Thursday, October 10, 2013

Shorty, Shorty, You're Blowing My Mind

Whether it is a result of Pershing's sleight of hand or the fact that we're all idiots (of which I'm often accused), there seems to be confusion around how Ackman went about restructuring his short position. It seems some people were looking for a precise reduction in the short interest that would be in lock step with Ackman's covering. This is not the case. In the same time period that Ackman was covering his short, an additional 2.1M shares were freshly sold. Also, there was a very large block trade of 3.1M shares that printed after hours on September 30. If you take the currently reported 24.5M shares short and 

  1. add back the 2.1M newly shorted shares
  2. add back the 3.1M printed after the close on 9/30
  3. subtract out the 4% of the SI that is typically covered every day under normal market ops....
That puts you at 28.5M shares, or pretty much right back at last settlement period's short interest of 28.6M shares, which is not at all surprising.

There are also some very interesting clues contained within Ackman's letter. In this letter he states that his Herbalife short position has been reduced from 16% of his assets to 12% of his assets. With this statement he virtually draws us a map from which we can render what his position looks like. Pershing's AUM was $10.8B and we know that Herbalife consumed 16% of that book, or $1.73B. Being short 24.5M shares at $50.50 places $1.2B on the book and Reg-T would require that he post 50% collateral, or ~$600M, placing his former position at $1.8B (or 16.6% of his capital) and his restructured position at ~$1.2B (remember this number).

He goes on to state that "in recent weeks we have restructured the position by reducing our short equity position by more than 40% and replacing it with long-term derivatives, principally over-the-counter put options...." and that they were "able to purchase long-dated, privately negotiated out-of-the-money put options on terms that offer us an attractive opportunity for profit versus their cost."

Importantly we are duly informed by Ackman's letter that they bought puts and that these options are out of the money. In his usage of "principally" Ackman raises the possibility that he also purchased exchange traded puts, or that he also sold calls(either OTC or on an exchange). 

By restructuring their short, Pershing square realized a loss of $198M on the 9.8M shares that they covered. Using exchange traded options as a pricing surrogate for the price Pershing would have paid for what they characterized as "principally over-the-counter put options" we can estimate he would have paid approximately a $98M premium to establish the right to sell Herbalife at $50/share. The premium Ackman likely would have paid for Jan 2015 puts is roughly $10.50/contract. Now, if you cover 9.8M shares and are left with 14.7M shares at $50.50/share, that puts his short at $742M with $371M required under Reg-T, or $1.1B capital at work on the position. If you add the $98M I believe he paid to open his puts on top of the $1.1B he has working on the equity short, that arrives squarely at the $1.2B he has working on Herbalife (12% of his capital). 

The premium Ackman paid for Jan 2015 puts struck at $50 would require Herbalife to break $40 for him to be in the money at expiration on those options. To subsidize the $198M realized loss as well as to recoup the $98M premium on the the puts he purchased, Herbalife shares would have to decline an additional $20.13/share beyond their previous average price of $50.50/share for Pershing Square to break even on their restructuring. Even if Ackman's counterparty GAVE HIM THE PUTS FOR FREE, Herbalife would still have to decline $13.47/share beyond Pershing's previous average to $37.03/share for Ackman to break even. In light of this, I find it particularly amusing that he would characterize a $4.16/share increase (to the analyst average price target of $77) as being a less attractive investment than a $35.81 crack to the downside. If he in fact PAID HIS COUNTERPARTY for the puts like all the rest of us schmoes have to, he'd need a $42.47 reversal just to be even stevens. 

I am often dumber than people claim I am (which gives me too little or too much credit depending on your point of view), but I have a hard time believing that Pershing Square investors are excited about a concentrated position in a stock that has to get cut in half before they break even, knowing that earnings are coming, audited financials are coming and a massive share repurchase may be on the way.  Regardless of what Ackman may have us all believe, with an effective short interest of at least 36%, and an earnings beat on the horizon, things may be easy peasy Ackman squeezy after all. Because Ackman restructured his position and lowered his breakeven from $50.50 to $30.37, Pershing square is in an even more precarious situation than they were before. Ackman's balls are in a very delicate situation right now, and I would not be at all surprised if the Street and Herbalife decided to give them a little squeeze.

No comments:

Post a Comment