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

Next, let's hear from Ryan on Hilton.

Thanks, Bill. So Hilton had another great quarter when we reported results a few weeks ago. So for example, at same-store sales metric RevPAR was up about 7%, and the company opened new units around the world that are rated just in excess of 4%. So it's overall fee growth, which is the primary driver of revenue, was little above 12% and the company exhibited very strong operating leverage and cost control, which is something they've done very, very well historically. So as a result, EBITDA was up 14% and earnings were up even more attractively than that. But overall, the company is growing at a very rapid rate. I think to your point about, in terms of thinking of our businesses in terms of what happens if there's more of a slowdown or worse in the economy, we're very excited about how Hilton is positioned, both on a near-term basis, but also some of the longer-term trends. So for example, when I mentioned the 7% RevPAR growth, that's something that we would say is above the typical level we would expect for Hilton over an economic cycle. Our view is that, that RevPAR rate is probably about 3% to 4% annually, in kind of a stable economic environment. And the reason that it's growing more quickly now than that is, effectively, there are certain parts of the business that are still recovering from the pandemic. So overall, RevPAR is above the pre-pandemic levels. But when you disentangle that a little bit, it's really all pricing that is above the pre-pandemic levels. Occupancy is still slightly below, and therefore, a company as it's getting its hotels more fully occupied to where they were pre-pandemic, is still exhibiting some of that extra growth. So we actually think, for the better part of the next year or so, the company will get back to its normal levels of occupancy, but that should, over the shorter term, help the company grow at an outsized rate. And then longer term, we think a couple of the key drivers that should help them navigate any economic potential contraction or slowdown are still intact. So for example, one of the reasons why the stock has done so well over the last month is earlier in the year, people were concerned about the company's ability to continue growing its units at its historical 6% to 7% rate. The company has grown closer to 4% to 5% since it came out of COVID. That's really just because like any other business that was trying to open restaurants. You had lags and getting workers able to do it. Materials were harder to procure, and then for Hilton in particular, along with more businesses where franchisees build some slightly more expensive structures, as interest rates went up, some of the marginal builders of those things had to either pace themselves or not do the projects. All those things together meant the company was producing units lower than its long-term potential. This quarter, the company grew at 4%. They actually said they would -- in the year at a 5% growth rate, their line of sight, which is pretty good because they have about half of their units already under construction that are supposed to come into the pipeline. They said they'll be back at 5% next year. And then really be able to -- I'm sorry, 5% in this quarter and then close to 6% next year and then back to the historical trend thereafter. And so when you think about a capital-light business like Hilton, that can add 6% to 7% growth to its units, which is effectively going to be growing its revenue in its earnings stream without any capital. That's a very, very strong driver over the long term in really any economic environment. And then the second thing is, typically, the way we think about the company's business is, it's RevPAR growth plus its net unit growth, should be roughly what its fee growth is. But the company has pointed out that one of the things they're experiencing that they think will be a sustainable trend is they're actually growing fee growth a little bit in excess of that algorithm, if you will, because of 2 factors. The first is that the franchise fees that they're getting today are higher than the average in-place franchise fees they've had historically because the value of the brand has grown so much over the last 20 years that some of the people who used to have a franchise fee at a lower rate when they re-up or they roll-off, people come in at a higher one, that allowed them to grow even more quickly on the fee side. And the second is the credit card program. They basically partner with companies like American Express, where you have a Hilton branded credit card. And if you use that at Hilton, you get a lot of great value in terms of points, and freebies and things like that, that consumers love. But you also get some value when you spend on categories outside of standard Hilton hotels as well. And those programs have been enormously successful. And given the strength of Hilton's brand, people are spending a lot of money. And that part of the business is actually growing at a much more rapid rate even at Hilton's core lodging business. And so those trends, the company thinks will continue and allow them to grow even faster than sort of the typical RevPAR plus net unit growth. So when you put it all together, we feel pretty confident that the company will do very well both on a near-term basis, even if there's a slowdown or worse, but also on a long-term basis because of the capital-light nature of the business and just the enormous growth opportunity ahead. So we think that Hilton is very well positioned to continue growing its earnings very strongly like it did this last quarter.

Just a quick point on Hilton and the leadership team there. And we have really a lot of superb really outstanding CEOs at each of our companies just to sort of highlight, Chris, when I think about the challenges he's managed through, talk about a business that was affected by COVID. They used that opportunity to take a lot of costs out of a business that we didn't think was particularly flat at the time. They've maintained that discipline. Now they use technology to sort of automate a lot of functions at the hotel level, which is a better experience for the customer and of course, have higher margins for the for franchisee, which of course makes the brand, more profitable and valuable. So I think just operationally, I think, has done an incredible job. And then when you -- they've been also super progressive about really buying back the shares, understanding the value of a royalty on a growing portfolio of hotels around the world. And we think it's one of the best businesses in the world, it's got a little bit of volatility because of just the nature of the hotel industry, but superb team overseeing this asset has driven sort of enormous value. So we thank all of our CEOs for their contribution, but let's say, this quarter, let's highlight Chris and the team there for doing a superb job. Let's talk about restaurant brands, Feroz?

Sure. Thanks, Bill. So Restaurant Brands reported another quarter of improving underlying performance in its key home markets, while its international business continued its very strong streak of performance. So starting with Burger King in the U.S., the brand has seen consistently improving traffic trends throughout the year, with the latest quarter showing flat traffic on a year-over-year basis, while its largest competitors actually had negative traffic. This was all done in a quarter with virtually no help from its fuel-the-flame advertising fund, the majority of which is yet to be deployed. The biggest driver of this year-to-date traffic improvement has actually been operational improvements like low-hanging fruits such as increased frequencies of franchisee training before new product launches. So looking ahead, based on our work, franchisee sentiment is among the best it has been in years. And with the help of recent actions as well as the remaining dry powder in their reclaimed the-flame program available to them, Burger King should see continued traffic improvement and more consistent same-store sales in this coming year. At Tim Hortons, in Canada, the company's multiyear effort to grow both its afternoon foods business as well as its beverage platforms led to about 8% same-store sales growth, which are now up about sort of low-teens percentage above pre-COVID levels. The company has set up both of these as platforms, which they can further layer products on to, which we expect again in the coming year. Now looking outside its home markets, what often gets lost and forgotten about restaurant brands is its crown jewel international business, which represents about half of its unit count and the vast majority of its unit growth. Restaurant Brands recently began sharing more details about this great business, and we expect that it will begin reporting its international segment as a separate business. We think this is a fantastic step for the company as it will highlight the rapid growth the capital-light nature and hence, the immense value in this business. So despite all these positive business momentum points, the shares are still down about 9% from their peak in the summer which is primarily due to what Anthony mentioned earlier, some investors believe that the emergence of these weight loss drugs will have a negative impact on food and beverage consumption. I think Anthony did a great job covering all the points, but I'd highlight a few more relevant to Restaurant Brands. First, this is largely a Western phenomenon and less of an issue in international markets where both obesity and the ability to afford these drugs is lower. Restaurant Brands has 4 great brands, each at various stages of unlocking international growth, which again is outside the purview of this debate. Second, each of Restaurant Brands concepts offer a diversified menu. Being long-standing brands, they have decades of experience tailoring and tweaking their menus to suit consumer preferences, including in low carb and low fat options. Third, as Anthony mentioned, many of the data points that have come out so far are from studies from early adopters and with people with access to the best care. In reality, these drugs have serious side effects and achieving these results requires very strict compliance. We don't believe that the average quick service restaurant consumer, which frankly skews lower income, will have the same compliance, we'll see the same results or even have the same desire to fully cut out restaurant spending. And then fourth, remember, Restaurant Brands' P&L is also more insulated given it's a franchise business model relative to, say, a company-owned concept. Look, ultimately, consumers come to restaurant brands concept because of their craveable food, the convenience and the value. And we think all of that is still a very compelling proposition, even if some small percentage of its consumer base permanently begin taking these drugs and curtailing some restaurant spending. The good news is that the company used a temporary weakness in its share price to resume its share repurchase program at a very advantageous time. So in just 2 months, in September and October, the company repurchased just under 2% of its shares outstanding. And so while the stock has partially recovered from these October lows, we still believe the shares are very cheap as they trade at less than 20x next year's free cash flow, and this earnings phase actually includes some of the investments they're making in the [ BKUS ] system. So it's even cheaper on that, excluding those investments.

Just a reminder in terms of how we -- our kind of favorite businesses in the world are what we call growth annuity. growth royalty-type businesses, Hilton, of course, a royalty on hotel rooms and F&B and hotels. Restaurant brands a royalty on the underlying brands, 5% gross revenue royalty. Alphabet, Google is basically a royalty on advertising spend, they are sort of capital light and then universal, of course, a royalty on music streaming. Those are our favorite kinds of businesses, and they tend to be our larger positions. As a result, I failed to mention Hilton's total return this year is 32.6%, I guess, through our last reporting period, which was Tuesday. And Restaurant Brands 11.2% total return. With that, let me turn it over to Charles, and Charles is going to update us on Lowe's.

Thanks, Bill. So first note that Lowe's actually hasn't yet reported Q3 earnings. They shifted their reporting calendar by a week. So they're going to be reporting next week. Therefore, I'm going to limit my comments to kind of broader perspective on Lowe's and the home improvement industry without specific reference, of course, to Q3 results. But to begin, just touching on the macroeconomic picture, which remains the core debate on Lowe's stock today. So in recent quarters, industry-wide sales have retrenched modestly from highs established in kind of late 2021, 2020 -- early 2022. And specific to 2023, this has been driven by record lumber deflation, moderation in DIY discretionary demand and in particular, with big ticket items, and the mix shift from large to small pro-specific projects and a general trend of consumers reallocating budgets from goods to services. Despite that same-store sales growth when viewed in comparison to 2019 is still roughly 30% above the 2019 baseline levels. And now that captures a lot of underlying inflation in the kind of core retail dynamics in certain mix shift in ticket, it also represents significant growth in Lowe's online business, which has more than tripled on a dollar value basis over that period of time and share gains with the pro customer which has increased from roughly 19% to roughly 25% of their customer mix today. But that's kind of just setting the stage for the environment in which they're operating this year. One observation we'd have about 2023 in particular, is -- and this should come as no surprise, but in response to kind of the interest rate tightening cycle and higher corresponding mortgage rates, existing home sales have declined precipitously over the last 18 months, and is now sitting below $4 million annualized unit. And this is relative to a normalized baseline of probably in the mid-$5 million unit range. Or ordinarily, volatility in existing home sales would not have a meaningful impact on the home improvement industry. However, we believe that the pace and the severity of the recent decline is partially responsible for some of the acute pressure that the home improvement industry is experiencing in recent quarters. And moreover, given the lack of existing homes available for sale and high mortgage rates, the switching costs are much higher for existing homeowners, and there was an expectation that there would be higher levels of in-place renovations this year, and that has not really materialized. Now against this backdrop, Lowe's same-store sales growth in recent quarters has been modestly negative, offset by material margin expansion and the benefit of Lowe's best-in-class share buyback program. And we believe the earnings are likely to end the year down roughly low single digits versus 2022. In Q3 sales in particular, when they're reported next week, are likely to be on a headline basis, the weakest headline number for the full year as both Lowe's and Home Depot are growing over challenging prior year comparables. And so for context, Home Depot, the other day reported same-store sales growth of negative 3.5% in the United States, and they noted that their DIY-customers were modestly weaker than the pro-customer base. And for Lowe's, the DIY-customer is a larger share of their customer base, you would expect them to underperform Home Depot in a quarter like this. We think that's already kind of priced into the market. We'll talk about that in a moment. But reflecting a little bit on 2024 which is what the investor base is focused on, there does remain significant uncertainty as to when revenues are like to positively inflect. I'd note that key measures of industry spend, including retail sales data and personal consumption expenditures have now largely normalized to pre-COVID averages, particularly when you back out some of this existing home sales dynamic, you can see on an underlying basis, the core repair business is pretty close to 2019 averages. Now this is despite a host of qualitative reasons, which would argue that relative spend on a go-forward basis. should be actually structurally higher than pre-COVID averages. And so while the near-term macroeconomic picture remains uncertain, we continue to be very favorable on the medium-term outlook and backdrop for the home improvement industry. These variables include historically old housing stock. The median home is now older than 41 years old. Baby boomers increasingly aging in place. Millennial cohorts entering home ownership for the first time. A national housing shortage and a general lack of new builder inventory. Continued post-COVID-19 hybrid work-from-home and still high levels of home equity when viewed in contrast to 2019. Moreover, for Lowe's in particular, we're very constructive on their ability to continue to execute against their transformation initiatives over the coming years. And so to that end, Lowe's continues to make progress on various business initiatives that should aid the company's ability to improve market share, generate accelerated revenue growth and expand margins. We remain optimistic about Lowe's ability to increase its earnings from current levels over the coming years. And in that context, we think the stock is very cheap. It's trading at roughly 15x earnings today, which is a low multiple for Lowe's relative to history and also a significant discount versus Home Depot at current levels. And we believe that when investors -- when some of these concerns on the near-term macroeconomic picture ease and people once again focus on Lowe's long-term earnings power, the share price will appreciate substantially.

What is the kind of rating gap between Home Depot and Lowe's on valuation?

Lowe's is trading at 15x roughly, Depot is trading roughly 20x today. So it's roughly a 23 percentage point delta in relative valuation.

And what's the argument for that gap?

I mean the argument in the current environment is basically what you're seeing is that there's more weakness in the present environment with the DIY-customer than the pro-customer. So if you look over the last number of years, Lowe's outperformed in 2020 because there was more DIY activity when people were locked down and sheltering in place. And then 2020 -- sorry '21 and '22 you saw larger pro projects, major remodels, deck extensions, redoing the backyard where pros were very involved, backlog, long backlog, difficulty in getting labor. And so Home Depot outperformed in '21 and '22. And that trend has been kind of narrowing and the delta between pro and DIY has been narrowing, but still persists today. Depot also has higher share of Pro. It's roughly 50-50 for Depot where Lowe's is 75-25. So when you have differential growth characteristics of the underlying customer base, that manifests itself in different same-store sales growth in the current environment. Now what's interesting is if you look at it on a 4-year stack basis relative to 2019 levels, the aggregate performance is like very similar. It's more the headline numbers. And then when you drill down a little deeper, you have Lowe's, which continues to expand margins in the current environment and has a significant opportunity to take margins up to 15-plus percent over time, which they've articulated and best-in-class capital allocation. Where they're buying in roughly 7% to 8% of their share count. Conversely, Home Depot's margins have actually been moving in the wrong direction for the last year, and they've been making SG&A investments and they're starting from a higher base. So there's a total disconnect on earnings, but it seems that myopically people are very focused on the same-store sales growth. And there are potential...

It doesn't seem to be -- I mean, we've had this multiple gap between the 2 companies since we made the investment. It's been a persistent 5-turn discount or something like that, 4- or 5-turn discount. Right? And at some point in the cycle, they had an advantage from a DIY perspective. Now that you could argue they have a disadvantage. Charles, it makes no sense.

I agree. I think when they had an advantage, it was so early in COVID that there was an element like this isn't sustainable so that no one ever like capitalized that advantage into perpetuity. And I think in the current environment, Home Depot is viewed as a safer hiding stock. They're also still much larger on a both market cap and on a revenue basis. And I think there is an element to or usually the market leader trades at a premium in many industry, as I think there's some truth to that. Our view is that with just great execution and continuing to execute against their playbook, I think that over time, Lowe's will be more fairly valued. In the interim, they're buying back roughly 7% to 8% of the market cap. And so that's accrues to our benefit for now.

So Lowe's is a modest contributor at 3.6% total return, most of that being the dividend year-to-date. With that, let's go to Ben on Howard Hughes.

Thank you, Bill. Howard Hughes continued to deliver strong financial results with resilient demand across its core portfolio of master-planned communities or MPCs. As we've discussed, these MPCs are located in sought-after low-cost, low tax and pro-business states, which continue to benefit from strong immigration trends. Howard Hughes had a sharp increase in new home sales in its communities with new sales up 113% year-over-year in Q3, which serves as the leading indicator of future land sales. As Charles talked about, the surge in new home sales is driven by a lack of resale inventory as existing homeowners remain reluctant to give up their low-rate mortgages. This dynamic led to robust demand from homebuilders and record average price per acre sold in its communities. In Q3, average price per acre was up 16% year-over-year, driven by Summerlin, Las Vegas and Bridgeland Houston communities. As a result, Howard Hughes substantially increased its full year MPC EBIT guidance midpoint to $325 million, which would be a record level for the company. In its operating asset segment, Howard Hughes had positive leasing momentum across its 3 core property types, office, retail and multifamily with a low single-digit net operating income growth across its portfolio. Given stronger-than-expected leasing activity, Howard Hughes also increased its full year operating asset NOI growth guidance to 2% to 4% for the year. And in its Ward Village Hawaii community, Howard Hughes continued to make tremendous progress in condo sales with more than 98% of all of its condo units sold or under contract. Company has 4 condo projects under development, which they expect will generate $2.5 billion of future revenue between 2024 and 2027 at attractive gross margins. While the core MPC business is performing exceptionally well, results of the Seaport in New York remain challenging. Howard Hughes experienced continued losses at the Seaport as they try to stabilize the Jean-Georges operated team building. Continued challenges of the Seaport led to an impairment analysis in Q3, which resulted in a noncash after-tax charge of $555 million. Howard Hughes also announced the formation of a new division called Seaport Entertainment, which will own Howard Hughes's entertainment assets in New York and Las Vegas. Conjunction with the announcement Howard Hughes hired Anton Nikodemus, a seasoned and senior executive at MGM and to run Seaport Entertainment and they intend to complete a spin-off of these assets by year-end 2024. This will allow the company to focus its attention on its extensive pipeline of growth opportunities within its MPC business while Anton and his team will focus on unlocking the value of these unique assets in a stand-alone company. And as with most real estate companies, a significant amount of investor focus is on the balance sheet given the current interest rate environment. Howard Hughes ended Q3 with nearly $500 million of cash and only $256 million of remaining equity needed to fund current projects in development. And amidst the capital markets environment, the company was able to extend or refinance the loans in 4 properties, which extended its weighted average debt maturities to approximately 6 years with limited maturities in 2024. In summary, while the core MPC business continues to perform well, the stock has underperformed the market this year due to continued elevated interest rate environment and the near-term challenges around the Seaport. But we believe Howard Hughes is well positioned to navigate these challenges while taking advantage of the enormous future opportunities in its MPCs.

Thank you, Ben. I think another thing I would point out here is, Howard Hughes has a fair amount of office exposure, that's an asset class that investors and real estate investors, in particular, today are very cautious about. I think the difference with Howard Hughes' portfolio is that the assets we own -- it owns, are in these little cities and where people actually like going to the office because the commute is easy and the occupancy levels as a result have remained high and actually leasing activity has been strong. So it's a really differentiated kind of story. Obviously, we've been a very long-term investor in the company. We bought a lot of shares earlier in the year. And then over the course of this year, we've had an ongoing 10b5-1 buyback or buy-in program, which has increased our stake into the company -- increased our stake in the company to about 36%. We like the business. It is a complicated story for Wall Street, but should generate a lot of intrinsic value, and compound it at a nice rate over a long period of time. Canadian Pacific, Manning?

Thanks, Bill. So the CPKC team continues to make great progress on synergies and network integration as they start to unlock the vast potential of its Canada, U.S., Mexico single-line network. At the combined company's inaugural Investor Day in late June, management established a set of very exciting financial targets, including a goal to more than double their earnings per share by 2028, while holding CapEx close to current levels, which implies that average free cash flow per share growth of nearly 20% per year through 2028. To address one of the questions received on what the growth profile might look like beyond 2028. We think robust growth will likely continue even beyond that period. As Keith likes to say, CPKC is only day one into their forever story, right? The story doesn't obviously end in 2028. We think a lot of the secular growth drivers come for the business, including taking trucks off the road, moving freight to rail and increased near-shoring investment in Mexico are just in their early innings and will definitely continue kind of beyond their production period. So while the long-term financial profile is obviously very exciting. Q3 results this quarter were impacted by several near-term challenges, including a port strike in Vancouver as well as the outage at a major customer facility. As a result, revenues in the quarter were down 4%, which included a 3% decline in volumes as well as a 1% headwind from price and mix, fuel and FX. Management, however, did a great job controlling what they could on the cost side, with total expenses down 1% and earnings per share down 9%. This was obviously a very challenging quarter for the company. But I think importantly, it doesn't change our view of the long-term growth story and it doesn't also change our view, obviously, at the Investor Day financial targets. In fact, the team has already delivered over $350 million of run rate revenue synergies. They're ahead of plan on their cost synergy realization. And we believe that the company's growth story remains very unique kind of in this industry. In addition to the challenging quarter, some Mexican regulatory headlines has made the news recently and have definitely contributed to the recent weakness in the share price. So as a little bit of background, the Mexican President recently announced his intention to start a passenger train system in Mexico that would run on tracks that are currently used by the freight railroads. I'll caveat all of this by saying that everything is highly preliminary. The details of this plan as well as the time line for any implementation are still to be determined. But I think there are several factors at play here that we believe if any changes do happen to how the system operates today, will be very manageable from the CPKC side. So first of all, the President's term expires in September of next year and he is not eligible for reelection. Trains has been one of the priorities of his administration, but the new administration, could very well, obviously have different priorities. Secondly, I'll say that it is in Mexico's economic interest to continue growing cross-border freight rail traffic between Mexico and the U.S. to grow their economy. And that interest is obviously highly aligned with CPKCs. Third point I'll make is, there are plenty of examples across the continent of passenger trains and freight trains coexisting peacefully on the same tracks. For example, in the U.S., Amtrak actually operates primarily on tracks that they don't own. The tracks are actually owned by Class I freight railroads. And then the last point I'd make on this topic is CPKC CFO spoke at an Investor Conference yesterday, where he made the point that there will be no near-term impact whatsoever from this regulatory change, and that any long-term changes will definitely depend on the new administration, what their priorities are as well as the result of the feasibility study that CPKC is currently conducting on the feasibility of passenger trains on a very small portion of their network around Mexico City. So as with all these regulatory changes, the devil is in the details. So we're definitely paying very close attention. but we don't believe this to be a major issue at this time.

Thank you, Manning. We're huge fans of Keith Creel and the team here. We've known them a long time. We made our initial investment in Canadian Pacific in 2013. So I guess, a decade ago and then had the opportunity to meet Keith when we recruited him away, from Canadian National and like with Hunter. He's an under-promiser over-deliverer. So we look forward to his continued leadership of the company. Negative performance, it was a 4.4 percentage point detractor or total return for the year and Howard Hughes is down 2.5% year-to-date. Now let's just talk about [indiscernible] on the economy. I'll turn it over to Ryan and Bharath, maybe I'll jump in. What are our thoughts on the economy. We've done a number of hedges over time. Actually, interestingly, maybe not so interestingly, we have mark-to-market losses this year or modest ones on some of our interest rate hedges because at year-end -- last year, our 30-year hedge was worth approaching $500 million. We ended up exiting at a number closer to $300 million. So we actually had a meaningful mark-to-market loss there, although a very successful investment versus our original cost. But maybe you can speak to how we're positioned today and why?

So I think maybe just stepping back for a second. One of the things that we've been increasingly doing over the last handful of years is trying to really pay close attention to the economy across really 3 different buckets. So we've always -- we cover hundreds of companies here and really try to pay close attention to what they're saying about their businesses, but also in looking at so many companies, you can get a pretty broad read-through from the company's about how they're thinking about what the future might hold, what they're seeing in their businesses on a real-time basis and a lot of the concerns that they have. And I would say across that first vertical really over the last 4 to 6 weeks, we've been hearing a lot of companies increasingly talking about how they think that consumer spending is starting to slow and that they're also when they look at their own employees, their wage gains are starting to slow, inflation is coming back down pretty meaningfully and consistently. And you've seen that a lot, over the companies that have reported, in particular, in the last few weeks, even Walmart this morning was talking about how it was becoming more cautious on the consumer because of the things they've seen really within the last couple of weeks to last month. The second bucket is what they call the soft government data, which would really be surveys at the Federal Reserve and other government agencies put out that really ask qualitative questions to businesses and the consumers and other folks about how they're feeling, how they're spending and what their thoughts are. And I would say those first 2 verticals, they've indicated a slowdown in the economy. And that does not mean necessarily if there's going to be a recession or contraction, but rather that I think, some people have thought that the economy might have the risk of reaccelerating. And to us, those first 2 kind of buckets that we look at, suggests that there is more likely to be a slowdown in the economy. And then the question is, does the slowdown turn in anything or more or not. The history often suggests when inflation is as high as it was a year to 2 years ago, when the unemployment rate starts rising above a certain level, the combination of both of those things generally make it difficult to navigate and people now term kind of to be the soft landing or getting inflation back to target without causing recession. So I think we've started seeing some signs that things are a little weaker than what people may believe. And then there's a third bucket, which is the hard government data. And that's one where I think a lot of people are deriving comfort that things seem good, large retail spending, large GDP, some employment reports that historically have been very elevated. But our view is even on those when you look underneath the hood, for example, unemployment -- employment rates are starting to come down a little bit. If you look at what employment levels are, they look slow, modest slowdown. But underneath the hood, there's not a lot of dispersion in sectors that are growing. In fact, there's actually just a handful of sectors that are driving a lot of that growth. And that may be because they're still catching up to their pre-pandemic levels. And when that levels out, you could see more weakness than what it appears on a surface level. So at a high level, we've got a lot of different data points we look at. We think a lot of them are indicating a slowdown. And so what's interesting about that to us, is when we kind of think about what are we looking for to hedge the portfolio. We often ask ourselves, what are we most concerned in the economy? And really, for the last 2 to 3 years, it's been -- we were concerned that inflation was too high. That would cause interest rates to ultimately be significantly higher. And that interest rate increase could be something that would cause a markdown in our equities by causing a contraction in the PE multiples. I would say, while we still think there are some reasons over time that fiscally, we have some challenges, which could impact long-term rates, what's been, I think, more on our minds now is looking at where the consumer is, looking at where the economy might be, and we're starting to think, for the first time really about some of the downside risk of the economy. And if there are any hedges that we should put in place in addition to consumer slowdown, there are growing risks overall, whether it's geopolitical risk that we've seen or even just the fact that long-term rates earlier kind of this fall have increased so rapidly. A bank failure in U.K. about a year ago, some very publicized pension failures. So I think we're mindful of those things. And we think a lot of the risk is going forward could be to the downside in terms of hedges. So one of the interesting things is really for the first time since the Fed started hiking rates in last March, we kind of have most interest rate levels, both the federal funds rate is at a high. The 2-year note over the last month was close to a high, 5-year note was close to a high. So people were expecting that interest rate policy would remain very, very tight. And our view is that inflation was starting to come back down, still above target. And the economy was starting to slow, but we're making a lot of progress. And then the question is, do we have a soft landing or something worse. And so against that backdrop, I think that the shorter-term interest rates have been quite elevated relative to their history since the Fed has started raising rates. And our view is that it may be the case ultimately that where the interest rates end up a couple of years from now could be a fair amount lower than what the market is pricing. So we saw an opportunity to do what we always try to do, which is be able to buy instruments which protect our downside risk, but also have asymmetric upside. If the scenario that we're concerned or think might play out ultimately comes to fruition. And I think we've kind of started seeing that recently on some new investments that we have made to really protect ourselves against the risk that there could be either interest rates come down a little bit because the Fed just doesn't need policy to be so restrictive. As inflation comes down or if there's some sort of accident or other risks that really poses outside external risk to the economy and the Fed immediately needs to lower rates. And so I think our portfolio now is well protected in an asymmetric way from some of the risks that we're starting to see that could be developing in economy really over the last kind of 4 to 6 weeks.

What I would say here is macro type, the sort of asymmetric hedges, we -- I would say, thought about and executed very, very episodically over the history of the firm. What's changed, I would say, beginning with the COVID-hedge and then is really a dedicated focus to this what you might call asymmetric macro type investments. And myself, Feroz, not Feroz, excuse me, Bharath, and Ryan are sort of our little mini macro team in the firm. And I would say Ryan and Bharath have done an outstanding job really covering the space. We find it very synergistic with our day job, right? We're looking for the best businesses in the world, these sort of durable growth companies. But having a view on the economy could help us. We find a really great business we want to own. Can that actually help us think about the right moment in which to enter, start buying shares because markets, particularly stock markets tend to be very short-term kind of oriented and can move on the basis of economic data. So we find a lot of value in tracking what's going on in the economy, finding interesting occasional asymmetric investments, of which we're, I'd say, finding a lot more today. Some of that's a function of a very volatile -- the world that we're living in. But we really like the -- it's very comforting to own a portfolio of these very well-capitalized, dominant growth companies and then to own these sort of interesting asymmetric hedges that protect us from unexpected, or events at least the market doesn't expect to happen or what you might call, in some cases, Black Swan type risks. I failed to discuss Fannie and Freddie. Really nothing of substance to report in terms of the business operations during the quarter. These are remarkable, amazing businesses. They remain in conservatorship. All of that being said, they're the 2 best performing equities in the portfolio. Freddie Mac and Fannie Mae, up 77% and 105% total return year-to-date. I think what that can be attributed to is; one, one of the major holders other than us, I believe, exited their position almost regardless of the price over the course of last year going into the end of last year, which drove the prices down significantly. And I think these are very interesting options on their exit from conservatorship. I think we are by far the largest holder. And we've had the view that if Trump or a Republican president is elected, it is likely that conservatorship will end the path to exit conservatorship begun by Treasury Secretary Mnuchin will, we think, be continued in a Republican administration. So it's a bit of a play on who the next or at least what party the next president is coming from. And I think that's somewhat reflected as one of the more interesting options on the election outcome. We think it's inevitable. They [ merge ] from conservatorship. They're continuing to recapitalize themselves by just generating profits. Anthony, what's the latest -- you have the capital levels end of quarter?

Yes. So as of the end of Q3, they held total capital of on a combined basis of about $102 billion. That excludes the value of some deferred tax assets, which they can't count as capital. The capital ratio as a percent of adjusted total assets is about 1.2%. Under the current capital rule you need to get to 3.8%. So it's incremental capital of about $215 billion. So ways to go, but they're making progress every quarter.

Okay. Great. Last but not least, I just want to talk about Pershing Square SPARC Holdings. As you know, we invested -- or we created a SPAC or Pershing Square Tontine Holdings in middle of 2021 -- I'm sorry, 2020. And then we entered into a deal to acquire a large stake in Universal Music in July or so or mid-2021 and then unfortunately, we're not able to close the transaction in the SPAC as we could not get through an SEC review in time to close. We purchased that stake directly at Pershing Square in the funds plus a co-investment vehicle. And we told our investors in the SPAC that we would give them, if you will, a free option on our next deal, a kind of thank you for being our partner, unfortunately, couldn't get that transaction done. And we began a process that took 2 years and $10 million and 15 amendments with the SEC. But finally, the registration statement for Pershing Square SPARC Holdings went effective, which means we can start looking for potential companies to acquire. We then distributed rights to all of the holders who held Pershing Square Holdings -- sorry, Pershing Square Tontine Holdings to the end of its life and that rights distribution is sort of underway. Many people have already received the rights, but we've kind of immediately once it went effective, we started looking for potential companies. Actually, our approach has been to let the kind of banks know that we exist. And we've had some conversations with the major private equity firms. And the good news is we, I would say, had a very positive reception in both the investment banks as well as a number of private equity firms are starting to show us potential transactions. And the phone, if you will, is ringing on our end differently from the SPAC world, where you had to sort of make a lot of phone calls on your own. So when people express an interest, they're already open to the idea of a transaction. And the really interesting thing about SPARC is we can basically effectively guarantee someone they're going to go public. We can guarantee that they're going to raise the minimum amount of capital, the capital that Pershing Square commits. We'll commit that capital at a fixed price per share, a fixed valuation and then we can raise up to an additional unlimited amount of capital, no underwriting fees, pure common stock capital structure. The only differential security we own is what is called a contingent warrant that we paid $36 million for that's 20% out of the money compared to price -- the transaction price for the merger. And we only receive that 20% of the money warrant in the event the rights that are held by the former Pershing Square Tontine holders get exercised. So if all the rights get exercised, we get our 5.1% warrant. We got a little under 5%, the balance going to some adviser directors. And if half of those rights get exercised, we'll get warrants on 2.5% of the company. But we have very good reason to believe that as long as we do a good transaction, ideally a great transaction, which we expect to do, all those rights will get exercised because it's a friction-free way to go public. We're going to be committing a large amount of capital on the same terms, same price as the other rights holders. We will have the benefit of true private company or private equity style due diligence, which will be -- form the basis for our investment. And we happen to be in a market environment which is effectively impossible for a company too, if you decide that you want to go public today, it's an enormously uncertain environment. And so we own this entity, and we're the only game in town if you want to go public and know for certainty you're going to go public, and there is no public announcement until such time that you know it's a certainty you're going public -- you're raising a minimum amount of capital from us, which could be a substantial amount of capital, a decent size IPO on its own, and the potential to raise additional equity with the only contingency just the SEC review of the -- what effectively would be an IPO like prospectus. That has to go effective. So we have to go through a common period as you do for any IPO. So if you own or an investor in or know of an interesting large, I would say, minimum size is probably in the $5 billion enterprise value range for company, bigger is probably easier. Minimum equity check would be $1.5 billion, and that could either be primary or secondary shares. You give us a call at Pershing Square. Anyway, we went over a few minutes from our normal 1-hour call. We are grateful for your long-term investment, and we thank you very, very much. Have a nice day.