggressive a forecast? Paul, do you have a comment there?
Paul C. Hilal
Partner
Sure. CP is down -- the total shareholder return on CP year-to-date is minus 14%. The industry, broadly,
is minus 21%. So we've been less battered than some of the other rails. No matter how good of a
multiyear plan management comes up with, it's hard to predict a global recession and the supply chain
destocking effects from that. So management -- the board -- CP plays the same role in the multiyear
plan development process as the board of any other company. Management develops it and the board
pays very careful attention. We carefully consume management's statements and analyzes, and we ask
questions to see if there were any other obvious issues, but the board has tremendous confidence in its
management team for very good reason.
Also, I would say with respect to oil prices, I think very few people would have predicted the decline in
oil prices. So I think it's hard -- management makes a prediction [indiscernible] when they give their
guidance, they have fair assumptions about things, like oil prices and interest rates and so on.
How's morale for the Pershing team, this has been a tough stretch. The answer I think, the morale's
excellent. No one likes to suffer a meaningful mark-to-market loss and decline, but we don't judge
ourselves based on short-term mark-to-market movements in the portfolio. We try not to get too excited
when the portfolio goes up in a month, and try not to get too disappointed when it goes down in a
month. What we're really concerned about is how our businesses are doing, and this is where we focus
our energy. And when concerns were raised about the Philidor relationship and elements of the Philidor
relationship we are unaware of, the structure, Valeant's ownership and so on and so forth. We dug into it
to get comfortable, or not get comfortable with the facts, and we've made a lot of progress. We are -- we
think this is -- will be a very attractive investment from our original purchase cost over time, and I think
an extremely attractive investment obviously, from the current share price.
WWW.SPCAPITALIQ.COM
28
We're hearing good things on the call about what benefits specialty pharmacy outlook's provide and
doctors' favorable view of their role, that's why it was still at our close. Was it doing something wrong,
unethical? And if so, what might Valeant's liability be and that they seem to play a close hand at the
role at Philidor. The answer here is I think they're a bit of a victim of all the negative press when all of
the negative news and controversy around Philidor showed up, Gruber [ph] matures one after the other
and said they're no longer doing business with Philidor. I think we don't know what happened to Philidor.
There've been some things alleged in the press. We don't know the facts. We'll rely on the company and
their independent counsel and the board review. We don't think -- whatever happened at Philidor, it will
rise the level of materiality in terms of potential liability to Valeant. The shareholders of Philidor who
received $133 million from Valeant, are my understanding are personally liable for any wrongdoing that
took place there, left a little bit of a hedge of some of the potential liability that we don't know the precise
answer. But in light of the fact that -- when we gave an example on our conference call of Novartis,
Novartis had a special pharmacy over 8 or 9 years violating the law, and it sounds like everything from
insurance fraud to pushing products that -- were there were safety issues in terms of the ultimate patient.
Fortunately, Philidor principal products are acne medication and toenail fungus cream, and I don't think
there's anyone yet alleged any health-related risks. And unlike the Novartis specialty pharmacy, this one
had been in business for basically 18 months, and so relatively smaller window. There aren't healthrelated issues alleged here. We do not think there's any accounting issue. The most credible potential
obligations, assuming they're true, would relate to whether their insurance -- whether the insurers were
forced to pay for a brand-new version of a product versus the generic. We again don't know the facts,
don't know the details, but we don't think it rises to a level of materiality. I think the reason why it was
closed is once you treat principle customers, say, they're no longer going to buy from you, you're out of
business, and I think Valeant -- again, guessing tomorrow, they're not going to set up a new specialty
pharmacy that they own or control or probably outsource this relationship and the revenues associated
with it to an independent highly regarded specialty pharmacy company to kind of take this issue off the
table.
Paul C. Hilal
Partner
Ironically, one of those customers that do business with Philidor has their own specialty pharmacy which
pay the fund as part of the Novartis case.
Which was -- that was?
Paul C. Hilal
Partner
[indiscernible] express.
So look, I hope they find a very high-quality specialty pharmacy. Maybe it will put the business to one of
them or multiple specialty pharmacy. We'd love to -- we're looking forward to that call.
So with that, almost 2 hours in duration. I'm going to pass -- there's still a bunch of questions I haven't
yet gotten to. Feel free to contact the IR team if you have any other further questions, and thank you for
joining our quarterly call.
WWW.SPCAPITALIQ.COM
29
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2015Q3 Pershing Square Holdings, LTD., Q3 2015 Earnings Call, Nov 09, 2015

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2015Q3 Pershing Square Holdings, LTD., Q3 2015 Earnings Call, Nov 09, 2015

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Pershing Square Holdings, Ltd.

FQ3 2015 Earnings Call Transcripts

S&P Capital IQ Estimates**

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William Albert Ackman

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