Baby Buffett: Bill Ackman 2.0

Bill Ackman bounds onto the stage in the ballroom of the Crowne Plaza Hotel in midtown Manhattan in front of hundreds of his peers: The crème de la crème of hedge funds, law firms, endowments and large pension funds. It’s early April, and Ackman is determined to give the Active-Passive Investor Summit a preview of what he internally calls ‘Pershing Square 2.0’: His rebirth as a kinder, gentler investor, more focussed on building companies that last than on making quick trading profits.
The ballroom responds with a yawn.

So, after a pause, the billionaire poster boy for activist investing—the more polite name for what used to be dubbed corporate raiding—pivots back to his comfort zone, unleashing a barrage of accusations about one of his most infamous and controversial positions, Herbalife, the supplements seller that he’s bet $1 billion against and calls a pyramid scheme. “We know they have been or are looking to hire criminal defence counsel,” he says cryptically of Herbalife’s top executives, as Twitter lights up like a Christmas tree. (Herbalife denies Ackman’s claims.)

Headlines soon appear across the internet and on CNBC: ‘Ackman: HLF Execs Hiring Own Lawyers an Ominous Sign’. After-hours volume in Herbalife stock heats up, but the shares fall only 0.3 percent.

What about Pershing Square 2.0? Not a mention, even though the biggest move for last year’s hottest money manager—his hedge fund was up 37 percent (versus 2 percent for the average hedge fund), nearly doubling his net worth to $2.5 billion—hides in plain sight, 10 miles west of the Las Vegas Strip.

Take a trip out there via US Highway 215, toward the breathtaking but desolate beauty of Red Rock Canyon National Conservation Area, and you’ll find the largest retail development in the nation since the financial crisis, rising up from the sagebrush. Some 1.4 million square feet of shops, offices and restaurants ranging from Macy’s to Apple, Traders Joe’s to Wolfgang Puck’s—the kinds of offerings that hark back to the days before the great mall die-off. From speakers submerged beneath the sidewalks of the city’s outdoor mall you can hear Frank Sinatra’s ‘The Best Is Yet to Come’.

And it will: Potential customers are filling the thousands of McMansions and townhomes being thrown up around the mall by the likes of Lennar, Pulte and Toll Brothers. Water crisis? Apparently not in Summerlin, Nevada, a planned community where new golf courses, swimming pools, bike trails, schools and churches dot the palm-lined streets and cul de sacs in neighbourhoods with names like Segovia, Aspenglen and Sterling Ridge that spread across 35 square miles.

Summerlin is a key asset for a real estate company with a legendary provenance and a low profile: The Howard Hughes Corp, 26 percent owned by its chairman, Ackman. But it’s far from the only asset: Summerlin is one of four planned communities and 30 real estate properties owned by Howard Hughes, which in 2014 reported $635 million in revenues and $190 million in operating profits on $5.1 billion in assets, with 45 million square feet of retail, commercial and residential land in its development pipeline, from Houston to the exurbs of Washington, DC. Howard Hughes is rebuilding New York’s South Street Seaport and owns 60 acres of beachfront property in Honolulu that should yield nearly two dozen luxury towers.

“Howard Hughes is the only company that I am, in effect, an executive of,” says Ackman, who has agreements that render him unable to invest directly in real estate or any other private companies through his hedge fund, Pershing Square. “It is the one we have the most control and influence over, and the most amount of reputational equity invested.”

Well, not much yet. The real estate community almost never talks about Howard Hughes. Nor does Ackman. But that will change, as he uses it as a holding company for his Pershing Square reinvention. Just as Summerlin offers families, mostly refugees from bustling big cities like Los Angeles, Chicago and New York, a chance for low taxes and a fresh, highly curated start, Howard Hughes offers Ackman a chance to change his reputation from the modern-day corporate raider everyone loves to hate into a corporate empire builder.

The model, ultimately, is Warren Buffett. Despite the fact that he’s the best known of a new generation of activists, along with Daniel Loeb and Jeffrey Smith, the 49-year-old Ackman bristles at the thought of such a legacy. After all, how many people under 40 have ever heard of Asher Edelman or Meshulam Riklis or Irwin Jacobs, the notorious and successful corporate raiders of another Wall Street era? Comparisons with the most successful activist ever, his Herbalife nemesis Carl Icahn, make Ackman especially uncomfortable. “We are very different from Icahn,” he sniffs, referring to Icahn’s penchant for nimble trades and quick fixes. “We invest in very stable, predictable businesses.”

Instead, he’s taking a page from Buffett, who focussed on trades until he found a publicly traded textile company named Berkshire Hathaway and then began swallowing businesses and stashing them under it. Ackman has the holding company, courtesy of assets acquired in 2010; the legendary Howard Hughes name was a bonus that came when he sucked up the Summerlin project. To build an enduring business, though, he needs permanent capital.

Hedge funds like Ackman’s are in no position to manage assets long term, since limited partners have the right to redeem interests every quarter. It’s why, by their nature, they are trading vehicles. So last October, Ackman issued shares in a new entity publicly traded in Amsterdam, Pershing Square Holdings Ltd, creating some $6.5 billion in new permanent capital from investors, mostly outside of the United States. Add to this his own and his employees’ money in Pershing Square hedge funds and Ackman has boosted his permanent capital to more than $8 billion (his total assets under management are now $19.5 billion).

“Pershing Square Holdings is recognition that, given the firm’s investing style, sometimes there will be periods of intense pushback and ridicule,” says Harvard Business School’s Michael Porter, who taught Ackman in the early 1990s and is a Pershing Square advisor. “If you are in a situation where capital can walk and you have investors that can be rattled, having a good anchor of permanent capital is very important.”

Redemptions have plagued Ackman in the past. During the financial crisis in 2008, and then after 2013, when Pershing suffered embarrassing losses on JC Penney and Herbalife, redemptions amounted to 10 percent of net assets. Those last redemptions proved foolish, given the massive 2014 that Ackman turned in, driven most prominently by investment gains in Botox-maker Allergan. They were also cautionary, as more of them would have undermined Ackman’s turnaround. “Imagine if we had redemptions and were forced to unwind—we couldn’t do Allergan,” he says.

This permanent war chest lets him take on ever larger targets with less heartburn—and look more toward the long term. “When I describe what we did in the early days of Pershing, we found undervalued companies, we proposed changes that would unlock value, and then after they took the various steps we generally exited,” he says. “People described them as more financial engineering.” He adds: “If you look at what we have done during the last five years, Canadian Pacific, Air Products, General Growth… even Allergan and Valeant was about creating a company. They both existed, but the combination was building something we wanted to own for years.”

For Ackman, holding assets means a return to his roots. For all his hedge fund bravado, his success is rooted in real estate.

It’s in his blood. His father owned a successful New York real estate firm. After graduating from Harvard College in 1988, Ackman quickly became a top producer. Later, at Harvard Business School, he ploughed nearly half of his savings into the stock of Alexander’s Stores, a retailer that fell into distress in the early 1990s. Sensing that Alexander’s real estate, such as 731 Lexington Avenue (current headquarters of Bloomberg LP), was worth more than the claims against the company, Ackman bought shares for a little over $8 apiece the day the company filed for bankruptcy, and within a matter of months he sold for $21.

A great trade for a kid, but the deal taught him a lesson in shortsightedness. Soon after he cashed out, Alexander’s was acquired by Steven Roth’s Vornado, which converted it to a REIT. Alexander’s now trades at more than $400 a share and has paid rich dividends for years.

After business school, Ackman partnered with classmate David Berkowitz to form hedge fund Gotham Partners, raising $3 million, largely from family and friends. He stuck with what he knew. His first major break was an audacious attempt to buy the distressed mortgage of Rockefeller Center Properties in 1995. Guppy-size Gotham took a 6 percent stake in the REIT that owned Rockefeller Center’s mortgage, and Ackman proposed a recapitalisation to keep it from would-be vultures, including Sam Zell, General Electric and Disney. Ultimately Ackman lost to a consortium that included Goldman Sachs, Tishman Speyer and David Rockefeller, but at 28, he gained major Wall Street cred—and a 39 percent return for Gotham in 1995. David Rockefeller and co-investor Leucadia National were impressed. Rockefeller became a Gotham investor.

In 1996, Ackman turned to racetracks for a new set of deals to swing with Wall Street’s power players. At the time, Starwood Capital’s Barry Sternlicht discovered so-called paired-share REIT structures in hotels and racetracks that allowed its owners to earn both lease revenue and operating income under a REIT tax shield. The loophole set off a buying frenzy for hotel chains like Sheraton, Westin and Wyndham. In classic greenmailer style, Ackman got involved by contesting the racetrack takeovers that Sternlicht and other dealmakers, such as Colony Capital’s Thomas Barrack and Apollo Global Management’s Leon Black, were eyeing, holding out for higher premiums.

Ackman’s paired-share REIT obsession eventually backfired in 1998, after Gotham won its proxy contest for REIT First Union. That year, the IRS closed the loophole, and First Union shares plummeted. Things continued to get worse for Gotham as Ackman strayed into golf courses, multi-level marketing firm Pre-Paid Legal Services and a privately held dotcom called Giftcertificates.com.

These deals eventually proved to be Gotham’s undoing after First Union shareholders balked at his attempt to merge it with his money-losing golf courses. Gotham investors began to lose confidence in him and withdrew capital, causing assets to fall over 40 percent between 1998 and 2002, as Ackman, as bold as ever, decided to try his hand at activist short-selling, eventually drawing an investigation from then New York attorney general Eliot Spitzer. Ackman was pressured into unwinding Gotham in 2003, and Berkowitz quit the business altogether. Ackman’s confidence was unshaken. “Not for a moment did I sense any despair in Bill,” says business school classmate Robert Jaffee, who invested in Gotham and is a current hedge fund limited partner. Pershing Square launched in January 2004 with $4 million of Ackman’s savings and $50 million from Leucadia. But because of Gotham’s failures, Pershing Square pledged to its partners not to invest directly in private companies—including real estate. This created a dilemma because real estate has always been his sweet spot. “It is an asset class I understand, and we have made a fortune in it,” says Ackman, who isn’t known for modesty. “I don’t know that I’ve ever made a bad real estate investment.” The financial crisis of 2008 presented the solution that led to Howard Hughes. As markets were descending into turmoil, Ackman bought up 25 percent of struggling mall REIT General Growth Properties at a free sale, helped steer it into a managed bankruptcy and then cherry-picked certain undeveloped assets from the carcass, an unwanted hodgepodge that rivals dubbed ‘Sh-tco’. General Growth turned out to be his greatest investing triumph, with a 130-fold gain on his stock, amounting to a $3.7 billion profit for his hedge fund. ‘Sh-tco’ turned into the Howard Hughes Corp, a $6 billion vehicle that has seen its stock climb 300 percent since it was spun off—and allowed Ackman back into the real estate game unfettered.

One of Howard Hughes’s most valuable assets is on Bill Ackman’s home turf: Manhattan’s South Street Seaport. Which explains why, on a stormy, bone-cold March evening, he is staring at blue jeans, which have been hand-painted with acrylic blue, purple, magenta, teal and white splatters that resemble the patterns of a Jackson Pollock painting. The offerings at the Rialto Jean Project, located at the Seaport, have Ackman puzzled.

“How do you check out the price? Nothing’s labelled. It has like a SKU, a sign and no price!” he exclaims to David Weinreb, the Howard Hughes CEO, who accompanies him. A young shopkeeper named Kandice quotes the jeans at $245. “That’s artwork, not jeans,” Ackman murmurs as he scans the denim hanging on brick walls inside a refurbished 19th-century row house.

He begins to barrage the unknowing Kandice as if he’s grilling a CEO: What percentage of customers are male? How much traffic does the store get? Is it really more of a wholesale business? Why open a store in this location? Is there anything other than denim and acrylic for sale? How do the clothes wash?

Kandice meets every Ackman demand, and he reciprocates with a parting thought: “When the theatre opens, you guys are going to be booming!” The theatre he’s referring to is a high-end iPic cinema, where filmgoers can take in 3-D movies while knocking back beer and cocktails and munching overpriced burgers. It’s slated to open in 2016 next door to Rialto in the Fulton Market Building, a piece of the $1.5 billion plan to rebuild the Seaport. In 2017, Howard Hughes expects to reopen the Seaport’s Pier 17 with 182,000 square feet of leasable space and a 1.5-acre rooftop for concerts, ice skating, weddings and Rockefeller Centeresque tree lightings. Then come the inevitable luxury residential skyscrapers.

Weinreb, as the Howard Hughes point man, is key. Ackman has real estate chops, but Weinreb lives and breathes it. The two first met in high school in Chappaqua, New York. Weinreb, who graduated two years before Ackman, was a celebrity at school because he starred in TV commercials for Ronzoni pasta and Bubble Yum gum, and used his earnings to buy an apartment in Manhattan. He then dropped out of New York University (and later show business) and wound up in Texas, where he sold real estate during the oil boom of the 1980s.

He eventually caught the eye of Chicago Bulls and White Sox owner Jerry Reinsdorf, who put him in charge of a few buildings. Weinreb’s Midas touch for turning around busted real estate deals in the aftermath of the savings-and-loan crisis quickly became legendary. “David has taken some dog properties and really made winners out of them,” says Reinsdorf, terming him “a smart guy who doesn’t tell people how smart he is”. That makes him a good pairing with the boastful Ackman. By the mid-1990s, Weinreb’s company, TPMC Realty (for ‘Turnaround Properties Make Cash’), was known as one of the pre-eminent distressed real estate firms in Texas. “Even in the worst of times,” Weinreb says, “there’s someone making money.”

In 2002, he reconnected with Ackman via a cold call. Seven years later, with the real estate market languishing, Weinreb began talking to Ackman about launching a fund to buy up distressed properties. The discussion eventually morphed into Weinreb taking charge of Ackman’s plan for Howard Hughes.

Weinreb’s background in turnarounds is what made the Las Vegas project so enticing. The mall was abandoned in 2007, as the real estate market began to sicken. Until a year ago it was fallow, with concrete and rusting steel columns sitting atop wasteland purchased by reclusive business tycoon and aviator Howard Hughes in the 1950s to avoid taxes. “We’re the largest landholder in a constrained market,” says Weinreb. “It was self-evident that Downtown Summerlin would have a bright future when the market recovered.”

More tantalisingly, Howard Hughes owns 200 acres of barren desert to the east, which is slated for 4,000 residential units and 1.4 million square feet of office space. And another 5,600 acres to the west and south, which will become increasingly valuable if Ackman’s projections, which call for Summerlin’s 100,000 population to double, come to fruition.

Control is important in all of the duo’s master plans. Besides its Las Vegas real estate and planned community, Howard Hughes also owns the Woodlands, a 28,400-acre planned community on the outskirts of Houston conceived in the 1960s by shale gas pioneer George Mitchell, as well as parts of James Rouse’s planned community in Columbia, Maryland. It also owns Ward Village, a 60-acre plot of coastal land in Honolulu, where the company has already broken ground on two luxury towers that are more than 80 percent sold.

Instead of pawning off projects to joint venture investors, Ackman and Weinreb are doubling down. One of Weinreb’s first moves, in fact, was spending $118 million on a deal in 2011 to buy out the 48 percent interest Morgan Stanley held in the Woodlands. They also decided to retain the 25 million square feet of strategic development Howard Hughes owns on all of its properties. Just as Buffett counts on steady cash flow from Berkshire Hathaway’s insurance holdings, Ackman is trying to position Howard Hughes as a real estate cash machine. Cash flow is expected to triple by 2016 to over $500 million per year, according to Compass Point analyst Wilkes Graham.

“Howard Hughes management isn’t concerned with meeting a quarterly estimate,” says James Davolos, portfolio manager at Horizon Kinetics, the firm’s largest outside shareholder. “They’re concerned with compounding the value of the investment over the next five, seven or ten years.”

And real estate will lead to other businesses. In Vegas, for example, Howard Hughes owns a minor league baseball team (and plans to build a stadium for it in Summerlin). And don’t be surprised if Ackman becomes the latest Wall Street titan to own a casino. One of Howard Hughes’s most unusual and potentially valuable assets is the air rights above the 1.9 million square foot Fashion Show Mall on The Strip, across from the Wynn hotel and sandwiched between Trump International and Treasure Island. “I took everything where the market wouldn’t assign a value,” says Ackman.

Bill Ackman on the Las Vegas Strip? The Howard Hughes Hotel & Casino?

“Ultimately, the best real estate has a big entertainment component,” says Ackman, as cocky as ever. “Never again am I going to miss anything like Rockefeller Center.”


The Howard Hughes Tax Dodge

The late business tycoon and billionaire Howard Hughes may be best remembered for producing the most expensive Hollywood film of its day (Hell’s Angels, 1930), flying around the world in record time (1938), his affair with Katharine Hepburn (1939) and building the largest airplane in history, the H-4 Hercules ‘spruce goose’ (1947). Or for his final decades, when mental illness turned him into a recluse who ran his empire from a hotel suite.

But despite his rococo extravagances, Howard Hughes was a master businessman, particularly skilled in the art of avoiding taxes. In his memoir, Hughes’s accountant Noah Dietrich claims Hughes paid only about $20,000 in income taxes a year. Indeed Howard Hughes Corp’s  circuitous journey into Bill Ackman’s portfolio began as a tax scheme. In the 1930s the IRS levied a 37.5 percent penalty tax on unnecessary accumulated surpluses. Hughes operations never paid dividends, so Dietrich began ploughing profits into undeveloped land. That’s how subsidiary Hughes Aircraft came to own the 25,000 acres of land adjacent to the Las Vegas Strip, now called Summerlin in honour of Hughes’s grandmother Jean Amelia Summerlin.

In 1972, Hughes put his Vegas real estate into Summa Corp, which finally began developing Summerlin in the 1990s. Summa sold to mall developer Rouse in 1996, and in 2004, General Growth bought Rouse for $12.6 billion. During General Growth’s bankruptcy, Ackman carved out a trove of unwanted assets plus the Howard Hughes name.

Fittingly, Howard Hughes Corp still retains about $250 million in crises-related tax-loss carryforwards today, so it currently pays no taxes. Eventually, Ackman may turn Howard Hughes into a REIT, dodging still more taxes. Hughes himself couldn’t have done better.