Pershing Square Holdings, Ltd. (PSH.L) Earnings Call Transcript & Summary

Okay. Ryan, Hilton hotel company. How can this possibly be a good investment in a world in which Bill Gates says business travel is going to be down 50%?

Sure. So you've certainly been right. It's actually been down more than 50% in the short term. But I think the key -- and really the couple of reasons we're excited about Hilton is longer term, our belief is that things will return to normal. People will be traveling the way that they used to travel, maybe slightly less, but we really think that people will want to revert to their routines. We think that as much as we've all done Zoom recently, it is not providing sort of the same level of intimacy in terms of the human kind of people-to-people contact. And we think it's going to be very important for businesses and for individuals to get back to being able to travel to meet their customers, to be able to get back to having the leisure activity they like. And so we really think there actually will be a lot of pent-up demand once a vaccine is available and widely distributed. So our view and one of the tenets of our thesis with Hilton is that ultimately, the world will go back to normal habits, will go back to normal. Now I think you can ask yourself a question, why would it be the case, though, that we're so excited about Hilton in today's environment until that happens? And I think the way we thought about it is really twofold. First, we think that the crisis has actually validated the attractiveness of the company's franchise business model. And second, we actually think Hilton will emerge much stronger from this crisis. And so actually, in a way, the crisis will be very helpful to Hilton's long-term value. In regards to its business model, we've long argued that the asset-light franchise nature is a very special model in that it will insulate businesses from downturns in the environment. You could argue COVID is a 100-year proverbial flood, in which a lot of companies are struggling, but Hilton has managed to make it through this crisis. Even though it is in a category that is very negatively impacted, it's made it through very well. Just to give you a data point, last quarter, Hilton's RevPAR, which is their term for same-store sales growth, is down about 60% as a result of COVID and the lack of travel. Yet Hilton actually still managed to generate a slight profit. So when you think about the number of companies that could be profitable when the revenues are down close to 60%, it really highlights why this is a special model that has a flexible cost structure and the advantage of not having a large degree of fixed cost that you can't cut. So we think that it really validates the model. And ultimately, when we get through the crisis, that will be something people are more willing to put an even higher multiple on. And then secondly, we think the company itself is going to emerge stronger. If you think about it from the franchisees' perspective, the value proposition of belonging to Hilton franchise is even much stronger than people thought it was before. At the beginning of the crisis, Hilton was leading the effort to come up with sort of a safety and cleanliness initiative. It Immediately partnered with Mayo Clinic and Lysol to develop standards, very important in giving anybody who could travel the confidence to stay at a Hilton Hotel. And also got a lot of cleaning supplies to make sure that things were safe for employees and for guests. That's something that a hotel on its own would certainly not be able to do, and they certainly wouldn't be able to market that benefit very widely to anybody that was available to travel. After that, Hilton has really reengineered the processes that their franchisees use in order to make sure that they can reduce their costs and stay profitable during a low demand environment. So the value proposition, we would argue, has gotten even stronger during this crisis. In terms of Hilton itself, they've taken out about 30% of their costs at the corporate level, and they're indicating that they do not think they need to replace those costs after the crisis, which means that the company will return to prior levels of profitability well before it actually recovers all the revenue it lost during COVID. So stepping back, the way we think about it is, at today's price, Hilton is a more valuable business in terms of the multiple you should place on it. But at the same time, it's going to recover its earnings profile a lot more quickly than it recovers revenue. And we think Hilton is a very good investment from here, even if it takes 4 to 5 years to recover to prior levels of business travel pre-COVID. But as I mentioned at the beginning of my remarks, it's very possible that due to the pent-up demand and due to people's desire to get back to habits as soon as they can safely, that Hilton recovers even a lot faster than that, in which case Hilton will be even a better investment than we had underwritten.

So if I had to share my point of view on this, I think that business travel will be different, but I think demand will be similar. And what I mean to say for hotels is for companies that are -- and again, there are some technology companies that are going to go virtual or pretty virtual. But when I've talked to those CEOs, what they tell me is that in order to keep the culture going, they're going to have many more off-sites. So they're going to bring the sales teams together, whatever, once a quarter. They're going to bring the technology teams together at an off-site. They're going to have people -- they're still going to have headquarters. They're going to have employees that are going to come, spend a week, a month at headquarters. They're going to stay in a hotel, and maybe they'll live somewhere else in the country. So I do think that business travel will change. I do think there's going to be a huge spike in business travel when people feel safe. Anyone in any kind of business where they have clients and customers, you don't want to be the last guy to show up at your client versus your competitors. And so I think there's going to be a fairly dramatic snapback in business travel. I think there's going to be enormous snapback in consumer travel. Just the nature of being stuck at home, again, I think there will be a huge positive impact. So I do think our assumptions ultimately will be conservative that we've been modeling in terms of the recovery. Bharath, why don't you talk about Agilent, bring us up to date.

Sure. Thanks, Bill. And just as a quick reminder, Agilent reports earnings for its most recent quarter on the fiscal Q4, which ends October 30, after market close next Monday. If you look at its prior quarter for fiscal Q3, Agilent reported highly resilient results, would just reinforce our investment thesis that the company has a durable business model with a significant margin expansion opportunity. In what management expects to have been the most challenging quarter to the year, organic revenue only declined 3%, and it was really supported by stable performance in the CrossLab service and consumables segment, which actually grew 1%. Now looking beyond sort of the ongoing disruption from the pandemic. Agilent is highly focused on new product innovation and sales efforts to drive market share gains. So for example, in its service business, the company has introduced new workflow solutions to capitalize on the trend of labs increasingly outsourcing multiple services to a single vendor. And they recently won several large lab-wide enterprise service contracts. Likewise, in their instrument portfolio, the company launched 2 new mass spectrometry product lines aimed at increasing testing throughput and reducing downtime. We expect these offensive product-driven initiatives to yield dividends for years to come as they expand the installed base of Agilent instruments and also increase the penetration of its service and consumables offerings. Additionally, we continue to be encouraged by Agilent's ability to expand margins over the last 2 quarters by 50 basis points and 95 basis points, respectively, despite facing modest revenue declines from the pandemic. Most impressively, Agilent was able to deliver these cost savings without furloughing a single employee. And the resulting stability has really allowed the Agilent team to remain fully focused on customers. To that end, the company has made significant investments in online tools and communication channels to be able to remotely respond to customer service issues and fills requests in a very timely and reliable manner. And as a result, customer satisfaction scores in fiscal Q3 were the highest on record for the company. As the business emerges from the pandemic, we expect Agilent to remain fully committed to its ongoing digital transformation, as it not only supports the higher standard of customer engagement, but also allows for a more efficient operating model. The company's recent margin expansion in light of the soft revenue environment through the COVID crisis just further reinforced our belief that Agilent has an opportunity to -- for significant margin expansion over time to narrow the gap with its closest peers. In addition to reporting earnings next week, Agilent will host a virtual investor meeting on December 9. And we look forward to hearing the management team's perspective on the company's long-term strategic plan and their updated outlook on its revenue growth and margin expansion potential. Thank you.

Thanks, Bharath. What are your thoughts on what seems to be increased investment in biotechnology, pharma, et cetera? How impactful is that on Agilent?

Yes. So coming out of the pandemic, there's a heightened focus on just safety standards across a bunch of different end markets from industrial end markets to energy end markets. And also within their pharma end market, which accounts for 40% of the revenue, there's just increased investment in new drug development. We believe that Agilent will benefit from those trends going forward, as it increases the demand for both their instruments and also for their service and consumables offerings.

Great. Anthony, bring us up to speed on Starbucks, please.

Sure. Thanks, Bill. Starbucks recovery is progressing extremely well in both...

And actually, could you speak a little louder, Anthony. You're a little quiet.

Sorry about that. Starbucks recovery is progressing extremely well in both of its key markets, the U.S. and China. U.S. same-store sales of down 4% in September included a 2% headwind from closed stores and was a dramatic reversal from the [ nader ] of down 65% in the depth of the pandemic. Management noted that the strong momentum they saw exiting September has continued into October. Comps are solidly positive in drive-thru and suburban stores, but are being more than offset by negative comps in dense metro areas, especially on weekdays. China underlying same-store sales were down 3% in September, which was another dramatic reversal from the low of down 78% in February. 97% of U.S. stores and 99% of China stores are now open, with China closer to normal operating procedures, given how that country has contained the virus, as 90% of stores offer seating there versus only 63% in the U.S. We view performance in both countries as exceptional, given the reliance on work and school commuting routines as well as the brand's emphasis on a third place experience. Management reported Q4 results at the end of October and issued admittedly conservative guidance for fiscal 2021. CFO, Pat Grismer, who has a well-earned reputation as someone who guides very conservatively, felt the need to issue an additional qualifier this time describing the guidance as hedged somewhat to be appropriately conservative in the current environment. Management anticipates a full sales recovery in China, which means a return to positive same-store sales growth by the end of December of this year and in the U.S. by the end of March, which seems quite conservative when compared with current trends of only low single-digit declines in both markets. The margin recovery will trail the sales recovery by about 2 quarters, as management appropriately prioritizes long-term growth. The company's store repositioning plan will be largely completed next year and will involve about 800 closed stores across the U.S. and Canada. And the company will be back on track for 6% to 7% annual unit growth starting in fiscal 2022. In the markets that are impacted by these closures, the company is rolling out new pickup-only locations, complement the existing fleet of traditional cafes. Much like our other restaurant holdings, we believe Starbucks will emerge even stronger in a post-COVID world. There's tremendous pent-up consumer demand for socializing, with CEO, Kevin Johnson, noting on the earnings call that he anticipates huge, huge demand for that third place experience once effective vaccines and therapeutics are rolled out. The business has outstanding momentum in its most important market in the United States, with innovation firing on all cylinders, including the Pumpkin Cream Cold Brew outselling the famous Pumpkin Spice Latte this quarter. And the Pumpkin platform in its entirety at all-time average daily highs, the refreshers and cold brew, excuse me, platforms growing double digits and even frappuccino, which was a platform that was in decline when we first invested in Starbucks in the summer of 2018, now back to growth. Digital will forever be more important in the restaurant industry than it was pre-COVID, and Starbucks digital ecosystem is the envy of all competitors. China is back to opening 600 stores per year and is on track to hit their 6,000 store target by September 2022. And the company now faces no viable scale competitors in that country. Management is hosting a Virtual Investor Day on December 9, where we look forward to learning more.

So I like all these Investor Days in December. My experience is companies don't like to report bad news right before the end of the year. And I think that when they want to get in front of shareholders, they have good things to talk about. So we're looking forward to those Investor Days. So we have Starbucks, we have Agilent, Lowe's, all giving presentations. Ben, why don't you update us on Howard Hughes?

Sure. Howard Hughes continues to demonstrate strong sales momentum in its master planned communities, and we are seeing encouraging signs for rebound in its income-producing operating assets. Demand for residential land in Howard Hughes' MPCs are accelerating, benefiting from out-of-state migration from higher cost of living in the higher tax states. New homebuyers are increasingly drawn towards the walkable communities and expansive open spaces that can be found in Summerlin, Bridgeland and The Woodland Hills, which are the 3 master planned communities, which represent the substantial majority of Howard Hughes' remaining unsold land. As a result, new home sales grew 30% year-over-year in Q3 and 9% on a year-to-date basis. Company remains confident that the continued strong momentum in new home sales will translate to robust land sales in the coming quarters. Turning to its income-producing operating assets. Collection rates improved across the board with retail and hospitality, the sectors most impacted by the pandemic, seeing promising signs of recovery. Despite being negatively affected by pandemic-related traffic declines, the company saw an increase in retail leasing activity and robust demand for available retail space in areas such as downtown Summerlin, reaffirming the attractive quality of the company's retail portfolio. Likewise, stronger occupancy levels in the recently reopened hotels resulted in positive quarterly NOI sooner than expected. Office and multifamily assets continue to remain resilient in this challenging environment with collections in the high 90% range. In Ward Village, Howard Hughes had robust sales activity despite the pandemic. 24 homes were presold with the help of a digital sales platform, which provides homebuyers with a completely online experience, including virtual 3D condo tours and live chat capabilities. And the company's latest luxury condo project Victoria Place is already 71% pre sold after launching sales in December 2019. At the South Street Seaport, which was largely shut down in the second quarter, Howard Hughes has reopened most restaurants and activated the rooftop at Pier 17 with a creative outdoor picnic venue called The Green, which has served over 42,000 guests. Overall, Howard Hughes is continuing to see positive business momentum build across its portfolio, and we remain optimistic about the company's long-term growth prospects. The company is also in a strong liquidity position with $857 million of cash on hand, allowing the business to preserve financial flexibility and opportunistically accelerate development as it recovers from the crisis.

Thanks very much, Ben. What's interesting about Howard Hughes is it stock price is down, in most cases, more than its competition, i.e., there is really not a direct comparable, but sort of looking at my screen, various REITs, even the New York City-based REITs have had better year-to-date stock price performance. But I would argue the Howard Hughes portfolio is more diversified in states that are more likely to see net inflows of population like Texas, Las Vegas, Hawaii. So very interesting company. We are in the process of a CEO search, and I hope to have an announcement about that before the end of the year. Fannie, Freddie, Anthony, some significant developments in the very recent few days. Why don't you update us?

Sure. Thanks, Bill. So the most recent development for Fannie and Freddie was FHFA's publication of the final capital rule for those companies yesterday afternoon. The rule is largely consistent with what the regulator proposed earlier this year, but is a bit more conservative in that the risk-based capital requirement, which is a dynamic calculation, was raised by about 30 basis points to 4.25%. The fixed backstop leverage requirement was unchanged at 4% of assets. And under the rule, the GSEs must always meet the higher of the 2. So right now, the risk-based capital requirement at 4.27% of assets is the governing metric. What you see the market reacting to today is the fact that the capital rules finalization itself was a procedural hurdle that had to be cleared before any amendment to the preferred stock purchase agreement can be negotiated. Treasury Secretary, Steve Mnuchin and Director of the FHFA, Mark Calabria, have a 2-month window ahead of them before President Trump's term expires on January 20, in which they have a window to amend the preferred stock purchase agreement. This amendment is of paramount importance to facilitating the exit of the enterprises from conservatorship, as it could extinguish liquidation preference on Treasury's senior preferred stock, which has already been fully repaid with a return above the originally bargained for 10% as well as permanently and the net worth suite among other items. On January 20, President Elect Joe Biden will take office, which will entail a changing of the guard. Biden is expected to name a new Treasury secretary and also may be able to replace FHFA Director, M,ark Calabria, whose term expires in April 2024 and is currently only terminable for cause, but may become terminable without cause, i.e., at the will of the President, depending on the outcome of the Collins versus Mnuchin case, which is before the Supreme Court. Oral arguments on this case have been set for December 9, in which the parties will be arguing the lawfulness of the network suite, the legality of FHFA's structure and various other provisions. A final decision in the case is expected by June of 2021. While these administrative and legal developments are pending, Fannie and Freddie are continuing to build capital and remain one of the only major sources of mortgage capital for homeowners during the COVID-19 pandemic. The GSEs now hold a combined $35 billion of on-balance sheet equity capital, which is major progress from 0 in early 2018, albeit only 12% of the required $283 billion under the new rule published yesterday. The combined market share of Fannie and Freddie of new single-family mortgage-backed securities issuances was 75% in Q3, up 9 percentage points year-over-year, reflecting the enterprises successfully playing their traditional role of stepping up to support homeowners during times of economic stress. Thank you.

Apologies, I was on mute. We own these investments now for 7 years, and I probably sound like a broken record in our view that they offer a very attractive risk-reward. I think the events of the last few weeks and of the next 60 days, I think, present really interesting opportunity. But beyond -- let's assume the Supreme court case doesn't go in the favor of Fannie and Freddie, let's assume that Biden can replace Calabria, I think our view basically is -- we're not going to go back to a world in which Fannie and Freddie have 0 capital. I mean we think that they are on a trajectory to become well capitalized public companies. The question is over what time frame and how quickly. But we think both the common and preferred offer very interesting risk-reward. So Pershing Square Tontine Holdings. I'm not going to be able to say much here for obvious reasons. An entity where the most material development is when and what company we ultimately end up merging with, and I really can't give you information about that. But what I can say is when we took these entities public, our proposition was if we could create the most investor-friendly SPAC in the world, we could recruit the best investors in the world or some of the best well-known investors in the world and we could also -- and if we created the most merger-friendly structure in the world, we could find an extremely attractive company that would want to go public by merging with us. And you can now see a 13F list of our investors. You can form your own view on the ones that have to file 13Fs, but there are many extraordinary investors that don't file 13Fs, including sovereign wealth funds that own less than 5% of PSTH and a large number, in the dozens of family offices globally, billionaire family offices that have -- that bought stakes in the IPO. And we think this shareholder list will be and is actually -- will be an asset for us in finding a potential target. In terms of timing, what we said at the time of the IPO is we said it would take us, we thought, about 6 months to identify a target that we would in a position to hopefully announce a deal by sometime in Q1 and then close a transaction in the ordinary course thereafter. Nothing that we have experienced to date suggests that we won't meet our expected time frame. So with that, let me go to a few other topics. One, the hedge. We obviously had a very large hedge in February because of a very, very bearish view we had on the virus and the impact on the global economy and the fact that the markets were really unprepared and governments were unprepared. We unwound that hedge as spreads widened and as governments around the world, including our government, started to take steps to address the risks of the virus. And we reinvested the proceeds in the companies that we've been talking about today. Recently, we rebuilt a hedge in the investment-grade -- U.S. investment-grade credit, and I track European investment-grade credit for different reasons, basically because spreads have come all the way back to where they were when we initially put on original hedge and just spreads are at -- pretty close to all-time tight levels. If you look at the individual single names in the indices, we are at all-time tights or pretty close to it for most of the companies in the index. And so just as a stand-alone investment, it looks very asymmetric. But when you can find a stand-alone investment that looks asymmetric, but it also has a hedging benefit, if the unexpected and unfortunate happen, that's actually an attractive thing to include in a portfolio. So I would say we actually are quite -- pretty bullish on 2021. We think the next couple of months are unfortunately going to be tragic and very difficult for the globe and for our country in particular. A couple of hundred thousand more people could die. And these extraordinary numbers, we have basically a 9/11 everyday. We could head to that in terms of the number of people dying in our country. It's a horrible tragedy. But the progress of Moderna, Pfizer and the other vaccines suggests that in relative short order, the world will be vaccinated and we'll return to something closer to a more normal existence. And we've been saying the back -- second half of next year is really when things start to return to normal. We think that has increasingly become a very good estimate. As a result, we're happy to be very much long in terms of our equity exposure. But it does -- we do think having a decent-sized hedge very low-cost hedge is just prudent and while there's still uncertainty in the world, you can see the newspaper and on the Twitter feed everyday. We have about 13 minutes. Let me see if there's questions that have not been addressed. So it's fair to say, Pershing Square Capital is waiting on the sideline for a major market correction, the answer is no. We are keeping a large amount of cash on hand, and we are focusing -- the substantial majority of the team is working on PSTH, with our highest priority for creating value for our investors. Obviously, Pershing Square Tontine Holdings investors as well as our other funds will benefit when we identify and announce a transaction that makes sense. So we are -- that's kind of a full court press, and that's really the -- we found an extraordinary public market investment. We wouldn't be shy about making it. But most of our energy is directed -- nearly all of our energy is directed, other than monitoring existing investments, to PSTH. A question about the all-male nature of the Pershing Square investment team, which is something I've been frustrated by for years and not with an effort -- not without a strong full-court effort on behalf of the firm to find a candidate, prove the gender diversity of the team. So I'm actually quite pleased to announce that we shook hands, I guess, over the phone with a truly outstanding candidate just this past -- in the past few days, will join the Pershing Square investment team in September. She's absolutely superb candidate with a traditional Pershing Square background, sort of investment banking, private equity, one of the top firms. And we give a test, we give 2 tests. We challenge our candidates. And we collectively concluded that she gave the first test, which is a take-home on a business, she gave the greatest presentation of anyone that we can remember in this firm, including the current members in the investment team in terms of her application for the job. So we couldn't be more enthusiastic about her joining the team, and we think she'll be an important contributor. A question on ESG investment criteria, do we -- these issues we think about? The answer is yes. And our view is you want to invest -- putting aside moral, ethical considerations, which we -- we don't put them aside. But I think if you -- the good news is you can put them aside and still have an economic rationale for investing in companies like Chipotle that source their products from smaller farms that don't use antibiotics and other products that are bad for consumers. That's a very appealing proposition to a very large number of Americans. And as a big part of the success of Chipotle is the ethos of the company. I think the same can be said for Starbucks in how they treat their baristas, how they pay them, the health benefits, the opportunities for education. So I just think Lowe's has a very kind of public-minded ethos. And I think it -- again, it offers marketing and other kinds of benefits. So we avoid industries, which we think are causing economic harm and survival harm, and we invest in companies that we think are great businesses, that create value really for all of the stakeholders, customers, employees and, ultimately, shareholders. And we think that approach leads to the best economic outcome and also leads to the best survival outcome. A lot of the Pershing Square investments are currently in consumer discretionary stocks. Do you anticipate looking at more defensive ideas in the near future to mitigate some of the risks, along with the current credit spread protection that you have? We think the nature of the businesses we own, we try to find companies that can survive the great flood or now we'll say can survive the great pandemic. We're looking for businesses that regardless the economic environment, regardless of what's going on in the world, that these businesses will succeed over the long term. And we value our companies based on our estimates of the cash flows they'll generate over their expected life, which is why we invest in businesses with strong balance sheets, with dominant market positions, great brands, kind of unique assets that provide them with a competitive advantage. And the result of that is we were -- and our companies were prepared, if you will, surprised by, but prepared for the pandemic, just the nature of their business models. And the story -- when the story -- when the history is written, the economic history of 2020, it will be, fortunately for Pershing Square, about the success of the dominant, well-capitalized business. But unfortunate for the world, the challenge is for the smaller, less well-capitalized, less well-known businesses that are not as technologically enabled. And I think good news is coming out of the crisis would be one of the great -- actually even middle crisis, I read a piece today about the amount of entrepreneurship, personal trainers that went -- are actually making more money now in the pandemic world, because they've built their practices differently and they've gone direct to consumer, and they're using social media to attract customers. People are -- I think entrepreneurship is an inherent skill. This is one of the great times in the world in which to be an entrepreneur. And it will -- for all the restaurant owners that will unfortunately might lose a particular restaurant, this will be the best time in history to start a restaurant coming out of a pandemic with low rents, enormous demand and minimal competition. So the world will recover, but our very dominant businesses will to continue to succeed. With that, I'm going to end the call, and I encourage you, if your question was not addressed -- there are certain questions we can't answer on a public conference call because of regulatory considerations relating to our -- some of our offshore funds. Please direct those questions to Tony Asnes and Alex Kosslyn at our Investor Relations team. You can reach them at ir@persq.com. Thanks very much, and operator, we're going to end the call.