High-profile activist investor Bill Ackman has been in the headlines recently -- but not in the way he'd prefer. The collapse in the share price of one of his top holdings, Valeant Pharmaceuticals International (NYSE:BHC), from its August high has saddled his Pershing Square funds with an unrealized loss that is estimated to have reached $2 billion. What went wrong?
"As a general rule," Ackman said, "we purchase simple, predictable, free-cash-flow-generative businesses that have sustainable competitive advantages due to brand power, unique assets, long-term contractual arrangements, or other factors. These companies are [generally] modestly or negatively leveraged (i.e., have more cash than debt) and do not need access to the capital markets to survive and thrive."
In his September 2009 presentation on Valeant at the Ira Sohn conference, Ackman introduced the concept of the "platform company" into which he tried to shoehorn Valeant:
"Businesses managed by superior operators that execute value-enhancing acquisitions and shareholder-focused capital allocation have substantial platform value."
It's now becoming increasingly clear that Valeant had no problem finding and executing value-destroying deals.
Ackman could not have known this with certainty at the time he made his investment, but there were certainly signs available to a professional investor doing in-depth due diligence, which Ackman is famous for.
While it's true that pharmaceutical companies are not the easiest businesses to understand, Valeant's acquisitiveness made it very difficult to assess the underlying growth and profitability. (The company didn't facilitate this, either.)
With that type of uncertainty, why did Ackman attribute the positive characteristics of a platform company to Valeant? My guess is that he allowed the stock and its phenomenal performance to convince him of the merits of the company instead of the merits of the company convincing him to own the stock. You can't argue with success, right?
Valeant also fails the "modestly or negatively leveraged" test. At the time at which Ackman made his first investment in Valeant, the company was already significantly indebted. By the end of the third quarter of 2015, net debt stood at nearly $30 billion.
To pursue its acquisition strategy, Valeant absolutely needed "access to the capital markets in order to survive and thrive," failing another Ackman criterion for long investments.
Valeant was incapable of financing its acquisitions internally like a proper platform company, such as Warren Buffett's Berkshire Hathaway -- to which Ackman had the nerve to compare Valeant.
On retaining the option to abandon
"I consider one of our investment strengths to be our willingness to promptly change our mind when confronted with new information which is inconsistent with our original investment thesis," Ackman said. "I have learned from prior experience that sometimes the better part of valor in an investment situation is to move on."
There is quite a bit of new information that has surfaced about Valeant -- most of it negative -- that obliterates the original thesis.
Valeant's strategy, conceived and executed by CEO J. Michael Pearson, is irreparably broken, and the company has renounced. How's that for new information?
Pearson, who is leaving Valeant as soon as his replacement is found, said last October that price increases in 2016 would be modest, and while the company might be involved in acquisitions in the near future, it would be as a seller, not a buyer.
Of course, it's always possible that Ackman has since developed a new thesis, but one thing is certain: It isn't the platform company.
Confidence and humility in investing
"I have learned that the key to long-term success in investing is to balance confidence with the humility to recognize when the facts are no longer consistent with one's original investment thesis," Ackman said.
In this instance, it appears Ackman tipped the wrong end of the balance, misplacing confidence over humility. And it has cost him dearly.