When Warren Buffett started buying shares of Berkshire Hathaway (BRK.A -0.21%) (BRK.B -0.27%) in 1962, it was a failing textile business. The appeal for Buffett wasn't Berkshire's business -- it was that its book value far exceeded its stock price.
Although he planned to sell the shares in 1964, a disagreement with management led him to angrily buy up more shares of the stock and take over the struggling company in 1965. During the next 60 years, Buffett turned Berkshire Hathaway into one of the most valuable companies in the world, exceeding a valuation of $1 trillion.
Today, investors may have an opportunity to follow another famous investor into a company trading below the value of its assets. Bill Ackman's Pershing Square investment fund has struck a deal with Howard Hughes Holdings (HHH -3.59%) to acquire a significant stake in the business and make Ackman its executive chairman. Ackman plans to use the business's cash flows to turn it into a diversified holding company, a la Berkshire Hathaway.
Should investors follow Ackman into Howard Hughes?
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What exactly is Ackman buying?
Howard Hughes Holdings is a real estate company that specializes in master-planned communities. It buys big plots of land, parcels them out to developers, and builds commercial properties and multifamily units around the developments. The business has benefited from the tailwind of rising land prices, but that's been more than offset by pressure on commercial office valuations and rising interest rates.
As of the end of September, management estimated its net asset value at $5.85 billion against a market value of $4.1 billion. Ackman's investment of $900 million dilutes the existing shares a bit, but adds that cash to the company's balance sheet. Ackman's price of $100 per share is still a premium to the current stock price, but a discount relative to management's estimate of its net asset value.
What Ackman gets in exchange is an increase in Pershing Square's stake in the company to 46.9%, and a 40% share of the voting power. He takes over as executive chairman, a position he stepped down from last May, and Pershing Square's chief investment officer will be in charge of managing Howard Hughes' investment portfolio. Pershing Square will also receive a quarterly fee of $3.75 million, plus 0.375% of the increase in the company's market cap in excess of inflation.
Importantly, Ackman gets a platform to start building a publicly traded holding company. He said one of the first steps it will take is to acquire or build an insurance business, which provides access to investable capital thanks to float, or the money an insurer collects in premiums before paying out policy claims. It's the foundation of Berkshire Hathaway, and it could be the foundation of Ackman's Howard Hughes.
Is this really the next Berkshire Hathaway?
Ackman is widely respected as an investor. He's often seen as an activist investor, using his influence to press for change in businesses and unlock shareholder value. However, he's also been more than happy to buy a great company when its stock has been unduly beaten down and just wait for the price to return to its fair value. That latter approach is very Buffett-like.
He's also comfortable using leverage to increase equity exposure. Berkshire Hathaway has access to low-cost leverage because it operates an insurance business. It's historically used the float to invest, expecting the underwriting business to perform profitably in most years. If Ackman develops an insurance business within Howard Hughes, he could similarly access capital through its float on top of the cash flow generated by the real estate business.
Going against the new Howard Hughes is the significant fee Pershing Square will collect to manage the investment portfolio. Buffett didn't take a fee when he took over Berkshire, and he kept his salary relatively low throughout his career. His compensation was the increase in value of his share of the company.
The real question for investors is whether Ackman can manage to be nearly as successful as Buffett if he follows the same playbook. Unfortunately, the answer is probably no. Competition in the market is much more intense today than in Buffett's early days, so the odds of Ackman being able to replicate anything that looks like Berkshire's returns seems unlikely.
Still, average investors who want to invest alongside Ackman now have an opportunity. And Howard Hughes looks like it offers good value at today's price, especially when you consider someone like Ackman was willing to pay a significant premium for the shares.
