By Pete Gallo
You have to hand it to Pershing Square Capital Management's Bill Ackman for picking winners in this era of consumer indebtedness. The hedge fund's latest filings with the Securities and Exchange Commission show it is leaving the slumping retail sector and moving to inflationary stalwarts—fast food and jails.
Late in the third quarter, Pershing more than tripled its stake in McDonald's, to 8.2 million shares at the start of October.
Momentum and market conditions have been favorable for shares of the Golden Arches, which have surged off a low of about $50 in March. Since the start of the fourth quarter, McDonald's shares have risen by roughly $8, hitting $64.45 on November 25. With 8.2 million shares, Pershing's stake now weighs in at approximately $528 million, representing a gain of about $70 million for the hedge fund's position since the start of the quarter.
Clearly, Ackman's investment team is exploiting a growing trend, as cash-strapped consumers trade in dining out with driving-thru in an era of steep job losses. Ackman realizes the company's 14% franchise fee on revenues will likely be fat on increased sales of dollar menu items but also recognizes that McDonald's has made huge strides financially speaking, reducing outstanding shares by 5%, increasing after-tax returns 16%, and increasing dividends by 33% over 2007 levels. In addition, global sales are up 10% over that same period.
Ackman also likes McDonald's because its 32,000 locations worldwide make it inherently currency-hedged, a smart theme to play in the era of possible U.S. dollar devaluation. On the flip side of this burger bet, Pershing in the third quarter sold all shares in the transaction-dependent Visa, a smart move considering that industry analysts were predicting a 10% drop-off in credit card usage during the holiday season—not to mention growing default risk among tapped out consumers. Also liquidated last quarter was a sizable stake in Saks, the parent of high-end retailer Saks Fifth Avenue. However, taking those two particular bets off may have been premature since Visa and Saks have performed solidly so far in the fourth quarter.
Also taken off the menu in the third quarter was a long-term position in Wendy's/Arby's Group, a move vindicated by that stock's 20% dip in the fourth quarter, to roughly $4 on November 25. One can assume Wendy's shares were sold to make more room for a bigger McDonald's bet, as Ackman likes to focus on a handful of stocks—only a half-dozen names based on the most recent SEC filings.
The other big recent pick in the Pershing portfolio was Corrections Corp. of America, owner and operator of some 64 jail and detention facilities across the country. From the start of the quarter through November 25, the stock had climbed from $21 to about $25.
Although Ackman's team missed a buying opportunity back in March, when the stock was trading at $9, the hedge fund has still managed to post a tidy profit on the bet. With 6.4 million shares at the start of the final quarter, the hedge fund's position grew from $134.4 million to about $160 million as of November 25.
Corrections Corp. reported $426 million in revenues in the fourth quarter, a 19% increase over the previous quarter, as a result of a spike in incarcerations in California and Arizona. Perhaps Ackman's team is playing Corrections Corp. of America as an unconventional real estate investment, as the tenants' monthly rent payments are as secure as they get. As with most of Pershing's plays, the hedge fund is a major stakeholder in the company, ranking just behind Lazard Asset Management as the company's second-largest shareholder.
And the sheer size of the Pershing stake may have prompted recent market interest in the company. In fact, the hedge fund's regulatory revelation that it bought a 9% stake in the company in the third quarter coincided with its recent rise—perhaps not a complete coincidence, given Ackman's star power among Wall Street watchers, pundits and other investors.
No mention of Pershing Square's portfolio would be complete without a mention of Target Corp. The hedge fund still owns upwards of 26.2 million shares in the company, based on regulatory filings. But it trimmed portfolio exposure down from 33 million shares, owned at midyear, following a proxy defeat. Target has remained roughly flat for the quarter, trading at about $47 as of November 25.