15. Warren Buffett, 1991 Berkshire Hathaway annual letter, February 28, 1992.
16. Quoted in New York Times, “Company News; Berkshire Hathaway Set to Acquire Dexter Shoe,” October 1, 1993.
17. Warren Buffett, 1993 Berkshire Hathaway annual letter, March 1, 1994.
18. Alice Schroeder, The Snowball (New York: Bantam, 2009).
19. Tren Griffin, Charlie Munger: The Complete Investor (New York: Columbia University Press, 2015).
20. Dale Griffin and Amos Tversky, “The Weighing of Evidence and the Determinants of Confidence,” Cognitive Psychology 24 (1992): 411–435.
21. Anthony Bianco, “The Warren Buffett You Don't Know,” Bloomberg.com, July 5, 1999.
22. Warren Buffett, 1999 Berkshire Hathaway annual letter, March 1, 2000.
23. Warren Buffett, 2000 Berkshire Hathaway annual letter, February 28, 2001.
24. Warren Buffett, 2014 Berkshire Hathaway annual letter, February 25, 2015.
CHAPTER 9
Bill Ackman
Get Of Your Soapbox
Our satisfaction with our views of the world is part of our self esteem and personal identity.
—Robert Shiller
I once saw the Nobel Prize–winning psychologist Daniel Kahneman say, “Ideas are part of who we are. They become like possessions. Especially publicly. I mean, flip flopping is a bad word. I love changing my mind!” This attitude stands in stark contrast to most investors, who loathe to do few things more than kill a previously held belief. Our inability to process information that challenges our ego is one of the biggest reasons why so many investors fail to capture market returns.
The world is always changing, but our views usually don't evolve alongside it. Even when we're presented with evidence that disconfirms our previous views, straying far from our original feelings is too painful for most to bear. This is so deeply ingrained in the fabric of our DNA that there is a name for this natural mental malfunction; it's called cognitive dissonance. For example, ask anybody if they have the ability to predict the future. They might look at you funny, and say, “Are you asking me if I have a crystal ball? No, I do not.” Okay then, do you select individual stocks. And do you regularly buy and sell them, in anticipation that their future price will be higher or lower? These people are paying lip service to the idea that they can't predict the future, because their actions contradict their words.
Investors actively seek out and consume information that makes them feel better about their current opinions. But this type of behavior is not limited to the Average Joe investor. In fact, the more experience you have, the more confident you become, and the less likely you are to accept you're wrong, even when a 50% decline says otherwise.
Human beings are social creatures that love to tell stories, and few things are more conducive to storytelling than investing. The stock market provides us with thousands of different companies to invest in. There are publicly traded businesses that are in oil service fields, grocery stores, transportation, artificial intelligence, pharmaceuticals, leisure, retail, equipment builders, and everything in‐between. And the prices are changing every day, providing literally endless material for fodder.
A Fidelity study showed that in social settings, people prefer to share their success rather than their failure. Fifty‐nine percent shared their profitable trades with friends and family; only 52% shared their failures.1 People love sharing their battles on the financial gridiron so much that at one point in 1998, there were 400,000 Americans participating in an investment club. These people would come together occasionally and talk about the stock they bought that doubled since the last meeting, the tiny biotech company that got approval on a new drug, or the technology company that just beat earnings. But the number of people getting together to talk shop has shrunk every year since then, and was less than one‐tenth the size by 2012.2
The stock market might take the blame for why people no longer meet to discuss their favorite companies. Two 50% declines will crush even the most enthusiastic storytellers. But perhaps there is another reason why people are no longer participating; it's really hard to become a better investor by getting ideas from others. Worse, once you share ideas of your own, hopping off as the story turns south will stifle even the most open‐minded, egoless people out there.
Most of the gains in the stock market come from the giant winners. In fact, most stocks downright stink. Four out of every seven common stocks in the United States have underperformed one‐month Treasury bills. And because there are so many lousy stocks, there's a high probability that over time, you will be exposed as an ordinary person, possessing no superior stock‐picking ability than the person sitting next to you. And being wrong again and again and again is mentally exhausting, especially when it comes to something as personal as money. Investors would be a lot better off financially if they would just keep their personal finances personal. We can learn a lot from somebody who takes the exact opposite approach, who is one of the most vocal and public investors of all time.
Bill Ackman started in the hedge fund world in 1993 at just 26 years old. He and a Harvard Business School classmate, David Berkowitz, with $3 million in capital provided from several investors, started Gotham Partners. They found success early on with classic, old‐school value investing. They bought companies for less than they estimated them to be worth, and this helped them turn $3 million into $568 million at their peak in 2000. But they got into trouble, like so many successful investors do, by straying from where their bread was buttered. Ackman's confidence led him to take positions that were unwise, by any objective measure, and he was left holding a roster of unpopular companies that were not in demand. The New York Times explained it this way: “An examination of Gotham's activities in recent years shows a series of ill‐timed bets, a surprising lack of diversification and a dangerous concentration in illiquid investments that could not easily be sold when investors wanted their money back.”3 So by the end of 2002, they announced their intention to wind down the fund. It was not so much a decision they made, but rather an outcome that was forced on them when investors started asking for their money back in droves.
Bill Ackman wasn't going to let one blown‐up hedge fund slow him down. He is one of the most competitive investors the industry has ever seen. Even as a high school student, he was always looking for a challenge. He once bet his father $2,000 that he would get a perfect score on the SAT verbal test. Just before taking the test, his father, convinced his son's goal was impossible, withdrew from the agreement, saving Ackman from a $2,000 loss. He got 780 on the verbal section, “One wrong on the verbal, three wrong on the math,” he muses. “I'm still convinced some of the questions were wrong.”4
After closing Gotham, Ackman eventually got back on the horse. In January 2004, he started a new fund, Pershing Square Capital Management. He began with $10 million of his own money and $50 million raised from a single investor, and would open the fund to outside investors in 2005. The money flooded in, attracting some $220 million.5
The new Ackman would no longer invest passively. Gone were the days of buying a company at a discount, and letting the chips fall where they may. Bill Ackman rose from the ashes of Gotham Partners like a phoenix and came out one of the most aggressive activist investors of his era. An activist investor is one who acquires a large enough shares in a company to enact changes. They'll try to persuade management to be more shareholder friendly, which is code for increase the stock price. If they're not successful, they can push for a seat on the board and enact changes from the inside.
Activist investors are a confident bunch. It's one thing to purchase shares in a company, it's another thing entirely to impose your will on a management team and tell them how to run their business. The stakes are high in this arena and when successful, the payoff can be enormous. For example, Ackman took a 10% stake in Wendy's, one of his first targets at Pershing, and they agreed to spin off Tim Hortons.6 From April 2005 to March 2006, Wendy's stock appreciated by 5
5%.7
In 2005, Ackman targeted McDonald's, proposing they spin‐off their low‐margin business. He bought 62 million shares and options that, if exercised, would value his stake at $2 billion, one of the largest ever for a hedge fund up until that time.8 McDonald's had other ideas, saying, “The proposal is an exercise in financial engineering and does not take into account McDonald's unique business model.” Ackman said, “Our intention is to change their intention.” Ackman is not one to take no for an answer. “I'm the most persistent person you will ever meet.”9
Other companies that landed in Ackman's crosshairs were MBIA Inc., Target, Sears, Valeant, and J. C. Penney. But perhaps no investor and no company will ever be more joined at the hip than his bet against Herbalife. If you Google “Bill Ackman Herbalife,” you get 180,000 results. Ackman's storied battle with the multilevel marketing company has been in the New York Times and the Wall Street Journal dozens of times, it's been written about in Fortune, the New Yorker, and Vanity Fair.
Joe Nocera wrote about Ackman's long and drawn out battle with MBIA Inc. in the New York Times:
But for sheer, obsessive doggedness, nothing he has ever done can compare with his pursuit of a company called MBIA Inc. In fact, I don't think I've ever seen a fund manager grab a company by the tail and simply not let go the way Mr. Ackman has done with this once‐obscure holding company, whose main subsidiary, MBIA Insurance, is the nation's largest bond insurer.10
After seven years, Ackman would ultimately be vindicated, and he walked away with $1.4 billion in profits.11 But his battle with MBIA was a warm‐up for the war he would have with Herbalife.
By definition, activist investors are public, because once you acquire 5% of a company, you must file a 13D registration with the Security and Exchange Commission. Short positions, however, do not have to be disclosed, but Ackman chooses to do so anyway, like nobody has ever done before.
Herbalife is a Los Angeles–based company that sells weight loss products and nutritional supplements. Herbalife has been in business for 37 years, and now operates in 90 countries. In its first year, 1980, Herbalife did $23,000 in sales. That grew to $500 million by 1984 and to $1 billion by 1996. In the year before Ackman shorted the company, they did $5.4 billion in sales and had the highest paid CEO in America.
On December 20, 2012, 500 people gathered to watch him deliver his short presentation, “Who Wants to Be a Millionaire?” Ackman accused Herbalife of being a pyramid scheme, and said he would donate any profits made, “blood money” as he called it, to charity.12
Ackman's presentation noted that Herbalife was worth more than Energizer Holdings, The Clorox Company, and Church and Dwight. These consumer companies own Arm & Hammer Baking Soda, Trojan condoms, Energizer batteries, Edge shaving gel, Clorox Wipes, and others that you find in homes all across the United States. Ackman asked the poignant question, “Has anyone ever purchased an Herbalife product?”
A key distinction between these companies was their gross margins, meaning their profits once you remove the cost of goods sold. The three traditional companies made between 42% and 46% on their products. Herbalife was running north of 80%.
Ackman showed another slide showing Herbalife's top‐selling product, Formula 1, and describes it as “a $2 billion brand nobody's ever heard of.”13 He shows a picture of this Formula 1, an Herbalife shake, and compares it with others: Oreos, Charmin, Crest, Gerber, Palmolive, Betty Crocker, Listerine, and Clorox. Formula 1 is a shake, but unlike competitive products made by GNC, Unilever, and Abbot Labs, it's a powder. Formula 1 doesn't even offer a ready‐to‐drink shake.
Herbalife sells 10 to 20 times as much powder as the competition, but it does so without a store. This is at the heart of Ackman's argument. Herbalife, he contends, is a pyramid scheme. Herbalife isn't selling its products to consumers, it's selling its products to distributors, who sell it, or don't, to consumers. “When you do the math, you find out your average club, these are the ten we went to in Queens, loses $12,000 a year.” He then shares a video from one of the distributors, “Where your money's made is not serving smoothies. Where your money's made is having hundreds, or tens, or thousands of distributors around the globe who are working.”
Ackman then asks, “How is it possible that Herbalife sells six times more nutrition powder than Abbot Labs, Unilever, and GNC combined? Perhaps it is cheaper…?”
Nope, it's 65% more expensive (per 200 calories of serving) than the next most expensive product. All right, you get the point. But this goes on for hours and hundreds of slides.14 He gets into the science of products, the patents, the R&D, he's read the annual reports and the SEC filings. He clearly has done his homework. No stone is left unturned. No cutlet is left uncooked, as Winston Churchill once said.
His three‐hour presentation, which included 334 slides, was the latest in his years‐long war with Herbalife. In 2012, he went on CNBC and said:
You've had millions of low‐income people around the world who've gotten their hopes up that there's an opportunity for them to become millionaires or hundred‐thousand‐aires or some number like that, and they've been duped. We simply want the truth to come out. If distributors knew the probability of making $95,000 a year – which is the millionaire team, as they call it—was a fraction of 1 percent, no one would ever sign up for this. And we simply exposed that fact. The company has done their best to try to keep that from the general public.15
He later would tell Bloomberg “This is the highest conviction I've ever had about any investment I've ever made.”16 Years later, he was still waging his war. In an interview with CNN, he repeatedly called the company a pyramid scheme.17
In those moments, Bill Ackman put himself in an almost impossible position. How could he ever admit defeat after telling everybody who would listen that this was a pyramid scheme that would go to zero? If he missed the mark on this, who would ever give him money again?
In the three days following his presentation, the stock had fallen 35%. The sell‐off provided an opportunity for one of his biggest competitors to step in.
On January 9, Dan Loeb, founder of the hedge fund Third Point LLC, filed with the SEC, announcing that he had acquired 8.9 million Herbalife shares, or 8.24% of the stock, which made him the company's second largest shareholder. Loeb wrote a letter to his investors saying that the majority of his stake was purchased “during the panicked selling that followed the short seller's dramatic claims.”18 In the five days since Loeb's filing, Herbalife's stock rose 20%. Then a week later, the Wall Street Journal reported that billionaire activist investor Carl Icahn took a stake in Herbalife, and a month later, disclosures showed he owned 12.98% of the company.
Carl Icahn and Dan Loeb against Bill Ackman – a face‐off raging all because Ackman got on his soapbox. It's impossible to know for sure whether Loeb and Icahn actually thought Herbalife was a good business and its stock was undervalued. In fact, that part was sort of irrelevant. What mattered was that Bill Ackman, by publicly acknowledging that he would go to the end of the world with this thing, just put a big, fat bull's‐eye on his back. Just the idea that Ackman could be squeezed was enough to send the stock higher. A short squeeze is when a stock that someone has borrowed through a short sale, is forced to cover as the price rises dramatically against them. This is one of the dangerous things about shorting a stock; technically the upside is unlimited.
Herbalife hit a low of $24.24 in a few days after Ackman's first presentation and hasn't been below there since. It has gained 5% in a day 50 different times since 2012, and at $71.70, shares are currently 70% higher than where they were when he first shorted the stock.
The key to successful investing, especially when you're a contrarian, is to have people agree with you later. But when you're so public about your investments, whether you're running a hedge fund or your own brokerage account, it makes it so much harder. Dealing with your own emotions is challenging enough. Dealing with the emotions and pressure of others is even harder.
Whe
n we are verbal about our investments, we lose track of why we're investing in the first place, which is to make money. Outside pressures come in to play. Ackman didn't need the money. If his investors were the only ones who knew about his position, he could easily have said we're wrong, covered his position, and moved on. But apparently he would rather preserve his reputation than his investor's capital.
Having big public scores is incredibly profitable. Beyond just the gains you harvest for your existing client base, nothing attracts money in the hedge fund world like success. And nobody played up their successes better than Bill Ackman.
Bill Ackman once said, “If I think I'm right, I can be the most persistent and most relentless person in America.”19 During a presentation, Ackman shares a slide that said, “Why are pyramid schemes illegal? Pyramid schemes are said to be inherently fraudulent because they must eventually collapse.”20 Well maybe Herbalife is a pyramid scheme, and maybe it does eventually collapse, but will Ackman still be short if it does? Aside from the mental and emotional costs of watching a stock you short go against you, there is an actual financial cost to borrow the shares. You would think that at some point, regardless of how compelling the case against Herbalife is, his investors will scream uncle.
On July 25, 2016, the Federal Trade Commission charged Herbalife with four counts of unfair, false, and deceptive business practice. Herbalife paid $200 million to settle the complaint and said it would “fundamentally restructure its business.” Herbalife's CEO described the settlement as “an acknowledgment that our business model is sound.”21 A year later, shares are up 11%.
During a Netflix documentary, Betting On Zero, Jon Silvan, a public relations strategist says, “Four hours later we get done with it, great presentation, and some genius in the audience looks at the stock and it's gone up. What's our response?” Ackman says, “It's irrelevant. It's not going up though.” He argues this point, refusing to acknowledge that his short strategy was failing.22 The stock was up 25% that day. Three years later, he's still short.
Big Mistakes Page 9