← Value Investing with Legends
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- [00:02]
A
Welcome to a new edition of the Value Investing with Legends podcast. My name is Michael Mauboussin and I'm an adjunct professor at Columbia Business School and a faculty member at the Heilbronn center for Graham and Dad Investing. I'm here with my co host, Tano Santos, the Robert Heilbron professor of Asset Management and Finance at Columbia Business School and the faculty director at the Heilbronn Center. Hi, Tano. How's it going today?
- [00:24]
B
Going good, Michael. Everything good. I'm not teaching just yet, so plenty of time for podcasting, for reading, for thinking until the spring semester.
- [00:32]
A
That is fabulous. Well, value investing is hard. You have to be able to do quality analysis to identify gaps between price and value. You may need to agitate executives to better manage the business, and contrary views can often lead to controversy. Our guest today runs a concentrated fund of stocks of high quality companies. He is known, too, for activism and even for opportunistic bets on macroeconomic outcomes. The fund has delivered excellent returns over time, comfortably exceeding those of the overall market. We're delighted to welcome Bill Ackman, founder and CEO of Pershing Square Capital Management, a firm he founded in 2004. Pershing Square has approximately $20 billion of assets under management. Prior to Pershing Square, Bill founded Gotham Partners with a Harvard Business School classmate, David Berkowitz. Bill graduated magna cum laude from Harvard with a BA in Social Studies and has his MBA from Harvard Business School. Since 2008, Bill has generously sponsored the Pershing Square Value Investing and Philanthropy Challenge, a competition that caps our Applied Security analysis course at Columbia Business School with Real World Stock Pitches, a finals event he hosts and prizes funded by Pershing square. More than 1,000 students have taken this course, and each year, the finalists have the opportunity to pitch a stock to Bill in a group of judges. We know that that experience has been really valuable for those students, so welcome, Bill. Thank you for joining us today. There are lots of topics we're keen to discuss.
- [02:03]
C
Well, thank you for having me.
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A
So let's start with some background. You grew up in Westchester county and went to Harvard University. Were there early experiences that shaped your temperament as an investor? Curiosity, persistence, and maybe even a little healthy taste for controversy.
- [02:19]
C
One of my more significant childhood experiences was I was about 16 years old, my father's car, one of the tires was deflated. Dad's like, great opportunity for you to learn how to change a tire. I said, terrific, I'm going to go do that. And so I actually went to the glove box, took out the manual Read what I was supposed to do. And it said, put the car on a level surface, jack it up and change the tire. And I said, dad, I need to move the car because our driveway has bit of a grade to it. And dad said, it's pretty flat. I said, dad, but it does really actually have a grade. And says here that I'm supposed to put it on a level surface. No, no, no, it's fine. I said, okay. I jack the car up, I take the bolts off, and then I sort of trying to get the tire off, stuck. So I have my legs under the car. I'm sort of pulling on the tire, and the car starts to tip off the jack, and I get my legs out from under the car before it collapses off the jack would have been bad. And it was this very significant moment for me because my father is someone I had enormous respect for. And my parents always told me to listen to them. But my takeaway from the whole experience was I'm always going to listen, but I'm going to make my own decisions because it's my life that I have on the line, and I've always lived that way. My parents would always tell me I never listen. I still hear it from my mother today. I said, no, Mom, I listened really carefully, but I make my own decisions. I would say that was one of the more important moments in my life.
- [03:37]
B
What do you get out of that academic experience in Harvard? I know that it's very important for you, your connection to Harvard. You speak about it often. Can you tell us a little bit about those years? What is that you learned? What kind of things were you thinking about at the time?
- [03:50]
C
I learned how to write at Harvard, even though it was something that was not taught to me, actually. Grew up in Chapequa, N.Y. went to Horace Greeley High School. Was considered a top 10 public school at the time I went there in the country, believe it or not. I left not being a good writer. Big believer that being able to write is a very important skill. And even from an investor's perspective, being able to articulate your thoughts, one of the best tests as to whether you really understand something is put it down on a piece of paper, it can make sense in your mind. And then if you put it down on a piece of paper and there's no clarity to it, then there are gaps in your understanding. So I would say learning how to write, maybe debate, take on different points of view, be challenged. Those are some of the great things that I experienced as an undergrad and also I built amazing relationships. One of the more meaningful parts of my Harvard experience, actually there were a couple that really outside the classroom, one was rowing. I went out from the rowing team. That was a time where you didn't have to be recruited. You can row onto the team, so to speak. I was on Harford varsity third boat stroke in the third boat for four years. And that was very significant. Rowing really teaches you that the limits of your physical mental limits are much greater than you believe. Business investing is a bit of a context board. You need to be in good shape and you also have to have a fair amount of persistence. You got to deal with failure well. The other really significant experience I had was I worked for Harvard Student Agencies, which was a for profit student organization that among other things published these travel guides called the Harvard Student Travel Guides. And I sold advertising. I sold advertising all over the world to hotels and rental car companies and credit card companies. And it was my first real business experience. And I learned sales, which is a very important skill and was very helpful to me when I eventually went and raised a fund coming out of business school. So I had great experience in the classroom and I also had great experience outside the classroom. And I met friends that I still keep in touch with today.
- [05:49]
B
Can I go back to one of the first things you said which I really like and I think it's something that I was educated in Spain. My children of course, have been educated here in New York. And something unique about this American education that I love is exactly the emphasis on your ability to express yourself while writing or public speaking, which is something I didn't receive as a kid back in Spain. And I always tell my PhD students that no idea survives contact with the paper. Once you start writing it down and you start committing to a particular line of argumentation, you're going to see the paper is going to force you to really think deeply. And I think it's a fundamental skill to have I like very much. I recommend this to my students. Bill of writing diaries. Write your thesis for that particular stock because you're going to force yourself asking do I really mean this? What kind of evidence do I need to bring to bear on that? So I think it's a wonderful skill. Have you graduated from Harvard? What do you do next?
- [06:45]
C
I work for my dad. My grandfather and his brother started the business right around the 1920s that arranged financing for real estate developers. Owners of property and the firm's clients tended to be the more entrepreneurial type clients. I was there for a little under two years. They Kind of give you a phone and a directory. You have to find your clients. So there's a sales element to it. But you learn a lot about real estate and financing and equity debt. It was my first mental model for thinking about the value of something. A very good experience. It in some sense provided the framework. Real estate people don't care about accounting, they care about cash flow. That's really the only thing that matters when they're trying to meet their debt service or pay a dividend or distribution and so on. So I had this cash flow focused view of how to think about value again. Also helped on my sales experience, negotiating experience, things that came in handy over the course of my career.
- [07:42]
B
And the step to Gotham Capital. When did that happen?
- [07:46]
C
Gotham Partners? Actually, Gotham Capital is Joel Greenblatt. We came up with the name Gotham Partners and there was no Google to check the name. So we didn't even know of Gotham Capital when we got the name approved. And for a while people would confuse us because we were in business around the same time. I went to Harvard, really to learn how to be an investor. Because one of the other thoughts working for my family business, it was a service business. You had clients and you were at the beck and call of clients. And it seemed to me that the people that were having more fun were the real estate developers, the investors. It seemed like in the hierarchy of finance, the people who get to make the investment decisions are having the most fun. So I wanted to be able to transition to that. I went to business school to learn how to be an investor. And I went to business school without even reading the course catalog to see if there was a class on investing. And I got there and there was literally not one class at Harvard on how to be an investor. Not one.
- [08:38]
B
You should have come to Columbia, Bill.
- [08:40]
C
You're totally right. The only class they had was a class like how to manage Fidelity Investments. How to be CEO of an Asset Manager as opposed to Tick stocks. Thirty days later, I opened an account at Fidelity. That was my first brokerage account. I said, Look, I had $40,000 that I had made after taxes for my job. This was going to be my tuition in the investment business. I said, look, if I lose it all, it's equivalent of another year of school. I had the very nice benefit of my parents paying for my tuition. I was responsible for my other expenses. And I lived out of my brokerage account and invested out of my brokerage account. And the first stock I bought went up. And that was the beginning. And it was October of 1990, a time when banks and real estate companies were getting crushed. And that was sort of an area where I felt I had a bit of a competitive advantage because I had spent the previous years in real estate and real estate finance. By the second year or sometime in the first year, it was kind of a little lonely going back to the Dorm room reading 10Ks and 10Qs. And there was a guy in my class, my section I thought was very smart guy. And I said, look, why don't we do this together? He lived one floor up from me and we started reading 10Ks and 10Qs. And we formed the first investment club at Harvard. There wasn't one prior to that. It was an investment club of two participants. They had a Bloomberg machine in Baker Library, which we would use. We had fun doing this. And by the second year of business school, I said, imagine if we could do this and people would pay us to do this. That would be pretty good. And I used the business school thing to meet some people. Seth Klarman, his book came out a month or two after I started the business school Margin of Safety. Sorry. I bought it at the bookstore. I called him and I said, hi, Seth, it's Bill Ackman. I'm a student at Harvard Business School. I'm not looking for a job. I've got actually a bunch of investment ideas I'd be happy to share. And by the way, I bought your book. And he said, you bought my book? I think I was the first person to buy his book.
- [10:31]
B
Now he's worth a fortune.
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C
I have a few copies, one or two signed by Seth. Both are pretty valuable. That's how I started. And then we graduated and David took a job at Denkers Trust in the derivatives area. And he's like, if you can raise 3 million, I'll come join you. And I started going down that road. We managed to raise $3 million. We launched 3-1-93 with $3.1 million. And the 0.1 was from me and David.
- [10:56]
B
I have to tell you, the first time I heard about you, Bill, was with the MBIA situation. I went back to those years. I was a young faculty member at the University of Chicago at the time. To me, what is striking thinking about that, and I want to discuss this with you, is how prescient the whole thing was. I didn't remember that it was 2002. It's incredibly early in the real estate cycle. It's complex. You have to go deep and understand what these guys are trying to do. And there are Many layers to this story. And I want to peel them off a little bit for our listeners because I think it's an important story. So in no particular order, the big thing, something is going on in real estate market. And I became aware of this later. I'm struck by the fact that you were doing these things already in 2002. The layer of you see this particular organization drifting away from its core business and doing other things and do they have the expertise to do these other things? And then the nitty gritty detail of actually going, looking at those balance sheets, looking at those financial statements, do they have enough capital making that calculation? How much can they lose before they go belly up type of thing? That basic value investing calculation. Tell us a little bit about that episode. Did you see already the risks that were accumulating in the real estate sector? Was it top down, bottomed up? How do you look at that opportunity?
- [12:24]
C
There was a company called Farmer Mac that is a government sponsored enterprise that a friend had recommended as a stock we should buy. And I read the annual report and the more I read, the more I said, this is not a stock you should buy. This thing is a complete, almost a fraud. And the catalyst for thinking it was fraud was that the debt of the company was listed as aaa. And when we called Moody's and S and P and asked them for the ratings reports, they said they didn't cover the company. They weren't actually AAA rated, which was pretty stunning. And their debt traded pretty close to where Fannie and Freddie traded. Okay, they're government sponsored but thinly capitalized. And they're supposedly securitizing farm loans. But farm loans are not fungible. You can have a thousand acre farm on one side of the street and 1000 acre on the other side of the street and they can have completely different outcomes based on the soil, the farmer, et cetera. So this whole notion of securitizing farm loans made no sense. The whole business didn't make sense. And the credit default swap had just became a thing at the time. And I thought, wow, this is pretty interesting. We could buy credit default swaps on this AAA rated company that wasn't really rated aaa, but how do we get the word out? And we went to our lawyers and they said, look, you should just write a white paper, we'll fact check it, we'll make sure everything in it, we've got a footnote and free speech and whatever. This was the first, I believe, activist short in history. A company called Farmer Mac. And you can find our reports Online, they were called Buying the Farm. And I ended up doing parts one, two and three. And we ended up making a ton of money because as we exposed this thing, the credit spreads widened very dramatically. We made a pile of money. The stock went down. After that experience, I asked one of the counterparties that we traded with, a guy I think at Lehman at the time who sold us some of these credit. False hopes. What other AAA rated company do you think doesn't deserve a AAA rating? And he said, there's this company, mbia, that guarantee a ton of stuff. I don't get how the magic works. You should take a look at it. And I did. And I read the annual report. By the end of the shareholder letter, I was like, this thing is very sketchy. MDIA was Municipal Bond Insurance Association. It started out guaranteeing muni debt. Municipal debt, particularly the general obligation debt, is sort of a full faith and credit of the municipality. And absent fraud and absent of really mismanaged municipality, it's highly probable to be paid. And really the job they did at the beginning was review the paperwork and make sure everything was fine. And they put this Good Housekeeping seal of approval on the debt. Now, with that AAA rating, you attract a lot of flies. There's only so much you can get paid guaranteeing obligations that never get default. But with a AAA rating, you can attract a lot of people for whom that rating is very, very valuable. And they just started moving out on the risk curve. And you saw that very clearly. And by the time we were looking at the business in 2002, somewhere I have my annual report with all my footnotes, it'd be interesting to pull it out in the 10K. They had a trillion dollars of obligations and they had 5 billion of equity. And it's almost hard to do the math in that. So it wasn't an investment predicated on a view that the real estate markets would be blowing up. It was predicated on the view that all you had to have was a tiny little bit of thing go wrong and this thing is toast. They took no reserves. It was like, oh, it's the most profitable insurance company in the world. They write premium and they don't pay claims. But the problem is they were taking on risks that were real risk. And over time, those risks got worse and worse. And yes, subprime CDOs, that whole story, the synthetic CDOs, everything else they were also taking the other side of. They were writing credit derivatives. And it's actually illegal for a New York insurer to be in the business of guaranteeing derivatives or being a counterparty on derivatives, we're like, how can this be? And they had this structure which they called a transformer that they used, where MBIA would basically guarantee the liabilities of an LLC which was in turn owned by a charity, and that entity in turn would be the guarantor of the derivatives. And somehow they thought this passed muster because they weren't owner. And we sat down with the insurance department. Anyway, the deeper we went on this thing, we said, how can this thing exist? And that's what led to our buying billion plus of credit default swaps on the company. And then when we heard the company itself was actually taking the other side of some of our derivatives, we said, okay, this thing is crazy and it's going to have to blow up. And it was just a question of time.
- [16:53]
B
When you actually take a derivative position, there's a maturity date by which the thesis has to work. How do you think about that problem operationally?
- [17:01]
C
The Farmer Mac thing happened really quickly. We basically did our homework, put on the position, released a series of Buying the farm and then the company responded. In Buying the Farm Part two, we took all the company's responses and rebutted all their things. And then we did that once more and then the thing blew up. I figured the same thing would happen with mbia. I thought the case was even more compelling. What the company did is they had a lot more political influence and power than former Mac. And so what they did is they went after us very aggressively and that delayed the demise for the company. All of a sudden we were under investigation by the sec. Elliot Spitzer New York Attorney General Then it was like these evil hedge fund guys, market manipulation that kind of discredited for a period our thesis. But the beauty of credit false swaps, particularly on a AAA rated enterprise, is is the carrying costs were like 20 basis points random on a billion dollars, costing us $20 million a year or so to carry the position. They had a term generally of five years, which I thought was, well, more than we needed. You can of course extend them the history. There was the MBIA short position and the investigation they catalyzed and ultimately a judge I believe they influenced that, held up a very important transaction for us, was a catalyst for winding up Gotham Partners, the first fund. And we told the investor we had a situation where we had actually a new investor coming in, a significant one and investors redeeming. And then we had this uncertainty of this court case. We had the complexity of being under investigation and the Only fair way to treat our investors. We said, look, we're just going to go into wind down and we're going to send you back your money as promptly as possible. So we unwound ultimately the MBIA bets in the Gotham funds. But we had an SPV that had the same bet on. And then when I launched Pershing about a year later, I put the bet on again. By the time the financial crisis came around, we eventually got a big payoff. And since the cost of carry was so low, we could have paid premium for 30 years and it was still been a decent investment.
- [19:02]
A
So Bill, take us back to the formation of Pershing Square. Were there any problems you were trying to solve with the firm structure versus Gotham Partners? Especially around for example, alignment or concentration or permanent capital? Or was it more of the same?
- [19:14]
C
The ambition was always to get to permanent capital for all the obvious reasons. There's a reason why Buffet, after 15 years of running a hedge fund, gave the whole thing up, gave up the promote to run a crappy textile company. Because he got permanent capital. And he realized that we're going to compound at a high rate over a long period of time. It matters enormously what kind of car I'm driving over the course of that ride. Permanent capital is always an ambition. The things we did at the beginning were one my former partner, basically the stress of the whole thing. He said, look, I want a calmer life. So he went in a different direction. So I was just me, I was on my own this time. And there's some benefits to that. There are some examples of successful firms that are run by two people. I think they're very few. You kind of need one person's ultimate accountable. So I think that was helpful. The early years of Gotham, we invested in only liquid securities. About six, seven years in we went back to the partners and we got permission to do illiquids and privates and set up side pockets. I said, you know what? Too complicated. Just going to stick to very liquid investments. The strategy works. If we want to do something that's going to scale, makes sense for us to focus on liquid large cap stuff, which is what we did. So Pershing does not make illiquid investments. That was important. I felt that at Gotham I sort of under invested in infrastructure systems, the non investment part of the business. And I committed to really invest in that part of the business. Lastly, I set up an advisory board, a group of people that were investors, gray hairs who I could go to would push back, who would help me when there were Big decisions to be made. I think those were a couple of the really important things I did at the beginning.
- [20:46]
A
So you've characterized pershing square's history sort
- [20:48]
C
of in three eras.
- [20:50]
A
The first 11 and a half years of the firm, challenging period from 15 to 17. And then kind of a recommitment to core principles beginning early 2018. Can you talk about each of those periods and lessons you learned from each?
- [21:03]
C
So, the first, as I described, 11 and a half years. We were concentrated activist investor. And we pretty much did very little wrong. We had a couple of unsuccessful investments. J.C. penney, a small investment, and borders. Almost everything else we did was a home run, 21% compounded net of fees. Over that period of time. Eight years in, we formed something called pershing square holdings, which was our beginning attempt to get to permanent capital. We took that entity public in October 2014, 10 years into the life of the firm. And then a year or so later, I made the worst investment. In a company called valiant pharmaceuticals. And we proceeded to lose 90% or so of that investment. And it was a pretty decent sized investment. It was 1200 basis points of capital. That alone would not be catastrophic, except the headlines were extremely negative. People started betting against the firm. We had a public entity that owned very clear portfolio investments. So people shorted the stocks we own, and they went long. The one stock we were short, a company called herbalife. And the permanent capital part of our strategy was about 6 billion at the peak. But the impermanent capital was about 12 billion. The bet that investors were making was that we're going to start to get redemptions from our investors. We'd be forced to sell this concentrated collection of investments. Of which we were major shareholders. That would push those prices down, that would contribute to negative performance. Which would motivate investors to redeem their capital, which would cause us to sell. And we found ourselves in the precise position. Our choice was wind up. Or the way I looked at it, is, at the bottom, Burging square holdings. Had an equity value of 3.9 billion. It was down 31% or so. And it wasn't permanent capital. While it was in a corporate form. Investors could vote to liquidate the entity. And so what I did is I borrowed a bunch of money. I redeemed money from the hedge fund part of the business. And I bought enough, along with a couple of my other partners we're holding, to make it permanent capital. We got to 25% of the shares. I said, look, if all the other capital leaves, we finally have a permanent Capital structure. I looked up. I was 50 years old at the time. And I said, okay, how much capital was Buffett managing when he was 50? The answer is the book value of Berkshire, which is a reasonable measure, was 400 million when he was 50 years old. So I said, okay, not inflation adjusted, but we got almost 10 times as much capital as wealth. Let's get out of the business of raising money. Running a hedge fund, particularly a big one. Anyone who gives you a few hundred million dollars feels appropriately entitled to sit down with the CEO once a year. But at 20 billion or whatever, you get a lot of those people, and you spend your time flying around meeting with investors. That took me away from the investment process. That ultimately was a meaningful contributor to a big mistake. And I said, look, we're going to focus on investing. 3.9 billion of capital is plenty of money. If we compounded anything close to what we have done historically. This turns into infinity over time. We've always wanted permanent capital. The plan was to get there eventually. Now we have it. We're just smaller than we thought. Oh, and by the way, we veered. Valiant Pharmaceuticals did not meet our simple, predictable model, didn't meet our checklist. But you know what? We never put our checklist down on a piece of paper. So we're going to put it down on granite. I asked a member of the team. The extended family was in granite tombstones. They said, come back. I want this thing on the wall like Moses, Ten Commandments. And he comes back with a deal toy. But the benefit of a deal toy is we made 50 of them, and we put them everywhere, in every conference room and everyone's desk. And we've kept to the principles, and we've had permanent capital, and it's a huge commitment advantage. Since January of 2018, the permanent capital era, we've conquered a 24% net, which is the best we've ever done over time. And I attribute it to one focus, two, no distractions. I'm not flying around meeting with investors. Three, as well as we did in our first 11 and a half years, investors actually diluted our returns because we had a concentrated portfolio and capital would just flow in. It's hard to manage money with capital leaving. It's also hard to manage money with all that capital coming in. And now we have a finite base of capital. What Buffett's had the benefit of for 60 years, we've had the benefit of for eight. And it's a huge advantage. And it enabled us, particularly in periods of stress. We could be Front footed and be committing capital when your typical investment manager is starting to raise cash because they're going to get redemptions and it's just a very privileged place to be. We intend to stay in this permanent capital. We're never going to have another dollar of impermanent capital. We didn't liquidate our hedge fund. Anyone wants their money can take their money. Then we had some stubborn people who wouldn't leave. So we have a couple billion dollars of that capital. And some of Those people are 90 or 100 years old. I have an investor who gave me $2 million 21 years ago and he took out a million a couple years after he invested. And now he's got $30 million and he's very happy and he's 94. He checks in periodically. Those are the only calls I take when my 100-year-old investor wants to see how things are going. I'm happy to take their call.
- [25:57]
B
This is key, something that we tell the students in the class, Michael, myself, many others, is that if you want to be a successful investor, it's not just about what you will have on the asset side. It's very important to think carefully about the liability side of your vehicle because that's going to be determinative for your performance. I think you have a beautiful line in your annual report last year, so I want to read it for the audience. Volatility is the enemy of the asset manager with short term capital and the friend of the investor with permanent capital. I think that really encapsulates that connection between the asset and the liability side of an asset manager. I want to go, Bill, back to your investment philosophy. So one of the things about your career, you've done many things. You've done the restructuring, you've done the turnaround, you've done the traditional value play on a company that you think is going to be compounding at a great return for the foreseeable future. You've done all these things. I want to take a little bit of a step back. What is that you're looking for that is common across all these modes that you have of operating? And one of the things that we tell the students is something that I learned from Bruce Greenwald is specialization is important that you become good at doing one thing repeatedly. You seem to have mastered this ability to change across many different ways of investing. Do you think is something you would recommend to the students? Is it something that you think is unique to you, something that you have the team to do it? How do you think about that everyone,
- [27:32]
C
over time, whatever investment philosophy you have, it develops with experience. When I first started, it was a small capital base. We were buying cheap things with a catalyst. That was Gotham in Pershing Square. It was about, let's find the best businesses in the world, durable growth companies. We can have a very high degree of confidence over a very long period of time. They're going to grow their revenues and cash flows at a very nice rate. When we think of as best businesses in the world, the problem with a strategy like that is everyone wants to own the best businesses in the world. You can only make excess returns if you buy the best businesses in the world at a price that makes sense. That led us to focus on cases where a really great business was either going through a really challenging time and we thought whatever the challenge was, was a reversible challenge, or for whatever reason the market didn't appreciate how great that business really is, or they overweighted a macro factor or something and how they thought about the company. One of our competitive advantages that we developed over time and really began as early as the early days of Gotham with the first big activist investment that we made, Rockefeller Center Properties, going way back in time, is that if you think about it, a private equity sponsor, when they take private a public company, they're paying a 30, 40, 50% premium. Why would someone pay a 30, 40% premium for a public company when it should be that markets cause businesses to trade at sensible prices? The reason why they prepared to pay the premium is because control is enormously valuable. Control is valuable because you can change the management, you can change the governance, you can change the strategy, the cost structure, etc. The biggest competitive advantage we've had historically is we're able to buy at a time when people are very disappointed with management or the circumstance. The stock is inherently cheap. But in our hands, the day after we own our position, we can get ourselves in a position of enormous influence, taking the ultimate step in that direction, which is running a proxy contest and getting control of the board. You only have to do that a few times before you're able to just use that track record to basically capture something pretty close to control. We get the control premium at a discount or the control benefit at a discount, which is a huge advantage. If we're paying 60 cents off, 70 cents on the dollar for something that's worth 130 cents to someone who's got control, that's our beginning advantage. And then we use that advantage to fix the thing that's causing the stock to trade. At a meaningful discount. And then we own some great durable growth company with a great person running it over a very long period of time. And we've done that a number of times. Why? Concentration. Because one, there aren't that many amazing durable growth companies that you find available at an attractive price. And two, being a big shareholder, the marginal share you can own on the margin increases your influence. We also have a limited amount of time, and I believe in running an organization with a small team. We have, depending on how you count, 30 billion of assets we're responsible for today at pershing square, typical $30 billion asset manager has hundreds, if not thousand employees. We have 41 employees, and that's not 41 investment professionals. We have eight of those, plus me. We also do the accounting. A couple of public companies that we're responsible for that. We do all the public filings. We still have a couple of private funds, and we're able to do that with a very small team. That's an advantage. But the hardest thing that we do today is picking the business that we can have a high degree of confidence is going to durably grow over a long period of time. And that's about assessing what Buffett called a moat. What are the structural and other competitive advantages of a company? And that's a very hard thing to do in a dynamic world, particularly with technological developments like AI, et cetera. You look at Berkshire Hathaway history. I mean, Buffett owned these businesses and he said were amazing. Newspapers, World Book Encyclopedia, I don't know, selling vacuums door to door. If you go back and look at Dexter Shoe, there are a lot of businesses that he owned that one of the best investors in the world thought had these durable moats. Some combination of technology or globalization disrupted them. So the key for us is finding those really durable moats. And that's the hardest thing that we do. It's something that I think the business schools need to do a better job teaching because anyone can build a discounted cash flow model. But the hard part is predicting the future. And you can only do that, I think, if it's this incredibly durable business. So understanding what makes a business durable, I think is the hardest job that we have.
- [31:58]
B
I couldn't agree more with you on this. I've been teaching business schools for 30 years, Michael, for, I think, as many as 25 years. One of the things I find myself more and more teaching less the technical components of valuation, which, of course, the kids need to know and you need to master them and more about. Okay, let's think about the core economics of this business. How does it work? It's difficult to forecast the future, particularly when it comes to technology or maybe sometimes regulation. How is it going to affect the business? But at least you have to identify what can go wrong from an economic point of view, what can compromise the business operations of this firm. And then you take an educated risk. I mean, it's difficult to predict the future, but at least you know the risks that you're taking. And most of the times the problem is that you don't know the risks that you're taking. So on this vein, preparing this interview, we look at many of your recent interviews. You had a very interesting take on. Let me put it this way, let me frame it this way, on the new economy. You were talking about Uber and how you think about that class of businesses. And I wanted to ask you a little bit about this. One of the things that is striking about the new economy is that you see these businesses with no capex whatsoever, so to speak, because you're not buying the cars, you're not paying the drivers, where the marginal cost of supplying an additional unit of what it is that you're doing is close to zero. So it's very difficult to compete with those businesses because they can always bring you down. You won't be able even to recoup your fixed cost investment. How do you think entry is going to evolve in many of these businesses where you are protected by these modes because of the network externality, say. And at the same time it's a perfect business because you grow with your customers. Uber grows with the economy. When people take rides, Netflix grows with the economy. Salesforce grows as their customers grow. And you don't have to meaningfully invest in growing your business. Pure organic growth, so to speak. How do you think about that new economy and how do you adapt your investment to those changes that are taking place?
- [33:59]
C
The only business I would say that doesn't meet that standard is actually Netflix. Netflix has to invest enormous amounts of capital in developing content. But yes, we love what we call these royalty collecting companies and some of them are new economy like you could say Uber. And some of them I would say are pretty old fashioned economy. And a good example of that is Hilton. The hotel business has been around for hundreds, thousands of years. Perhaps what's unique about Hilton is they separated the brand from the owner and the real estate investment. Buffett always would say the best businesses in the world are ones that are a very high return on capital and they provide more and more Opportunity to invest incremental capital at high returns. I think that's a very good business. But I disagree with him. I think the best business in the world that earns enormous returns on capital in order to continue to grow at a high rate, they don't need to reinvest. You can actually literally take that capital out of the business. Those are our favorite companies, the capital light model. The capital light businesses generally can grow faster, they consume less capital, and if they are the dominant company in their respective space and the moats are large because of network effects or otherwise, they can be really amazing businesses and our portfolio is basically filled with them. Universal Music is a royalty on people listening to music and Hilton's a royalty on people staying in hotels and Uber's a royalty on people getting driven around Brookfield. The asset management business is one of the great businesses because it's a royalty collecting company. The only capex we have at Pershing Square, the management company, is the build out of our space, which we did six or seven years ago and we did a nice job and I don't think we're going to have to do that again. Maybe we have to paint every once in a while. The most valuable businesses in the world tend to be ones that have truly recurring type cash flows. So we prefer those kinds of businesses versus widget companies which make things. There's a risk that a couple people in a garage make a better. The threat to Uber is that Tesla is going to produce a car every five seconds at a very low cost and just the entire universe is going to become Teslas and their market share will be so significant that they'll displace the platform. That's the risk. If you believe the world will be autonomous vehicles, not made by just one manufacturer, by many, and that really what the customer is looking for is not a Tesla to take them from one place to another, but a clean vehicle that arrives at the fastest time at the lowest cost. Isn't the marketplace the controller of the marketplace, the place that the consumer is going to go the first stop for transportation or delivery over time? We think Uber's got a very dominant position there and we think that dominance actually only goes up over time.
- [36:30]
A
Pershing Square is known for concentration. Do you guys have any specific governance or process elements, whether it's checklists or pre mortems or descent protocols that keep the benefit of concentration from turning into a fragility?
- [36:44]
C
We think about sizing something based on how much we can make and how much we can lose and we're prepared to risk something like 5 percentage points of capital on any one investment. So for something to become a 15% investment in the portfolio, we have to believe that the probability of a permanent loss of capital of a third of the position, 5 percentage points, has got to be de minimis. It relates to things like the financial position of the company. If it's an unlevered company or it's a very conservatively financed company, that helps mitigate obviously that kind of risk. The example I gave was the 15% position. We have to believe the business is sufficiently protected from the risk of a permanent loss of capital. And that's an assessment of some of the factors we talked about before. How durable is the growth, the nature of the business? We don't like companies that have exposure to extrinsic factors we can't control. So think rates, commodity prices, regulatory factors. So if you have a portfolio of mining companies and oil and gas companies and banks, I think very differently about concentration of your portfolio. Basically unlevered or conservatively levered royalty collecting companies that you purchased at attractive valuations and businesses that you have a lot of influence over. So if you look at the portfolio we have today, 95% of our portfolio looks like that, or 97%. Maybe it's 95%. And we have two positions. One is Hertz, where we bought into a company that has very, very levered balance sheet and going in the midst of a turnaround. The probability of a permanent loss of capital in that kind of situation is well above zero. But our assessment of what they're doing and the probability of their being successful in doing so tells us that the upside here is like a 7x. So the downside is we could theoretically lose our money. And the upside is we can make seven or eight times our money. So we will invest a small amount of capital. This was a couple percentage point position on the way in and something which can go to zero but where we can make multiples of our capital. And in the case of Hertz, we believe that we could help them minimize the risk of a financial loss. So it's not just a completely passive exercise. We bought basically 20% of the company just yesterday. They did a convert which is going to give them another 400 plus million of capital. Really take away the risk of default from the company. So it was a case where we felt we could help. The stock was trading around three and a half dollars prior to our investment. We thought the presence of us as an investor would one cause the stock price to go up, which would actually Increase their access to capital, reduce the risk of pollution, and then we could also be financially supportive of the company. When they did this transaction Yesterday, we were 125 million of the transaction. But again, because of the risk, that kind of position is small. So the way we avoid risk with concentration is one, we minimize exposure to businesses that have exposure to factors we can't control that are risky. Own these dominant low leverage companies and we keep investments where there could be permanent loss of capital to be very, very small. And that's really the factors I can
- [39:51]
B
say I want to pivot a little bit and take a step back. With the advent of course, of artificial intelligence. What is the room for an active investor doing a stock selection analysis and how you think competitive dynamics are going to be affected by this outburst of artificial intelligence? Does it worry you for the future of the industry?
- [40:15]
C
How do you think about it already? I would say the vast amount of capital in our industry is managed passively, which is really machines, not so much picking stocks. It's really just machines following the direction to own whatever is in the index. And that's been a very important and significant phenomenon in our industry. And it's a major factor in markets. If 25% of every company is owned by indexers and an even greater percentage because a lot of people for business reasons pretty much follow the index, the marginal buyer and seller of a stock is going to move it a lot more. And you see this phenomenon where the marginal buyer and seller today is often a pod shop. So the combination of index ownership plus the very large amounts of capital managed by investors that have very short term orientation leads to a world in which companies that miss or exceed estimates. When you see massive stock price moves for even mega cap companies, I view that as a favorable world for the concentrated investor because every once in a while a really great business, the price is going to go down a lot because they disappointed for some reason. And there'll be a ton of liquidity at that time where you can buy an investment. So I think that's a positive factor. Now on the AI side, are the machines going to become so smart that they won't need people? Maybe there's some truth to that. Usually what happens is machines are controlled by humans that because of the levers that are available, they move greater amounts of earth and as a result they produce greater buildings. And now that software is going to become cheaper and cheaper because AI is going to write a lot of it. It's amazing, like a super enhanced version of word processing spell check for Writing software. It's going to. Fewer people will be needed to write software, but it will open up the world to, I would say, human creativity in a way that it hasn't before. We're at a place now where you don't need to know anything about writing software. Where you can write software. You're going to should see an explosion of new kinds of software to solve new kinds of problems, because people who didn't have access to programming before can now build a company or just write a little app for themselves to solve a particular problem. I think the market will demand more and more and better software, which will require continued significant investment in producing the best software. On the investment side, what I like about what we do that I think is relatively protected from AI is there's a very significant human component. The assessment of a board, how they respond to a large owner, the negotiations that take place, the selection of who's the best person to run this company, recruiting them to do so, engaging with them, and negotiating a compensation arrangement. A lot of these things are things that I think is not going to be done by AI. There's a very human part of our strategy which requires a human element. If this were a very quantitatively driven firm, I would have a very different answer to your question. So I think it really depends on the nature of the investor.
- [43:02]
A
So, Bill, you launched the Pershing Square Value Investing and Philanthropy Challenge at Columbia back in 2008, and you host the finals and you fund the prizes, which is all wonderful. Is there anything that consistently impresses you about the top student pitches? What are the common mistakes that you see that students make over time? And has anything they've ever talked about changed your own process or how you thought about something?
- [43:25]
C
Almost every year the quality has gone up. I remember the first couple of years, I was a little disappointed, I would say, with the quality of the students and the pitches. I actually think Columbia Business School has become a materially better business school over the last. How long has the prize been going on? It's maybe almost 20 years now. Maybe that's because of the Pershing Square price recruiting better students. But I think Columbia's become known as a place to go where if you want to go into the investment business when you graduate, it's a very good place to go. So I think it's something some combination of very good faculty, good programs, and attracting good students and becomes a sort of virtuous cycle. The finalists are excellent. I think sometimes the decks they put together, they're like 200 pages of stuff. And usually you can get lost in the forest there. The vast majority of investments, there are really only a handful of things you need to understand in order to know that this is a place you want to invest in. To demonstrate they've done a lot of work, they put a whole phone book worth of stuff. And I think the more impressive ones are ones where they give you everything you need to know, but not the stuff you don't need to know.
- [44:28]
A
I emphasize that with my students as well. How does one learn that skill of distillation to the linchpin key issues for a particular investment? Is that just reps and experience or is there some way you can teach that to others?
- [44:43]
C
A lot of it's experience. I think one way to teach it is just case method going over example after example of investing. At the end of the day, what matters for the success of a business is let's start with revenues. Is this a business that is going to grow over time? Is that growth being driven by them selling more products or delivering more services? Or that growth being driven by their raising price? Excess inflation every year? So understanding what's high quality revenue growth versus lower quality. A company that has driven price to drive revenues, but the same product sales or same service sales is growing at a slower rate. Is a company sort of taking advantage of their market position but probably creating the opportunity for a competitor to enter? So understanding that line item, now let's look at the cost structure of the business. Are there costs controllable and how much control do they have over their costs? And is this a business that will be a beneficiary of technology or otherwise? Will their costs be will come down over time? Or is there something about the nature of the cost of doing business, whether it cost of goods sold or the nature of the people they need to recruit to run their enterprise, that it's going to be hard for them to control their costs and then that gets you to profit? Let's keep it simple. And then the nature of this business is that a business where you have to take the cash that you generated and reinvest substantially all of it back into the business to maintain your market position to grow? Or is it a company where you sort of have the option of taking out that money and dividend it to your shareholders. But there are some interesting places to put that capital that can enhance and build your position? I think those are among the things that you really need to be thinking about. Are there extrinsic factors you can't control, that you wake up tomorrow and the business is worth half as much because some government agency makes a decision or some commodity price moves or the nature of the business is inherently sensitive to interest rates. And then I think the last piece is if you're a passive investor because you don't have the scale or influence to impact the company, you've got to be a very good judge. You're stuck with the existing management team and board. And do they have a track record of doing the right thing? A useful exercise often is to go back and read the last dozen years of annual reports, but read them sequentially, start in 2015 or whatever, see what management said, and then see what they did. And you learn a lot reading conference call transcripts. Read the last five years of conference call transcripts. What do they say? How honest are they with shareholders? And what do they do? And then how are they compensated? What are their incentives? I'm going to say those are the kind of basic factors that you need to know.
- [47:09]
A
Bill, you mentioned you have a fairly lean investment team. What do you look for when you're hiring analysts? Things like temperament or curiosity or intellectual humility. And are there any specific techniques you all do organizationally to sort of debias without killing the creativity that's so important?
- [47:29]
C
We've adopted really, for the last, well, more than a decade, strategy for recruiting people. We don't hire people into the investment team laterally from another hedge fund. We hire generally people who maybe they graduated from Columbia Business School, they went to work for Goldman Sachs for a couple years, and then they spent two or three years in private equity, or they went straight to private equity out of business school or out of college, actually. We have many students, people here that were at Wharton, for example, but they very early on showed a real interest in business and investing, something they really want to do. They were passionate about it. They learned about Buffett when they were 16. Ryan Israel's our CIO. He was probably reading the Berkshire annual reports at 12 or something like that. So there's a passion for this business. I think they already come with that. We like private equity as a training ground because private equity investors are forced to think about valuation the way that we do. What's the entire business worth? And they also think about, and typically are involved in decisions about management and compensation and governance, which are key things for this strategy. The other thing that's critically important here, I'm an extremely straightforward person. I have been that way my whole life. The ethos of this firm is the same way. It doesn't matter if you're 25 years old and your first day at Pershing Square. If you think I'm wrong about something, you tell me I'm wrong. One of the great ways to advance yourself in terms of perception among the team here is you find out something we're doing where we're making a mistake or we're thinking about something wrong. So we have this very comfortable dynamic. And one of the things we screen for as part of our process for recruiting people. We give people a couple of tests when they kind of make their way through the process. One is give them a stock and we say, okay, go do the work, come back in a week, pitch it to the team, and there they can rely on whatever resources they want. And they come back and then they sit across from eight people. We're asking them questions, they have to answer them and we see how they do. And they have to be strong enough to have conviction in their work. They have to be humble enough to recognize when they might have missed something in the wrong. And investing. If you want to be a great investor, you have to be confident. You have to be confident on the basis of the homework you've done. And the only reason why you have to be confident is the best investments in the world are generally the ones where everyone else thinks you're wrong. The best equity investment we ever made, we bought 25% of general growth stocks during the financial crisis and they had $27 billion worth of debt and the stock was down 99.5% and the company was going bankrupt. They weren't like, you guys are stupid. And we were filing a 13e every three days buying stock that was 100x from our initial share because it's the most contrarian thing you can do. But you have to have a lot of confidence that you're right when the whole world is making fun of you or writing negative articles about you. At the same time, you have to be humble enough to recognize that, whoops, there's a new fact that I didn't contemplate that's just occurred. Whether it's regulatory change or some kind of event, or you learn something new that causes you to question the character or honesty of management, et cetera, and where you're prepared to reverse your view. And that can be harder if you're a high profile investment firm and everything you do is super public and scrutinized by the press and changing your mind, when you've been out there in your letters or otherwise, talking about why XYZ is a great company can be A harder thing to do. So you have to be intellectually nimble enough to realize when you're wrong. So it's this combination of confidence and humbleness. And you need to have both. Because if you're just humble, you'll never pull the trigger. If you're confident, you're going to go off the cliff. We try to find people who've got a good measure of both, and they learn that at the firm. So it's character, transparency, openness, and an ability to articulate your point of view. Ryan, who's our cio, was one of the top few people in the country in high school in debate. It's helpful to have those kind of skills.
- [51:14]
B
So we're getting to the end of this interview, Bill, and we always close it with two questions. Let me ask mine and then Michael
- [51:21]
C
will follow with his.
- [51:22]
B
Mine is what worries Bill Ackman, what keeps him at night with excitement. What is that thing that you think we should immediately address and what thing that makes you very excited, that that's a great prospect.
- [51:34]
C
What worries me is a very tragic event that took place and what it represents in only the last couple of weeks. One of the big tragedies of our country and other countries is that great politicians, a long history of assassinations. That's tragic. But Charlie Kirk was someone that I knew who basically went on 200 campuses a year, open mic and debated topics. Religion, marriage, family, Christianity, Israel, war in Israel, Gaza, et cetera. He was killed, was assassinated, basically. And that's crossing a red line. And then we see these shootings of these ICE employees. I would describe them as politically motivated assassination. Killing someone for speech related reasons, I think is a very dangerous thing. And I worry a lot about that for the country and what it means. Does this discourage speech? Free speech is really important. One of the most important things we need in order to preserve our democracy. And we don't want a world in which people are afraid to share their views. Because I think that's a very dangerous world.
- [52:39]
B
The only thing that we have in our societies is the conversation. And you never have to lose faith in that conversation. Right in the process, we'll do things together. We may not agree on everything, but we'll do things together. And I think the moment that breakdown occurs, Bill, we're in real trouble.
- [52:57]
C
We're in some trouble because this was my whole advocacy, frankly. On college campuses, on the Columbia campus, on the Harvard campus, There wasn't overt censorship, but there was a massive amount of self censorship where members of the faculty, students were not comfortable sharing their views on a topic because of fear of cancellation, fear of not getting the grade on the exam, fear not getting their PhD because their views are not consistent with views of history department, et cetera. I think that's very negative for education and I think we're not going to get to the truth listening to just one side of it. What makes me inspired one I love my job. It's one of the great jobs and I work with a really super interesting team. We do fun stuff every day. I'm an optimist. I think there's a path, hopefully soon. The events in the Middle east over the last year set up for peace in the Middle east, but only if we can get this war done in Gaza. We get rid of the terrorists. The vast majority of countries in the Middle east are focused on prosperity for their people. And wouldn't that be a wonderful thing if we have fewer wars? I'd like to see the war in Ukraine over. I think we're getting closer to the end of these two major wars and I think that's a setup. This has not been a great war for Vladimir Putin. I don't think Russia has really achieved anything for the country economically, politically. And if the cost of war for Hamas has been very significant, normally those kind of incentives discourage kind of future wars. So that's my optimistic coping.
- [54:26]
A
My final question is there's anything you're reading or listening to these days? Are there book or books that you would recommend to our listeners?
- [54:34]
C
Two things I would say. I spend a lot of time on X these days and not just posting. That's actually a relatively small amount of my time. It's a really, really good way to learn about anything that you're interested in because there are a lot of super smart people who know a lot about whether it's health issues you're interested in or fitness issues you're interested in, or politics or investing or the macro economy. There's the car dealership guy if you want to find out everything that's going on with car dealerships or the people who are talking about what's going on with the housing market. And I find it an amazing research tool for our business. It's an amazing tool. Depends on who you follow. Obviously if you're disciplined, you don't just follow people who agree with you, you follow people who disagree with you. And I think that is a very powerful thing to do in terms of getting to the truth. On the book side, there's one book I read maybe a few months ago for this crowd, I think would be useful. It's a book called the Financial History of Berkshire Hathaway. I think it's Adam west, who's the author. It's only for geeks who are really into that stuff, but it really takes you through quarter by quarter every financial thing that Berkshire did over time, every acquisition, et cetera. And you learn a lot following what Buffett did right, what Buffett did wrong. I encourage you to read that one. And then there's a book I'm in the middle of now. It's called the Compounders, and it's about small companies that became large companies by looking at these stories, perhaps helps you identify other ones. With that I need to run because I'm 20 minutes late from my previous thing. But I really enjoyed my time with you guys and thank you so much. Thank you for being teachers and faculty. I'm a great beneficiary of some great teachers years ago. The amount of impact you have is enormous as your students go on to do great things. So thank you for that.
- [56:14]
A
Bill, thanks for joining the Value Investing with Legend podcast. And to all of you, thank you for tuning in. We'll see you in our next episode.
- [56:21]
C
Thanks, guys.
- [56:22]
B
Thank you so much.
- [56:23]
C
Bill, thank you for listening to this episode of the Value and Value Investing with Legends podcast. To subscribe to the show or learn
- [56:31]
A
more about the Halbrun center for Graham and Dodd Investing at Columbia Business School, please visit grahamanddodd.
- [56:37]
C
Com. Thank.
- [56:47]
A
You.