Bill Ackman: sell your shares when this happens

Everything Bill Ackman does is big, and he doesn’t like to make mistakes. Here’s when the Pershing Square Holdings (LSE:PSH) manager knows when it’s time to quit a position.

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Lee Wild, head of equity strategy at interactive investor: Hello. With me today, I have star investor Bill Ackman, CEO of FTSE 100 company, Pershing Square Holdings. Hi, Bill. Thanks for joining me today. Great to talk again.

Bill Ackman, founder and CEO of Pershing Square Holdings: Sure. Good to see you.

Lee Wild: Focusing on companies and I reflect back to you mentioned earlier the decision to exit the Netflix Inc (NASDAQ:NFLX) investment, which was I think seen broadly as a brave decision and ultimately the right one for you. Making big calls like that was, I think, also a great example for retail investors so, I mean, for them, what are your three red flags, or red flags that mean you should sell a company even if it's at a loss?

Bill Ackman: Sure. So, number one, Netflix is a great business. Reed Hastings and the management team have built a remarkable company and its brought delight to consumers and people all over the world. Almost everyone has a Netflix subscription, but that's part of the problem.

In order for the business to be a valuable business over time, they have to continue to grow at a pretty rapid rate, at least now, and what intrigued us initially was when the stock went from 700 to the high 300s, if the long-term growth rates within the relevant range of where they had been historically, that was a very undervalued stock. And our thesis based on the due diligence we had done and what management had stated is that the miss in subscriber growth in the quarter was more sort of Covid-related, difficult to predict, and not due to kind of reaching the headroom of potential growth.

And I think that you should sell an investment when you learn new information which is inconsistent with the original thesis, and the new information we learnt was that the number of non-paying subscribers, so-called password sharing subscribers was much, much higher than we thought. And to get someone from being a free Netflix customer to being a paying customer when they've been enjoying the service [for] free can be quite challenging.

And when you add the kind of existing base of subscribers to the subscribers that had a free ride, if you will, you're kind of hitting up, you know, closer to the number of smart TVs today in the world. And so, that ability to grow, the miss in the quarter and the miss in the second quarter, may not be or [is] probably not Covid-related, in fact, but rather because you're getting closer to the ultimate limits of growth, at least based on existing smartphone or even smart TV penetration, so that was a real concern.

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The second thing that was kind of inconsistent with the original thesis is that Reed Hastings hated advertising and never wanted advertising on Netflix, and they kind of acknowledged, well, in order to make the maths work, and make the business model work, we're going to have to go to an ad-supported tier in our pricing, and that's something they have no experience with. And our business is finding companies where we can predict with a very, very high degree of confidence what a business looks like over a very long period of time. And the only way to value a company, in our mind, is not just pick a multiple of next year's earnings, and that's maybe a trading way to think about the value of business, it's an interesting heuristic, but the right way to think about a business is find a business where you can predict the high degree of confidence what the cash flows will be over many, many years and build them up.

We lost the ability to build a model with Netflix because the dispersion of potential outcomes, if ad-supported streaming is successful, or it's not, or what if the growth rate is slower than we expected, or it's not, you know, the risk profile changed, and the predictability had changed, so we sold.

So, I guess the advice to a retail investor would be, if you bought Tesla Inc (NASDAQ:TSLA) because you loved the cars, you thought you were paying a fair price for the stock, and you thought it was going to grow on some kind of basis, and then another, you know, Lucid Group Inc Shs (NASDAQ:LCID) or someone else or BMW (XETRA:BMW) comes out with a car that's much better than Tesla, and you expect all of a sudden Tesla not to have its monopolistic share of the business, you know, you should sell.

So, if you have a thesis going in and then new facts emerge that are inconsistent with the thesis, generally, if you keep twisting the thesis to come up with a reason for owning the stock, it's going to be a problem. And it didn't take much courage for us to sell. We sold because it was the economically rational thing to do, and for me, courage is not required. You know, we're very visible, you know, everything we do is big, and so a mistake, the numbers would be large. And so, you know, we're kind of used to that, and we don't like making mistakes. We don't make that many, but if we make one, you're going to read about it in the newspaper, and it's going to sound really big. And so Netflix was a, you know, $400 million is a lot of money to lose around the Pershing Square funds, whatever the exact number was, or 400 basis points of profit. But, this is a high-return strategy and we can afford to lose 400 basis points, we'll be fine.

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

Bill Ackman:Thank you very much, Lee.