Bill Ackman’s hedge fund Pershing Square Capital Management posted a gross 15% return in November when all but one stock in his fund returned less than 15%. The only stock other than (GGP) that had a double digit return was Fortune Brands (FO) with 10.1% return in November. Using the dollar values that are in Pershing Square’s 13F filing as weights, Pershing Square had an average return of 1.7% excluding GGP. This means its GGP position contributed 13.3 percentage points of its November return.
How did this happen? Well, Pershing Square acquired 46 to 48 million shares at a price of $10 per share in November when the shares were trading on the open market at around $17. We know that doesn’t make sense - two different prices at the same time!
When General Growth Properties came out of bankruptcy November 9, it raised additional capital by issuing additional shares to Pershing Square and other investors such as Bruce Berkowitz’s Fairholme Funds and Teachers Retirement System of Texas at $10 per share when the stock was trading at $17.39 per share. One might wonder how it's allowed to issue shares at such a huge discount to the market price. If an individual investor bought GGP shares in the open market on November 9, he or she might take offense at paying $17 (if he or she knew). Nevertheless, the company had the right to claw back those shares sold at $10 if it could get more than $10 per share in a public offering.
The interesting part. It initially offered 200 million shares to the public at a below-market price of $14.75, but then backed down to 155 million shares. Insider Monkey, your source for real time insider trading data, thinks it’s probably because GGP thought it couldn’t sell 200 million shares. So, instead of selling 200 million shares at an even lower price (maybe $11 per share?), management opted for selling 45 million fewer shares. That meant a lower number of shares would be clawed back from Pershing Square, Fairholme Funds, and Teachers Retirement System of Texas. Why didn’t the management decide to reduce the offering price? We don’t know. Credit Suisse analyst Andrew Rosivach says in a Barron’s article that management’s decision led to a short squeeze in GGP shares. We are going to leave to your imagination what Rosivach is implying and we’ll assume the company reduced the size of the offering because it couldn’t sell 200 million shares at $14.75. (If it had sold 200 million shares, Pershing Square’s return would have been lower than the 15% reported)
As a result, Bill Ackman‘s Pershing Square had a larger number of GGP shares purchased at $10 when the “market price” of the shares was more than $17. This leads to an instantaneous return of more than 70% for the 46 million additional shares bought by Pershing Square. Is it OK for Pershing to value all 89 million (or so) shares at $17 per share when the company (GGP) itself managed to sell only 155 million shares at $14.75? When it comes to valuing the holdings of practically failed banks - i.e. Citibank, (C) Bank of America (BAC) - in the spring of 2009, the market price wasn’t appropriate. In Pershing Square’s case, it apparently is. Even though GGP management couldn’t find buyers at $14.75, it seems it’s OK for Pershing Square to value those same shares at the latest closing price, which was incidentally much higher than $14.75.
We’re not Pershing Square’s client, and probably its actual clients wouldn’t complain about this measly accounting issue. One thing is clear: market prices aren’t always market prices and valuing a fund’s holdings is not as straightforward as you (may) think.