LDG, Part I: An Eye On Pershing Square

Bill Ackman’s remarkably well timed purchase of Longs Drug Stores has already been called the “trade of the year” by at least one publication. We always love to read about a great “Trade”, but even before the news of the CVS acquisition broke we had already begun looking at the filings made by Pershing Square for different reasons.

As you recall we followed the CSX/Chris Hohn court proceedings intently as they related to the use of total return swaps by activist shareholders. As such, the filings made by Ackman had some interesting language that caught our ‘HedgEye’.

A total return swap, for those that are not familiar, is a contract which gives the purchaser a synthetic economic interest identical to an outright long or short position, typically on a significantly leveraged basis.

Even if the economic interest exceeds the equivalent of 5% of shares outstanding, most funds do not file their position with the SEC since the swaps do not confer voting rights. One of the arguments made by attorneys for CSX during their suit against TCI was that, as the fund had arranged to have the banks providing them with exposure to CSX via swaps to vote their shares according to instruction, TCI by extension had filing requirements.

In his ruling, Judge Lewis Kaplan seemed to agree with CSX’s argument that using swaps as an end run around filing requirements violated the spirit of the law, if not the letter of it in his conclusion that “Some people deliberately go close to the line dividing legal from illegal if they see a sufficient opportunity for profit in doing so. A few cross that line and, if caught, seek to justify their actions on the basis of formalistic arguments even when it is apparent that they have defeated the purpose of the law”.

We are not lawyers but, when Pershing Square filed a 13D for the famously well timed LDG purchase, a sentence in the discussion of the swap transactions they had executed caught our eye: “These Swaps do not give the Reporting Persons direct or indirect voting, investment, or dispositive control over any securities of the Issuer and do not require the counterparty thereto to acquire, hold, vote or dispose of any securities of the Issuer.”

We don’t know if Ackman’s attorneys at Proskaur Rose had already been including that language in their boilerplate before the CSX/TCI dust up but it seemed to put one possible issue to rest, if only they had disclaimer language that could answer some of the other head scratchers raised by the timelines for these trades.

Attached are some charts which map out the series of events laid out in the 13D filings made by Pershing Square in recent weeks. We will be exploring several different aspects of this situation in the coming week –stay tuned.

Andrew Barber
Director

Keith McCullough
Chief Investment Officer
RESEARCH EDGE, LLC