Poor Ideas From a Known Investor

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Sometimes, truth takes some time to emerge. This is what Bill Ackman, the founder of Pershing Square Capital Management, says about two of his high conviction investment ideas that, so far, have gone sour. Ackman built a long position in J.C. Penney (NYSE: JCP), which is down by 17% Year-To-Date (YTD), and a huge short position in Herbalife (NYSE: HLF), which is up by 69% this year. Mr. Ackman is a superb value investor, but is there still some hope left for his money-losing positions.

A failed turnaround that may become a success story

After the failed strategy put in place by J.C. Penney's former CEO, the Apple veteran Ron Johnson, the company is coming back to reintroducing discarded brands and distributing discount coupons. These efforts are being led by Mike Ullman, who returned as CEO after having led the company from 2004 to 2011. According to Ullman, Ron Johnson had shifted away from J.C. Penney's core customers: middle-aged Americans on tight budgets. Let's see the most relevant highlights from Ullman's strategy.

(1) Ullman has shored up the liquidity profile by securing a $2.25 billion term loan, guaranteed by the company's huge real estate base. (2) The company is rolling out the Home shop-in-shops to 500 locations within the U.S. while implementing a more aggressive promotional strategy with a return of coupons (3) J.C. Penney is bringing back inventory in key categories such as basics and historically successful private-label products (such as St. John’s Bay).
I believe in Ullman's strategy and I am not alone since billionaire investor George Soros has taken a 7.9% stake in the company. Even though second-quarter sales might be weak, I think the company would finally re-emerge thanks to the come back of the historically proven strategy.

Hedge fund titans clash

Bill Ackman has, very publicly, taken a $1 billion short position in Herbalife. He maintains that the company is a Ponzi scheme that makes money through recruiting new distributors rather than through selling its nutritional shakes and pills. As a matter of fact, Herbalife's products do not appear in stores like most consumer goods products do. The company sells its products through a network of self-employed salespeople.

According to the company's own statements, its direct selling method is a great way to reach customers cheaply. On Herbalife's defense, its method is widely used to push sales of low-value items such as kitchen appliances and cosmetics (think of Avon). In the words of Herbalife's CEO, Michael Johnson, “Ackman made a bogus accusation. We have millions of customers around the world. We don’t pay for recruiting. We have been in business for 32 years.”

On the other side of the trade, we find the legendary billionaire investor Carl Icahn and his company, Icahn Enterprises (NASDAQ: IEP), which is up 61% this year and pays a 5.5% cash dividend. Icahn's company initially accumulated a 12.98% stake in Herbalife, making his investment vehicle one of the company's main shareholders. Apparently, he hasn't sold a single share. These two amazingly smart investors can not be right at the same time. Herbalife is either a valuable company, as Icahn seems to believe, or it is a pyramid scheme, as Ackman claims. 

Foolish bottom line

Bill Ackman is a wonderful value investor, but it looks like (no-one can be sure yet) these two positions (J.C. Penney and Herbalife) can be counted as two major mistakes. Even if I think that J.C. Penney should be rated as a "buy," I am not sure it is worth the $75 per share Ackman says the company should be valued at. In the case of Herbalife, it is tough to make a call, but at the current valuation and given the doubts that surround the business, I would most definitely stay away from it right now.  

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Federico Zaldua has no position in any stocks mentioned. The Motley Fool has the following options: long January 2014 $50 calls on Herbalife Ltd.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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