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Bill Ackman’s Pershing Square Management (now managing about $8.3 billion), announced on Tuesday a new billion dollar holding in Starbucks. Typical of his disclosure of major new positions, he made a lengthy presentation at an investment conference. We will get to a discussion of his rationale regarding SBUX, but we’ve followed Ackman’s career, since we’re in the same business (on a much, much smaller scale), and a few highlights will likely be of interest to our readers.

His long term record is outstanding. According to Pershing Square’s website, since inception in 2004 through calendar ’17, the compound annual return, after fees, has been 13.6%, versus 8.7% for the S&P 500 index.  However, the really great years were the early ones, when returns from 2004 through 2007 were  up 42.6%, 39.9%, 22.5% and 22.0% respectively. The year’s 2007 through 2014 were still good, though not as spectacularly consistent,  down 13.3%, up 40.6% (must have been short in 2008), up 29.7%, down 1.1%, up 13.3%, up 9.7%, up 36.9%. The last four years, from 2015 through 2018 have been disappointing, down 16.2%, down 9.6%, down  1.6% and up something like 10% YTD in ’18.

Ackman has made some spectacularly big gains, since he makes big bets, and has had equally impressive losses. Among his largest gains have been MBIA, General Growth Properties, Platform Specialties, and Restaurant Brands (which is an outgrowth of his holdings in Burger King and Tim Horton’s, which merged). His losses have included JC Penney, Target and Valeant. He become a household name with a well publicized short position in Herbalife a few years ago, and finally exited the position after an extensive and expensive campaign to put the company out of business.  Ackman’s brilliance and tenacity are unquestioned. One could question, however, whether any money manager has the right to personally decide whether a company deserves to be in business. It’s one thing to announce a short position. It’s another to take it upon yourself to contact bankers and employees and anyone else you can find (in the case of Herbalife: their sales network) in an effort to discredit the organization.

Which brings us to Ackman’s current large bets within the universe that we know pretty well, namely his positions in Restaurant Brands (QSR), Chipotle (CMG), and, most lately, Starbucks (SBUX). His $8.3 billion portfolio is down quite a bit from $18.3 billion in 2015, no doubt due to his lackluster performance lately. His CMG is worth about $900M, his SBUX is worth about $1 billion, and his QSR is worth about $1.5 billion. These three positions, therefore, represent a total of about 41% of his $8.3 billion portfolio.

In summary, we don’t think this major portion of his portfolio will outperform the general market, or even the restaurant industry in general.

Regarding Restaurant Brands (QSR), by far the largest of the three positions: We’ve written extensively, which readers can access through our Home Page. In a nutshell, the stock is more than adequately valued, since the largest contributor to their EBITDA, Tim Horton’s, is a troubled chain, Popeye’s is too small to move the corporate needle much, and Burger King, though it has performed well under QSR’s leadership, continues to operate in a very competitive burger segment. The “low hanging fruit”, that was opportunistically picked by the QSR financial engineers, is gone, so the earnings progress of the past won’t be duplicated from this point forward. We refer readers, again, to our previous more extensive discussions. A heck of a case can be made, in terms of the fundamentals and the relative valuations, that QSR should be switched into MCD immediately.

Regarding Chipotle (CMG), still almost $1 billion holding, Ackman’s original position, taken a couple of years ago, in the 400s, after falling to a low of about $260, has come back to a profitable point, and Ackman’s has exited about 25% of his position. We wrote, a couple of years ago, that he had no “edge” relative to his knowledge of CMG. There was no undervalued real estate, or other opaque asset that  could be monetized. His opinion was no better than yours or mine whether the brand could, or would, regain its previous popularity. Ackman has gotten lucky, because CMG has run back to $440 today (was briefly over $500 in mid ’18), and he is more or less even on the position. The huge move in the stock has more than adequately anticipated the fundamental recovery, now selling at over 50x ’18 EPS, and 27x trailing EBITDA. It is three full years since the crisis of ’15, and same store sales are only up by single digits against easy comparisons. Backing out menu price increases, traffic has barely improved from the lows. Further backing out the progress with their mobile app, in store dining traffic is still less impressive. Suffice to say: CMG, still challenged, is no bargain at current levels.

Regarding Starbucks (SBUX), the most recent purchase. Once again, we have written extensively on this situation, which we encourage you to access with the Search function on our Home Page. This is a great worldwide brand. They will continue to grow, especially in China. They will continue to buy back billions of their own stock. However: the future growth will be slower than in the past, so the price/earnings multiple is unlikely to expand, which Ackman is counting on. Ackman has discovered  that Starbucks is selling caffeine, and we’ve pointed out many times that selling an addictive product is a significant corporate advantage. (Maybe that’s why Constellation Brands, STZ, has invested $4 billion, for a 38% in Canopy Growth, CGC, a cannabis company with a market cap of $10B, over 20x ’19 estimated sales.) However, back at SBUX, food sales are about 25% of sales, so, backing out the increase in food sales,  caffeine sales are down over the last couple of years. In a nutshell, as in the case of his CMG purchase, he has no edge. His argument that the valuation of SBUX, in terms of earnings and cash flow, is well below the long term average, that is almost inevitable when growth expectations are less than was the case historically. Ackman expects SBUX to double in price over the next three years. Since the earnings per share will likely not grow at more than a mid-teen rate, even including stock buybacks (don’t forget the rising labor costs), he is counting on valuation expansion, which we consider unlikely. Having said all that, we consider it unlikely that he will lose money on this position over the next several years. Starbucks is a very strong company. It will just not be as profitable as he hopes.

In summary:

We don’t expect that Ackman’s performance, nominally and relatively, will improve by way of the above 41% of his portfolio. Starbucks is unlikely to do any major damage, but Restaurant Brands is substantially overvalued. He should switch immediately into McDonald’s or something else. He should consider himself lucky if he can exit Chipotle in one piece. From a broader standpoint: If this is the best Ackman (a very smart guy) can find in the marketplace today, it is not a good commentary on the state of the market.  situations.

Roger Lipton