An Ephemeral Form of Value: Thoughts on the 2015 Pershing Square Investor Letter

January 29, 2016 Moats 16 Comments

The 2015 annual letter from Bill Ackman’s Pershing Square makes for some interesting reading.  After seeing his fund decline by 20.5% in 2015 versus a 1.4% increase for the S&P 500, Ackman is prompted to undertake an assessment of what went wrong in the letter.  What conclusion does this Master of the Universe draw?  Well, Ackmans spends about a page on his own firm’s errors and about 7 on outside forces that combined to create the underperformance.  Perhaps this 7/1 ratio is completely appropriate, but it’s amusing nonetheless and gibes nicely with my image of him.

Anyway, the most interesting part of the letter is the two unforced errors he admits to committing.

The first, the failure to sell key holdings at peak valuation, is too silly to talk about.

The second mistake is what he calls a “valuation error.”  Specifically, he believes the firm assigned too much “platform value” to certain companies.  What is platform value?

To try and figure it out, I turned to Ackman’s public pronouncements on the subject.  Ackman has twice spoken publicly about Platform ValueTM.  The first time was a presentation entitled “The Outsider:  Perspectives from Allergan’s Largest Shareholder” that Pershing Square released in April 2014.  In it, Ackman argues in favor of a Valeant/Allergan combination.  The second time was a presentation he gave at the Ira Sohn conference in May 2015 highlighting the value of Valeant shares.  This presentation was entitled “45X,” a sly reference to the shareholder returns generated by Jarden, another platform company, in 14 years as well as the shareholder returns generated by Valeant in the years after Michael Pearson became CEO.

Based on these presentations, Platform ValueTM is a new intangible asset Ackman discovered.  Specifically, it is the ability to “execute value-enhancing acquisitions with shareholder-focused capital allocation.”  That is, value should be accorded to management teams that have demonstrated ability over a long period of time to make intelligent investments.  In this way, a company should not be valued on the earnings power of its assets alone but on the basis of its platform potential as well.  As Ackman wrote, “(I)nvestors should consider both the earnings potential of the  company’s asset base, as well as the potential to generate additional earnings through future, value-enhancing investments.”  (emphasis in original)  Thus, employing a typical price/earnings multiple severely under-values the platform company.  To rectify this error, an additional component of value, Platform ValueTM, must be considered as well.

According to Ackman, companies that exhibit Platform ValueTM include Liberty Media, ABInBev, Jarden, Transdigm and Danaher.  Among Ackman’s current holdings, both Valeant and Platform Specialty Products have Platform ValueTM.

The Platform ValueTM analysis is similar to the analysis I undergo for one of my personal holdings, Berkshire Hathaway.  How much value should we ascribe to Buffett’s ability to wisely invest owner’s earnings?  Or, perhaps more relevant these days, how much discount should we give to the company due to Buffet’s mortality?  But, Ackman’s notion of Platform ValueTM  goes far beyond simply ascribing value to superior capital allocation skills.

In fact, Ackman is (was?) able to come up with a precise premium that should be accorded a platform company based on the amount of assets it can acquire.  He is giving value to a company’s ability to buy a target and effectively cut expense and realize revenue synergy thereby using the platform to create value where it otherwise did not exist.  For example, Ackman stated in the “45X” presentation that the value of company immediately increased by 98% once Valeant acquired it.  Therefore, he argued that shares of the combined Valeant/Allergan deserved a 26% platform premium if one assumed it would acquire $20 billion of assets.  The math:

Acquired Assets                                        20

  1. Value Creation                                 20
  2. Pro Forma Market Cap                     78 (based on the then current VRX share price)

% Shareholder Value Creation(a/b):          26%

Cutting to the chase, 8 months later Ackman is much less excited about this new intangible asset he discovered.  He writes:  “Our biggest valuation error was assigning too much value to the so-called ‘platform value’ in certain of our holdings. We believe that ‘platform value’ is real, but, as we have been painfully reminded, it is a much more ephemeral form of value than pharmaceutical products, operating businesses, real estate, or other assets as it depends on access to low-cost capital, uniquely talented members of management, and the pricing environment for transactions.”

A bit later he turns to Platform Specialty Products specifically, stating,  “(W)e assigned too much platform value to the company. Our assessment was incorrect as execution difficulties, operating issues, currency effects, and financing issues have destroyed rather than created value.”

Before anyone accuses me of piling on after the fact, I talked about the problems of platform companies back in October of 2014 – although I referred to them by the more prosaic term “rollups.”  I cited 7 reasons that aggressive acquisition strategies usually fail.  Too bad Ackman doesn’t read Punch Card Blog![1]

Beyond these considerations, isn’t Platform ValueTM just a fancy way of saying “growth rate”?  Ackman seemed to be saying that these managements were so successful and their hunting grounds for acquisitions so fertile that a high inorganic growth rate was virtually assured.   Investors, therefore, should adjust their valuation approaches to platform companies accordingly.

Thought of in these terms, it is clear that Platform ValueTM  is indeed a very ephemeral form of value.  Projecting growth rates far in to the future is a notoriously difficult undertaking.  It becomes increasingly more difficult as the growth rate goes up.  Skepticism as to future growth rates would seem to be a fundamental tenet of value investing.  I’m not sure how Ackman can call himself a value investor and approach growth in this manner.  Perhaps as he says in his final paragraph, he will exhibit more humility going forward.

 

[1] Incidentally, the company I wrote about at that time, XPO, is down about 45% since the post appeared.