Bill Ackman and the Current State of Activist Hedge Funds, Part I

Bill Ackman, the forty-three-year-old founder of hedge fund firm, Pershing Square Capital Management, has had a rough go of late. Readers may recall that in 2007 he raised $2 billion from private investors in order to start a new hedge fund, Pershing Square IV.   Employing a highly-leveraged mix of common stock and call options,  Ackman invested the proceeds in trendy discounter, Target Corp.  Since its launch, Ackman has pursued a public campaign against Target, pressuring it into not only selling off its credit cards division, but also spinning off the land underneath its stores into a separately-managed real estate investment trust.  However, his attempts to unlock value on behalf of Target shareholders have thus far proven to be a colossal bust, as evidenced by his failed attempt in May to nominate several fresh faces (including himself) to the company’s board of directors. The current poster boy of hedge fund activist investing, Ackman’s plight reflects, or at least resonates with several key themes currently affecting the activist landscape.

First, one major challenge affecting today’s activist investor involves access to capital and leverage.  As a primer, activist funds are typically considered longer-term, illiquid investments. This is because the average activist fund enforces a 2-3 year lock-up period to new investors when launching the fund. Managers do this so that they can more easily concentrate on building long term value for investors, and thus minimize short term distractions caused by fund maintenance, redemptions, and reporting monthly performance. After all, raising media attention, influencing corporate governance, and generating further value from a target company is no overnight project! In Ackman’s case, he was fortunate-enough to raise capital for the fund in 2007, when market conditions were much more favorable and investors were much more willing to part with their capital for long periods of time.

In contrast, in today’s environment activist hedge funds face a tougher time raising large sums of cash from investors. Unwilling to part with their capital for the long term, risk averse investors are resorting to placing funds in liquid investments.  On top of this, banks and other lending firms are increasingly refusing to lend to hedge funds.  This is the combined result of new heightened lending standards, as well as need by these institutions to shore up cash reserves.  As a result, many activist managers, or raiders, are putting to use smaller sums of capital.  With capital so difficult to access, most new players are either waiting on the sidelines for now, or picking their battles with much smaller-sized corporations.

Another challenge faced by activist managers involves the exit strategy.  Obviously, the goal of any activist investor is to acquire a stake in an undervalued company, force it into implementing changes which unlock value for its shareholders, and then exit out of the position.  However, the stock market selloff of late 2008 left many activist investors in a precarious position.  Due to the declining markets, their positions have lost a considerable amount of value.  In the case of Ackman, he started acquiring shares in Target during 2007 when it was priced in the 60’s.  Yet, by this past spring, his levered investment had lost over 90 percent of its value as Target (TGT) shares plummeted.  Since that time, Target’s share price has rebounded into the mid-$40 range, and Ackman has pledged more capital to his investment (including $25 million of his own).  Nonetheless, while plummeting share prices can momentarily aid an activist investor in his attempt to drum up opposition to corporate boards or policies, it also renders him and his investors helpless in realizing any near-term profits.  What Ackman may have intended to be a quick profiting opportunity is slowly developing into a potentially long and drawn-out battle.

To be continued…

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