Ackman’s Reputation May Get Marked Down in Target War

Date: Friday, April 17, 2009
Author: Katherine Burton, Bloomberg

William Ackman sent a letter to clients in February telling them he lost 90 percent of their money in a $2 billion fund set up to invest solely in Target Corp. In the five-page statement he explained why he remained confident that his bet on the retailer would pay off and asked investors to double down.

Ackman forgot to say he was sorry.

The incident reveals much about the 42-year-old founder and chief executive officer of New York-based hedge-fund firm Pershing Square Capital Management LP, who sent another note three days later apologizing for failing to apologize.

“It’s a sign of someone becoming very stubborn,” said Brad Balter, head of Boston-based Balter Capital Management LLC, which farms out money to hedge funds and isn’t an Ackman client. “Being wedded to a position can kill a manager.”

Or it can make him very rich, said Ackman, whose main $4.4 billion Pershing Square fund returned an average 21 percent annually in the past five years, compared with a loss of 4 percent for the Standard & Poor’s 500 Index. His most profitable wager, that bond insurer MBIA Inc. would implode, took five years of hounding regulators and rating companies about the firm’s unwarranted AAA rating before it started to pay off. He ended up with a profit of more than $1 billion.

“Good ideas sometimes take time,” Ackman said in a telephone interview last week.

‘Reputational Risk’

Recouping his bet on Minneapolis-based Target may take years, Ackman said. The stock, which he started buying in April 2007, when it was about $60 a share, now trades at $38.54. It’s his biggest money-losing investment, erasing as much as $1.9 billion of clients’ cash across all his funds.

And there is more than money on the line, as a failure to improve the stock’s value may call into question his activist approach to investing, said Chris Young, head merger and acquisitions analyst at RiskMetrics Group, a proxy-advisory firm in Rockville, Maryland.

“Every loss for an activist has a reputational risk,” Young said.

Investors are impatient after hedge funds fell an average of 19 percent last year, the biggest losses on record, according to data compiled by Chicago-based Hedge Fund Research Inc. Pershing Square’s main fund was down 12 percent in 2008, the first loss since its inception in January 2004. It’s up 10 percent this year.

Activist Investing

Ackman’s brand of investing -- pushing companies to make changes, whether selling real estate, repurchasing stock or putting themselves up for sale to boost the share price -- works best when markets are rising. In the longest U.S. recession since the Great Depression, many of his rivals have pulled back from such tactics until the crisis passes.

“For activist investors who had a tough 2008, the fights this year will be a referendum on their performance,” said RiskMetrics’s Young, who plans to provide a recommendation for investors at Target’s May 28 annual meeting. “It’s going to be interesting to see how fellow shareholders evaluate them.”

The third-largest shareholder in Target, with an almost 8 percent stake through shares and options, Ackman isn’t retreating. On March 16, he launched a proxy fight that would put him and four other directors on an expanded 13-person board. From there he hopes to push the second-largest U.S. discount chain to sell its credit-card business and place the land under its stores in a real estate investment trust that would lease the property back to the company.

‘Distraction for Management’

Though Target’s shares have climbed 34 percent since then, they’re down 35 percent since Ackman first bought his stake, and analysts say the proxy fight is more of a hindrance than a help.

“Ackman’s highly creative and aggressively marketed proposals have been a real distraction for management and come at the worst possible time for what we believe is a great retailer,” said Bill Dreher, senior retail analyst at Deutsche Bank AG in New York.

Target says in its April 8 proxy statement that Ackman is only interested in short-term stock market gains because more than half of his investment is in options that expire within two years. The company also says that Ackman’s proposal to lease back its land would expose it to “large and increasing lease payments, undermine its competitive position and jeopardize its long-term strategy.”

David Keuler, managing director at Mason Street Advisors LLC in Milwaukee, said he may not support Ackman’s proposals.

Ackman’s Plan

“We aren’t necessarily predisposed to Ackman’s slate,” said Keuler, whose firm owned about 600,000 Target shares at the end of 2008. “I think management has done a good job for investors.”

Deborah Weinswig, an analyst at Citigroup Inc. in New York, said in a report last week that she didn’t expect proxy-advisory services such as RiskMetrics to recommend Ackman’s nominees.

Ackman says his plan is sound. When he bought Target, he said it had the “strongest operating management,” but the stock was undervalued. Now he’s unhappy that it isn’t performing as well as Bentonville, Arkansas-based Wal-Mart Stores Inc., the largest U.S. retailer.

Target shares fell 27 percent in the past 12 months, while Wal-Mart’s stock dropped 9 percent. Sales at Wal-Mart stores open at least a year, considered a key gauge of retail performance, rose 3.2 percent in 2008, compared with a 2.9 percent decline at Target.

Target also wrote off a net $811 million of credit-card losses last year; Wal-Mart doesn’t own its own card business.

Flipping Burgers

“We want to be a part of the discussion in the Target boardroom,” Ackman said. “They’ve underperformed not because they have a bad CEO, but because the board has no independent directors with experience in retail, credit cards or real estate.”

For Ackman, who started his first hedge fund at the age of 26, three months out of Harvard Business School in Boston, the fight with Target is nothing new. His investing strategy marries intense research with a high level of showmanship. He flipped burgers for half a day at a McDonald’s in Florida when he was trying to get the company to sell more of its restaurants to franchisees. He showed 163 PowerPoint slides at a press conference last November at which he outlined his Target plans.

It took Ackman only nine days to raise $2 billion for a fund whose target he didn’t disclose to investors. While it was the fourth time Ackman had created such a vehicle at Pershing, it was by far the largest amount raised for a fund dedicated to a single stock.

‘Single-Stock Risk’

“It’s a bull-market strategy,” said Brad Alford, head of Alpha Capital Management LLC in Atlanta, which selects hedge funds for clients. “I don’t understand why any prudent investors would take that kind of single-stock risk.”

About two-thirds of the money came from other hedge funds, including Daniel Loeb’s Third Point LLC in New York. Investors were told they would be locked in until December 2010; that the fund would use options to double the size of its gains, or losses; and that the investment wouldn’t be hedged. Fees were set at 0.25 percent of assets and 20 percent of profits.

Investors said they put money with Ackman because stocks tended to jump once news emerged that an activist was behind a sizeable purchase. What’s more, he had a track record of forcing management to unlock hidden value.

Shares Tumble

Target shares rose to a high of $70.14 on July 13, 2007, a day after news broke that Ackman had bought a chunk of stock, and then fell to a low of $25.37 on March 9 of this year, as the economy slowed and the credit crisis worsened. In February, after getting a request from at least one investor to exit the fund, Ackman decided to cancel the lock-up and stopped charging fees. He said a “majority” of investors stayed in, and some re-upped, though he declined to provide any details.

“This is an investment that we’re going to own probably for several or more years, and there’s a lot of opportunity from here,” Ackman said in a March 16 interview with Bloomberg Television. “If we’re completely unsuccessful, I still think it’s going to be a decent investment over the next couple of years.”

Target isn’t Ackman’s only troubled holding.

He owns 40 percent of Ann Arbor, Michigan-based bookseller Borders Group Inc., which is down 94 percent since he started buying his stake in November 2006, and 25 percent of General Growth Properties Inc., the second-largest U.S. mall operator. Its shares have tripled to $1.05 since he began buying the stake in November.

The Chicago-based company today filed for Chapter 11 bankruptcy in New York. Pershing Square will provide $375 million in financing to help the company operate during the Chapter 11 process, General Growth said in a statement. Ackman said in March he may join the board, and expected the equity to “survive intact” in the event of a bankruptcy.

Harvard Classmate

From his youth growing up in Chappaqua, a New York City suburb, Ackman has been sure of himself. He recalled for the audience at a Wall Street Journal conference last year in New York that his father, Lawrence, a real estate investor, told him he could do anything, and that he believed it.

He started his first hedge fund with Harvard classmate David Berkowitz and raised $3 million, even though neither had any professional experience. Their clients included the billionaire Ziff family, former owners of Ziff-Davis Publishing Co., and Martin Peretz, editor-in-chief of the New Republic and Ackman’s former Social Studies professor at Harvard, where he also got an undergraduate degree.

When Berkowitz and Ackman started Gotham Partners Management Co. LLC in September 1992, they leased a windowless Park Avenue office from brokerage firm Furman Selz Financial Services Ltd. One day, founder Bernard Selz got into the elevator with the two, and Ackman introduced himself.

“You should call me sometime,” Selz said as he got off.

The two partners rode the elevator to their office. Ackman, without taking off his coat, got on the phone with Selz’s secretary to set up an appointment.

40% Returns

In the first five years the firm posted returns of about 40 percent a year, and assets peaked at $580 million. Ackman expanded the breadth of the fund’s investments in 1997 into private equity, including a controlling stake in Gotham Golf Corp., which owned 26 golf courses.

A New York court barred Gotham in December 2002 from merging Gotham Golf with First Union Real Estate & Mortgage Investments, a REIT in which it also owned a stake. At the end of the month, Ackman and Berkowitz told investors they were forced to unwind the fund, which faced “substantial” redemption requests.

While investors have said Ackman’s extreme confidence in his own ideas has always been a risk, Ackman said he has acknowledged his investment errors. He pointed to a decision late last year to sell most of his stakes in Sears Holdings Corp., the Hoffman Estates, Illinois-based retailer, and New York-based bookstore-chain operator Barnes & Noble Inc., which were both money losers last year.

“When I make mistakes, I fold the tent and move on,” Ackman said. “But if I believe I am right, I’m willing to go to the end of the world. I’m the most persistent investor you will ever meet.”

To contact the reporter on this story: Katherine Burton in New York at kburton@bloomberg.net