Investors widely interpreted Bill Ackman's abrupt exit from Valeant Pharmaceuticals International Inc. this week as a loss of faith – and, therefore, yet another sell signal for the beleaguered shares.
But there was a compelling reason for the trade, regardless of the company's prospects: The tax benefit to Mr. Ackman's hedge fund greatly exceeded what it would likely gain by sticking it out with the company. That means the news of Mr. Ackman's sale means little for whether bottom-fishing investors should pick up the shares, which are now testing remarkable new lows.
At the risk of taking shots at an investor far wealthier and likely smarter than I, it may be the first wise move Mr. Ackman has made with Valeant. Many Canadians may have first learned of the Ackman acumen when he bought into Canadian Pacific Railway Ltd. in 2011, ultimately reaping a nearly fourfold gain when he sold his shares last year. However, they've now been attuned to first-class disasters in his short-selling campaign against multilevel marketer Herbalife, and his muscular defence of Valeant, where he ultimately joined the board of directors.
The bottom line: While Mr. Ackman's Pershing Square Holdings posted a return of more than 40 per cent in 2014, nearly tripling the return of the Standard & Poor's 500, the fund posted a 20.5-per-cent loss in 2015 and another 13.5-per-cent loss in 2016, according to company documents.
Valeant, down a shocking 93 per cent from Pershing's average cost at the announcement of its position, is the largest contributor to that problem. News reports suggest the Valeant position was a frequent topic when Mr. Ackman met with investors in his funds – and that Mr. Ackman may have simply tired of defending the holding. ("Strong operational execution and new product launches coupled with deleveraging should drive equity returns from current levels," Pershing said in an investor presentation a few weeks ago, and Bloomberg News reported he defended the investment at a Feb. 28 client lunch.)
Regardless, the news this week Pershing had taken its position from more than 18 million shares to nothing shocked the markets, sending the stock down more than 10 per cent to new lows. A number of analysts cut their target prices. BMO Nesbitt Burns analyst Gary Nachman wrote, "This was a time when it would have been more ideal for the top shareholder to continue to support these efforts rather than 'throw in the towel' when the stock is so depressed."
Here, however, is what Mr. Ackman has that most investors do not: A massive, previously unrealized, long-term capital loss that can be applied against gains from the stocks he actually gets right. Bloomberg estimates Pershing's overall loss on Valeant at more than $4-billion (U.S.). A little digging through Pershing's filings with U.S. regulators suggests the 18.1 million common shares of Valeant he sold on Monday cost him – and this is a rough estimate – around $2.8-billion. His proceeds on Monday were on the order of $200-million.
That's a loss of around $2.6-billion. At the long-term capital-gains rate of 20 per cent, however, that loss has a value of more than $500-million. With nearly $11-billion in the Pershing funds at the end of 2016, that could keep the funds from paying any capital-gains taxes for two to three years of double-digit returns, if Mr. Ackman can find his way back to them.
Was the capital loss the biggest motivating factor in the sale? We'll see if Mr. Ackman comments. However, to get the same value from an actual gain in Valeant shares, Pershing would have needed to see the stock triple to more than $40, I figure. And, it is not well known, but Pershing has sold Valeant stock for this purpose before: At the end of 2015 and 2016, Pershing sold a total of more than eight million Valeant shares, explicitly saying in regulatory filings that the sale was "in order to generate a tax loss for [Pershing's] investors."
Now, then, what does this mean for whether or not you buy Valeant? That is a topic in and of itself. The easiest thing to say is that the purchase of Valeant shares is best done with "play money," capital an investor can afford to completely lose. The shares of debt-heavy companies with deteriorating financials and opaque results can blow past 80-per-cent and 90-per-cent losses and ultimately generate a 100-per-cent wipeout. Valeant may ultimately avoid that, and any kind of rebound would likely reward those who swoop in on this vulture opportunity.
But the company's most recent financial update suggested the road is as long and hard as it's ever been. There are plenty of reasons to avoid the company's stock – but Mr. Ackman's tax-advantaged selling, and the end to his sad, misguided involvement with Valeant, isn't one of them.