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Following Ackman & Tilson — Notes from the Value Investing Congress

By Travis Johnson, Stock Gumshoe, October 18, 2011

I’m afraid the mind is more willing than the body today, I seem to have picked up some sort of flu bug so I’ll be brief today and will share some more thoughts on the Value Investing Congress and the ideas we learned about in the weeks ahead. Which is probably for the best, since many of the ideas experienced little spikes in trading as the folks in the audience posted their buy orders during each talk … a little wait for the shares to calm down, assuming they do calm down in these turbulent markets, might actually be a boon.

But anyway, the presenter that’s catching attention today is Bill Ackman of Pershing Square, so I thought I’d give you some shorthand for what he and Whitney Tilson, who organized the congress and owns some of the same stocks, talked up late this afternoon.

Tilson focused on the two biggest positions at T2 Partners, his management firm — those being Berkshire Hathaway (BRK.B) and JC Penney (JCP).

He has been holding Berkshire for more than a decade, and I’ve also owned the shares for a long time — but he specifically argued that the stock is appealing now specifically because of Warren Buffett’s announced buyback authorization that puts a floor under the shares … essentially, that Buffett could, if he so wished, do massive buybacks if the shares fall to near book value again, and that the shares currently trade at a 35% discount to Tilson’s estimate of intrinsic value, so the upside is about 50%. Downside of about 5% and upside of 50% is pretty good, and I won’t argue with him — I too bought Berkshire again just a few weeks ago, right before Buffett’s buyback announcement (which was just lucky, I’m afraid, I have no hotline in to the Oracle), and I agree that the risk/reward looks good.

That doesn’t mean that the shares can’t fall 10% if Buffett falls down the stairs and scares everyone, but I think the stock no longer has much if any of a “Buffett premium” so I’m not so worried — the shares trade at arguably a small conglomerate discount these days, not at a Buffett premium, so I think the risk of losing Buffett is slowly evaporating as investors accept his advancing age with equanimity and see the succession plans slowly developing. I can easily justify buying the shares here, and Tilson certainly thinks it’s attractive, but if the world goes to hell in a handbasket again and everything starts dropping precipitously, definitely keep an eye out for Berkshire trading near or under book value (which is somewhere in the high-$60s right now).

And the other large holding from Tilson is JC Penney (JCP), which is also by far the largest holding of Bill Ackman. Tilson and Tongue gave a thorough explanation of why they believe the shares are undervalued, with the basic argument being that their historic underperformance (lower margins, lower sales/sq. ft. than competitors) provides a real opportunity for what they claim is a management team brought down from the heavens … and that there’s hidden real estate value in their balance sheet, too.

Ackman started buying JC Penney about a year ago and mentioned it at last year’s conference too, but he has continued to add to the position and now owns 26% of the company (he had to negotiate for the right to buy up to that point, giving up some of his voting rights in exchange).

The argument from Tilson and Tongue is that JC Penney has great opportunity to turn a decent business into a very good one — and that they already have initiatives to drive better sales and margin numbers, to go with that trumpeted new management team.

The new CEO is the heart of the argument — Ron Johnson will start as JCP CEO in November, and several folks emphasized not only that he has the ideal experience for a retailing CEO (he was in charge of marketing at Target during their glory growth years as they created their cheap chic image, and he built the Apple stores into the most creative and compelling retail story of this decade), but also that he has made a huge sacrifice to take over JCP and has bet heavily on improvement and on his ability to rethink and rejigger the concept of the department store — he gave up about $73 million in restricted stock to leave Apple, and was given only about $50 million in stock by JCP in return, and he personally bought $50 million worth of long-dated warrants/options on JCP that incentivize him to get the share price much higher in six or seven years.

So if you’re going to bet on the ability of a CEO to improve operations, I can see how he’d be the ideal person — that obviously doesn’t guarantee anything, but it is interesting, and there is room for improvement. Tilson and Tongue say that their calculations give JCP a share price of $38 if they can improve sales by 15% (which would still leave them underperforming their peers over several years), and that an improvement in margins and much more efficient advertising spending should be able to push the shares to $53, with another $12-$15 of value in their real estate holdings (they own about 39% of their stores). So they put the value on the shares in the high $60s, with some other smaller holdings (shares of a few REITs, part ownership of some shopping malls) worth probably a couple more dollars a share.

This, then, is the opposite of what Warren Buffett often says — he tells us to buy a company that can perform even if they hire an idiot as CEO, because they probably will eventually. For JCP, it’s all about the new management, the big holdings by Pershing Square and Vornado, and the expected improvement in sales, merchandising, and margins driving the share price higher. I somehow can’t get myself that excited about JCP, but I’m probably being short-sighted — in general, betting along with Bill Ackman has been a very wise decision most of the time.

Ackman and an analyst from Pershing, Ali Namvar, also presented a separate idea of their own that they hadn’t previously talked about much — they now own 15% of Fortune Brands Home and Security (FBHS), the very recent spinoff of Fortune Brands (which is now Beam inc (BEAM)). I’ll probably go into this a bit later in the week, because I’ve got another spin-offs article to write thanks to a recent teaser campaign rolling on that topic, but the basic argument is that the shares have essentially no downside, a position in the marketplace that’s far better than their afraid and overindebted competitors, and they offer what is effectively a call option on an eventual recovery — even a partial recovery — in new home building.

As I said, I’ll go into that one some more later — but the key points are that if housing stays at this depressed level they could cut costs and are worth $14; if housing recovers partially over the next few years, they should be worth $18 today; and if housing is going to recover completely to the recovery rate of 1.5 million housing starts a year by 2015 or 2016, they should be worth $27/share today (those aren’t price targets, they’re discounted back to today’s price for current valuation based on expected performance). More on this one another day, spinoffs have some special characteristics that often make them great investments and hopefully this one will give up the price jump it enjoyed this afternoon.

And finally, Ackman mentioned an investment that I’d never heard of that sounded potentially interesting (though tough to trade) — Pershing Square backed a blank check company IPO in London back in February called Justice Holdings, and it’s now trading at a discount to cash value. Blank checks, or SPACs (special purpose acquisition companies) are blocks of capital that are raised on the market with the intention of using that capital to make an acquisition, and they can often be low-risk investments if you buy them near cash (they have to return the cash to shareholders if they don’t get an investment done in a couple years — this one has 2-1/2 years to run but Ackman said the environment is such that he thinks they’ll make a deal far faster than that).

So in this case, you can buy a share of $1.5 billion in cash that’s being run in part by Bill Ackman with the intention, so he said today, of probably taking over a company that would otherwise IPO but is finding the current environment too weak to get an IPO through. And he says you can buy it at a discount to the cash value, which would be rare for something attached to such a luminary investor and with limited downside risk unless they make a stupid or overpriced acquisition. It trades only in London at JUSH, and it closed yesterday at 920 pence — might be worth looking into if you’re interested in riding those coattails, assuming that the shares don’t pop back up to a premium valuation after his mention (it probably won’t pop much, I’d guess, but we won’t know until London opens tomorrow).



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