Ackman-Roth Scored With Sears Before J.C. Penney Debacle

Pershing Square Capital Management LP CEO William Ackman
Pershing Square Capital Management LP Chief Executive Officer William Ackman has had to contend with a default claim by the retailer’s bondholders, the wrath of billionaire investor Carl Icahn, and a host of money managers betting against Pershing Square’s positions. Photographer: Scott Eells/Bloomberg

Just when it looked like 2013 couldn’t get worse for hedge-fund manager William Ackman, one of his longest-standing investment allies is abandoning ship.

Developer Steven Roth last week sold more than 40 percent of the J.C. Penney Co. shares that his Vornado Realty Trust acquired in conjunction with Ackman’s Pershing Square Capital Management LP in 2010. Vornado, which joined Pershing Square in winning wagers on McDonald’s Corp. and Sears Roebuck & Co., is cutting its stake after J.C. Penney’s declines left his firm and the hedge fund with combined losses topping $800 million.

Since January, Ackman has had to contend with a default claim by a group of the retailer’s bondholders and bets by Carl Icahn and other well-known money managers against Pershing Square’s investments at J.C. Penney and Herbalife Ltd. The exit took Ackman and the company’s other directors by surprise and could make it more difficult for J.C. Penney to raise cash to complete a turnaround after reporting net losses of more than $1.2 billion in the past six quarters.

“They had a seat at the table and know what was going on at the company,” Sam Lieber, the chief executive officer of Alpine Funds in Purchase, New York, and a real estate investor since the 1980s. “It doesn’t look very good.”

Ackman, whose firm is based in New York, didn’t return telephone calls and e-mails seeking comment. Wendi Kopsick, a spokeswoman for New York-based Vornado, declined to comment.

Sears Encore

When Ackman announced the J.C. Penney investment in October 2010, with money from Pershing Square and Vornado, the transaction was modeled after the retail play the firms had made six years earlier in Sears Roebuck & Co. The Sears deal generated more than $140 million in profit for Roth and helped push the department-store chain into a landmark merger with Kmart Corp.

In the J.C. Penney deal, Pershing Square and Roth’s Vornado acquired stakes totaling 27 percent. This time the result has been different, as the retailer’s sliding shares have left Ackman and Roth facing potential losses of $568 million and $249 million, respectively.

Roth, who said as recently as November that he was committed to the J.C. Penney investment, faced pressure from Vornado shareholders to abandon deal-making strategies outside of owning retail and office space, according to Alexander Goldfarb, an analyst at Sandler O’Neill & Partners LP in New York. When Roth reversed course on J.C. Penney, Vornado shares rose and those of the retailer dropped 18 percent in three sessions, leaving Ackman, the biggest stockholder, in a deeper hole.

Two Guys

Vornado realized a loss of about $97 million last week by selling 10 million J.C. Penney shares at $16.03 each to Deutsche Bank AG, according to a filing with the U.S. Securities and Exchange Commission. Vornado said it had an “understanding” with Deutsche Bank to wait a week before selling any more shares.

Roth gave no indication he was thinking of cutting Vornado’s stake during a J.C. Penney board meeting that took place a week prior to the REIT’s share sales, Ken Hannah, the retailer’s chief financial officer, said yesterday at the Bank of America Merrill Lynch Consumer & Retail Conference in New York.

“Steve was as supportive and as constructive in that board meeting as he had ever been,” Hannah said, according to a transcript. “There was not one indication coming out of that meeting that he was going to do anything with his position.”

Firms Consulting

Roth, 71, made his name in real estate in 1980 by taking over Vornado, whose sole asset was the struggling Two Guys discount-store chain. In an April 2005 letter to shareholders, he compared his strategy to that of T. Boone Pickens, noting that the oilman discovered in the 1970s that he could “mine” for crude more cheaply by purchasing energy stocks than drilling wells.

In disclosing their J.C. Penney stakes, Vornado and Pershing Square said they were consulting on the investment, adding that the hedge fund had acted as agent to “execute certain transactions” on the REIT’s behalf.

While this marked the first time Ackman, 46, and Roth reported collaborating on a publicly traded stock, they had invested privately in the same company at the same time, sometimes using a similar options strategy.

As a graduate student at Harvard Business School, Ackman acquired 2,000 shares of Alexander’s Inc. at less than $9 apiece after the department-store chain filed for Chapter 11 bankruptcy protection, according to Maneet Ahuja’s 2012 book “The Alpha Masters” (Wiley, 272 pages, $29.95). Roth held a 27 percent stake, and later acquired majority control through Vornado and Interstate Properties, his private investment vehicle.

Rockefeller Center

Both were betting that Alexander’s faltering sales had obscured the value of its real estate, including a flagship store occupying a block in midtown Manhattan. The site later became the headquarters of Bloomberg LP, parent of Bloomberg News. Less than a year after buying in, Ackman sold at $21 a share.

In the 1990s, Ackman sought backing from both Roth and fund manager Richard Rainwater in pursuing the publicly traded REIT that held a $1.3 billion mortgage on New York’s Rockefeller Center, according to the book. Ackman ultimately partnered with Joe Steinberg, chairman of Leucadia National Corp., and lost out to a group including David Rockefeller. Roth later contacted Ackman and told him to call next time he had a good idea, according to the book.

McDonald’s Gains

After Ackman became a hedge-fund manager with an activist bent, he took on McDonald’s in September 2005, disclosing he had accumulated stock and options equaling a 4.9 percent stake. Two months later, Vornado reported it had acquired 1.2 percent of the restaurant chain. Vornado ultimately reaped more than $289 million of gains, according to filings.

In the Sears investment, Pershing Square was buying the shares for Vornado as well as itself from the start in 2004, building combined holdings of 4.9 percent, although Ackman didn’t disclose his firm’s role until 2009. Vornado announced in November 2004 the acquisition of a 4.3 percent economic interest in Sears, including 1.2 million shares held outright and options on 7.92 million. The combined stake was just below the 5 percent threshold that would have triggered disclosure by the firms.

Sears stock jumped 23 percent on the day Vornado revealed the holding, and Sears and Kmart announced their merger less than two weeks later. After closing out its position in 2006, Vornado said its net income from the Sears investment was $142.9 million.

Paper Losses

Ackman didn’t make any filings at the time disclosing his role in the investment or his profits. In a March 2009 letter to the SEC, Pershing Square disclosed it started buying Sears shares in June 2004 for its own account and approached Vornado to “induce it” to consider a strategic transaction with Sears.

At J.C. Penney, Vornado has paper losses of almost $87 million on its remaining 8.6 million shares and $65 million on a forward contract obligating it to buy 4.82 million more for an average of $29.10 each, according to filings by the REIT. Pershing Square has potential losses of $401 million on a $1 billion investment in J.C. Penney shares plus $167 million of partially realized losses on derivatives tied to the stock.

“We’re in this thing for the long haul,” Roth told analysts on an August earnings call. “We have an enormous amount of confidence in Ron Johnson,” he added, referring to the retailing executive hired away from Apple Inc. in late 2011 to revive J.C. Penney. In a November call, Roth reiterated the REIT was “committed” to its investment.

Credit Line

J.C. Penney announced late last month that its sales fell 28 percent in the holiday quarter ended Feb. 2, sending the shares down 17 percent the next day. The results showed the company hasn’t fully recovered from Johnson’s decision as chief executive officer to curtail sales events and coupons, a move later reversed.

The retailer in a filing last month disclosed changes to its primary credit line allowing it to sell convertible preferred stock without triggering repayment provisions under the lending agreement.

Unidentified debt holders represented by Boston-based law firm Brown Rudnick LLP claimed in February the retailer had already technically defaulted on 7.4 percent bonds due in 2037. Plano, Texas-based J.C. Penney sued to block the claim in Delaware, saying the company was exposed to “irreparable harm,” including the risk of higher borrowing costs.

“December changed a lot of things,” said Bernard Sosnick, a retail analyst at Gilford Securities in New York. “The decision by Vornado casts doubt on the outlook for the company and confidence in the leadership under Ron Johnson.”

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