Interactive Investor

Bill Ackman: an industry as certain as food and oxygen

12th November 2021 10:32

by Lee Wild from interactive investor

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Pershing Square boss Bill Ackman explains why he’s just bet big on a single company, why it’s a certainty like food and oxygen, and the stock he sold to pay for it.

Lee Wild, head of equity strategy, interactive investor: Hello, with me today I have star investor Bill Ackman, CEO of FTSE 100 company Pershing Square Holdings (LSE:PSH). Hi, Bill, thanks for joining me today.       

Bill Ackman, founder and chief executive Pershing Square Holdings: Good to see you.

Lee Wild: Now, Pershing Square Holdings has just taken a 10% stake in Universal Music Group (EURONEXT:UMG), the music rights owner, as part of its spin out from Vivendi. You’re betting big on a single company, what makes you so confident you’ll make a profit on this investment?

Bill Ackman: Sure. Just for clarification, Pershing Square Holdings owns about, perhaps, 7.5% of UMG, the other funds that we manage own the balance, we’ve raised a co-investment vehicle. But, yes, it’s a large investment and we size investments based on our perception of both risk, what’s the probability that we’d lose money, and what’s the opportunity for gain. And in this case we think, at the price paid, the probability of a loss for us is about as low as we can calculate. And then on the upside case, you know, we thought there was a huge opportunity versus even everything else we own. So it had the most upside and the least downside, again, at the price paid, and that made for a really attractive investment.

And what drove the nature of this investment, what makes it so appealing is really the changes that have taken place in the music industry over the last couple of decades. But what you had is a business that was a pretty good business in the 90s that became a terrible business as music piracy, theft basically, killed the business.

Apple (NASDAQ:AAPL) began a recovery with, you know, I guess, the iPod and then the iPhone and the beginning of music, you know, digitisation of music that people would pay for, but that was not a great recurring business. It’s really Spotify (NYSE:SPOT) that saved the industry, working with Universal initially to build out a consumer offering that was appealing. And it was so appealing that rather than steal music, people signed up and paid the relatively modest, you know, few dollars a month, $5, $6 a month for a family plan today. You know, globally, that numbers in the low single digits in some of the emerging markets, to sign up for a streaming account.

And it’s really music streaming over the last decade, and the lines crossed in 2015 when the declines from the physical sales and downloads were replaced by revenue from streaming. And when those lines crossed, all of a sudden, it became a growth business as the streaming business became a substantial percentage of the revenues and it grew much more quickly. And what you had was a kind of hits-driven business where people wouldn’t go and buy a physical – you know, think of a CD, think of the logistics involved in delivering, you know, manufacturing, the capital intensity of that, the physical delivery, dealing with the inventories, dealing with the returns, trying to get it right. Versus the business of, you know, just getting participation in the monthly subscription revenues of the distributors like Spotify. And going from Spotify, you know, when you had only really DSP to now Apple Music, YouTube Music, Amazon Music, a couple of hundred other streaming services.

So, you know, if you look at this business, as we often do, using kind of a strategy analysis – I’ll steal from Michael Porter. You know, I think the company’s really uniquely positioned and in music, Universal owns the rights, in effect, on a third of global music and that’s a very, very strong and dominant position for the company. And they’ve earned that by virtue of really being the best place to go if you’re an artist and you want to become a superstar. You want to partner with Universal and they’ve got the best management, they’ve got the most market share and they’re taking share. So it’s the best business in an amazing industry and the way to think about the business today is it’s really just owning a royalty on people listening to music.

And I think, of all the assets in the world, you know, music is one, as I’ve said before, other than food and, you know, let’s say, oxygen, it’s a certainty people are going to consume music over the next thousand years. They consumed a lot of it over the previous thousand years, they’re going to consume even more because it’s cheaper, it’s easier to get access to it, it’s become more important. I can go on and on, but look at what’s going on in social media. I mean TikTok built a business worth reportedly $100+ billion dollars selling these little music videos. And up till very recently, you know, earlier this year, they were paying nothing for those music rights.

And now Universal is beginning to receive revenues from the TikToks of the worl­d and all the other social media applications where they realised if you add music, people spend more time and time is, you know, what advertisers pay for. A lot of controversy with Facebook, you know, where anger drives people’s attention on social media, but the other thing that drives people’s attention, if you add music to an application; an exercise app, even to Facebook. And so it’s a very high quality, great business and we’ve bought it at a very attractive price.

Lee Wild:  Well, my next question was going to be what is it about Universal that fits into your portfolio? Now, you’ve given us a lot on Universal there, but what jumps out is its dominant market position. Are there characteristics that you adopt on stock acquisition across your portfolio that Universal, you know, ticks all tho­se boxes?

Bill Ackman: It literally ticks all the boxes, you know. When we describe what we’re trying to do, we try to find simple, predictable, free cash flow, generative business. This is precisely that. We like business that earn very high returns on capital, this is precisely that. We like businesses with strong, dominant market positions with strong balance sheets. The company has about €1 billion of net leverage and that’s really zero leverage when you net out the market value of a Spotify stake.

So it’s a conservatively financed, super high-quality, high return on capital, predictable, fast-growing, durable-growth company. And we were able to buy it at an attractive price and so that’s the reason we kind of put the chips, a big chunk of the chips on the table in this one. And we think it’s something we can own for a decade or more, they don’t come around that often and when you find them, you’ve got to bet big.

Lee Wild: Other than Universal, has the Pershing Square portfolio changed much in the past six months? What stocks have you been buying and selling and why?

Bill Ackman: Sure, we sold Agilent (NYSE:A), which is an amazing business, we more than doubled our money in a couple-of-year period of time. And we did even better, of course, because we bought a lot more of that position during the pandemic last year. It’s a really well-run company that fits a lot of the attributes we’ve talked about. The only negative is the market kind of revalued it to a price where we still think it’s going to be an attractive, kind of low double-digit return for a stock market investor. But we needed capital to make our commitment to Universal. So we sort of regretfully sold Agilent, but it’s an amazing company and we wish the management team well.

But it was a, only because of scarce resources. You know, at the price paid, Universal’s a better business, at half of Agilent’s price, you know, obviously wouldn’t sell it there. But we’re always open to selling even a long-standing holding if it reaches a price where it’s hard for us to earn the kind of returns we like to earn for our shareholders, and where we’ve found a better use of the money. And that’s what happened here. But other than Agilent, we really haven’t done anything new in the, kind of, positions.

Lee Wild: Well, because of the Universal deal, do you now sort of think, well, you know, well done everyone, we’ll sit back for a bit. It’s a great trade, a great investment, we won’t be doing anything for a while now, or are you always on the look out and if another Universal or another big opportunity came along, would you then think, “Well, yeah, let’s look at how we can finance this, if we have to sell something.” You’re always on the lookout, are you?

Bill Ackman For sure. You know, I stepped out of an investment team meeting where we’re looking seriously at a new idea to take, to do this video with you. So absolutely, we don’t rest on our laurels, so to speak. The other thing I’ll point out actually which is significant is we just did a bond financing and, you know, we raised €500 million of debt at a 1.4% interest rate, fixed for six years, unsecured, you know, no mark to market covenants. And $700 million of US dollar bonds at a, you know, just call it 3.25% yield, a 10-year instrument. Let’s call it a billion three of incremental cash we raised. And then we tendered for our public debt and we were only able to buy back about a third of it.

So we actually have a decent amount of free capital to put to work, which we would love to put to work on a new idea. And one of the things I think is not appreciated about Pershing Square Holdings, if I could dirge for a second, is, you know, one of the questions is why do we issue this long-term debt, why don’t we use margin debt? So number one, we will never use margin debt because it’s, you know, if the market crashes, you can be wiped out and be forced to sell at precisely the wrong time. And the fact that we are, our closed-end fund, we own the highest quality businesses in the world, allows us to borrow money at extremely attractive rates, certainly in our view.

Blended costs of the capital was something in the twos and we can deploy the capital and earn, you know, we’re looking to earn well north of a 20% return. About 20% of our capital today is represented by that debt, by 20% of our total assets. The balance, 80%, is represented by the shares that our shareholders own. When you look at the fact that we charge a management fee and an incentive fee, people obviously view that as a negative because that’s a drag on returns versus owning the underlying portfolio directly. But the fact that we’ve replaced 20% of our equity with very, very low-cost debt basically makes up for the fees that we charge. And so interestingly, if you look at the gross returns of our private funds and you compare them with the net returns of PSH, they’re basically about the same.

And so you can effectively invest in Pershing Square Holdings and earn the underlying return on the assets without paying the fees economically because of our ability to issue very, very low-cost debt. And so that transaction which we just did, at the tightest spreads at which we’ve ever issued debt – and we issued our original bonds, call it seven years ago, they were issued, or six years ago, they were issued at something in the 350 basis points spread. We just issued debt at 160, 170 basis points spread and so that is a very significant event I think was ignored by the market.

We can now take that capital and go invest in something and earn a much, much higher return and that of course will help create intrinsic value or growth in our NAV. And so, you know, fast forward, over time, we make a great new investment, it increases NAV by a nice amount, that frees up – that reduces our leverage, allows us to issue, you know, long-dated debt at an attractive price and it continues. And we’ll always keep that leverage quite low so we don’t think it meaningfully affects the risk of Pershing Square Holdings. And so it’s a really attractive development that I don't think anyone’s focussed on or thought about.

Lee Wild: Great. Bill Ackman, CEO of Pershing Squ­are­ Holdings, thank you very much for joining me today.

Bill Ackman: Sure, thank you, Lee, appreciate it.                                                                                                                                                               

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