When the Wolves Bite

by Scott Wapner

  One of Gotham’s first investments was in Circa Pharmaceuticals, which had seen its shares plummet. Ackman saw it as a real-estate play, believing the property assets were worth more than what the stock was currently trading for.6

  “Wall Street was just dumping the stock,” Berkowitz said at the time. “But it still had significant assets.”7 The investment was a hit with Gotham. They sold after several months with a 63 percent gain.8

  With Berkowitz the operator and Ackman the investor, the two newbies on New York City’s hedge-fund scene were off and running, albeit somewhat more slowly than they’d hoped. The fund fell 3 percent in its first month—not exactly the start they were hoping for. Things would quickly turn, though, and Gotham would end its first year up more than 20 percent.9

  Word began to spread about the dynamic young investors, eventually reaching a man named Daniel H. Stern. Stern was a partner at the storied Ziff Brothers Investments and had seeded several up and comers, such as Barry Sternlicht, who started Starwood Capital, and Daniel Och of Och Ziff Capital Management. With Stern’s blessing, the Ziffs gave Ackman and Berkowitz $10 million to play with. They also agreed to pay Gotham’s expenses until the young firm got up to scale.

  It didn’t take long for Ackman and tiny Gotham to flex their muscles.

  In 1994, when Ackman was just twenty-seven, he launched an audacious effort to control one of New York City’s most iconic landmarks. Earlier that year, Gotham had quietly grabbed a nearly 6 percent position in the real estate investment trust (REIT) that owned Rockefeller Center and had fallen into bankruptcy protection.10 Ackman partnered in the investment with the Leucadia National Corporation, which owned a 7 percent stake and backed Ackman’s ambitious turnaround plan.11 A bidding war soon ensued, with the twenty-something Ackman up against such real-estate heavyweights as Sam Zell and Tishman-Speyer—not to mention David Rockefeller himself. And though Ackman would eventually lose his bid, the tussle alone, and the young activist’s rabble-rousing along the way, had pushed the value of Rock Center’s REIT sharply higher. It paid off handsomely for Gotham.12

  It was also Bill Ackman’s first foray into activist investing.

  The Rockefeller play helped Gotham finish 1995 with a 39 percent return, while earning the young investor a nice payday along with some lucrative reputational capital with Leucadia’s president, Joseph S. Steinberg.13

  In 1997, after a few more up-and-down investments, Ackman and Berkowitz invested in Gotham Golf (the name of which was purely coincidence), which controlled about two dozen golf courses around the country.14 Ackman was betting that its real-estate assets would keep appreciating in value. When they didn’t, Ackman and Berkowitz doubled down, continuing to buy golf courses, which only increased the company’s growing debt load.

  Though Gotham Partners had returned a strong 19.65 percent net of fees in 2001,15 by 2002, the size of the golf position had quickly become an anvil around the fund’s neck. Losses were piling up, and investors had begun asking for their money back.16 These payouts, known as redemptions, were a hedge fund’s worst nightmare. This was especially true for Gotham, which had a highly concentrated portfolio made up of only a few names and positions, some of which were illiquid and not easy to unwind.

  Ackman and Berkowitz tried to merge the failing golf company with First Union Real Estate Equity & Mortgage Investments, an REIT holding that Ackman had bought in 1998, but the plan was derailed when an investor sued to block the transaction.17 The situation grew more precarious by the day, with Ackman holding out hope for a lifeline. He thought he’d found one in the famed investor J. Ezra Merkin, who agreed to put $60 million of fresh capital into Gotham Partners.18 Merkin had invested $10 million in one of the firm’s credit funds in the past and had even shaken hands with Ackman on the new money.

  The only question was the timing. Ackman and Berkowitz needed the money quickly to avoid showing losses. In the meantime, they turned to their other positions to help ease the strain the redemptions were causing.

  One such “long” they were banking on was an investment in a controversial company called Pre-Paid Legal Services. Pre-Paid was a multilevel marketing company that sold services to individuals and small businesses and had more than 1.3 million members nationwide. Not everyone was a believer though. The company was heavily shorted on Wall Street, with skeptics charging that Pre-Paid’s services were actually worthless and that the company was fraught with accounting issues.

  Ackman and Berkowitz disagreed, however, and had become the company’s staunchest supporters, holding one million shares of stock.19 In fact, the two men thought so highly of the company that Pre-Paid had become Gotham’s biggest position, with 13 to 15 percent of the fund’s capital dedicated solely to the investment.

  On November 19, 2002, with a wave of redemptions rolling in, Gotham put out a report titled “A Recommendation for Pre-Paid Legal Services, Inc.” on its website.20 On the document’s front page, Ackman and Berkowitz said, “We believe that much of the press coverage of Pre-Paid, has been unfair, unbalanced, and in many cases simply wrong. It is our intent in this report to both lay out in detail the bullish case for Pre-Paid and to refute many of the bearish arguments.”21

  Ackman said Gotham held more than one million shares of Pre-Paid Legal’s stock and that “based upon our research and analysis, and after giving due weight to the shorts’ arguments, we believe that Pre-Paid is a highly attractive business that is extremely undervalued.”

  In one section under the heading “How do the Shorts Sleep at Night?” Ackman called Pre-Paid “one of the most heavily shorted of all companies listed on a US exchange,” saying, “We are at a loss to understand what the short sellers are thinking. They must believe that the business is going to implode… and soon.”

  Ackman’s advocacy was working. Pre-Paid Legal’s shares began rising. Ackman began to hope that his Hail Mary play was working. But just a few weeks later, on December 6, New York’s Supreme Court formally blocked the golf company merger, meaning Gotham Management wouldn’t get the tens of millions it was counting on to help with its finances.

  The ruling left Gotham Golf on the brink of bankruptcy. Even worse, Ackman had to tell Merkin they could no longer take his money.22

  Three days after the devastating court decision, Ackman tried to salvage another of the fund’s large positions when he released his blistering report on MBIA, questioning its Triple-A bond rating and beginning the seven-year legal and financial saga. But for now, Ackman couldn’t afford to play the long game—he needed a win just to stay in business. Though the stock initially fell when Ackman went public, it quickly rebounded, leaving Ackman and Berkowitz in something of a stranglehold.

  It soon became clear that the only viable option was to wind down the firm.

  Over the next two weeks, Gotham sold more than 20 percent of its position in Pre-Paid Legal. Company insiders started bailing too, raising questions in the media as to whether Gotham had grown so desperate it had pumped and then dumped the stock.23 Ackman refused to comment publicly on the suggestion, which was raised in a Sunday New York Times piece, on the advice of a public relations consultant.24

  In January 2003, after ten years in business, Gotham Partners Management, whose assets had grown from $3 million to $300 million, and which had scored annual gains of 20 percent since inception, began the process of winding down. It was a difficult, even embarrassing, decision, but at the time Ackman said that “to wind down seemed the fairest thing to do.”

  Embarrassment would be the least of Ackman’s worries a few weeks later, when New York Attorney General Eliot Spitzer began an investigation into Ackman and Berkowitz, probing the MBIA short and the alleged sketchy trading in Pre-Paid Legal. Ackman felt the probe was a witch hunt that was only initiated because of MBIA’s contacts high up in Albany, the state capital.

  The Spitzer investigation dragged on for months, leaving Ackman not only out of a job but also under the government’s glare and on the defensive. Spitz
er was a pit bull. He’d already earned the title “The Sheriff of Wall Street” for taking on the big banks and dealing out more than $1.4 billion in fines over analyst research reports. Many wondered whether Ackman would be Spitzer’s next piece of roadkill. On May 28, 2003, Ackman made the trip to Lower Manhattan, to 120 Broadway, where Spitzer’s office was located, for a nearly eight-hour deposition.25

  Joined there by his attorneys from the New York law firm Covington & Burling, Ackman was peppered about his report on MBIA, running through the intricacies of his detailed allegations against the company and what they all meant. Lawyers from the A.G.’s office then turned to Pre-Paid Legal, asking, among other things, where the investment idea had come from in the first place. “David Berkowitz came up with it,” Ackman said. “I don’t know where he got it.”26

  Ackman was asked about the timing of the Pre-Paid stock sales and news reports that the firm was selling even as it was “touting” the position on its own website. Ackman took issue with the characterization and defended the sales, saying a disclaimer on Gotham’s website made it clear that it could alter its position on the stock at any time. He also explained why he couldn’t go public to explain the sales when they occurred, arguing that given Gotham’s precarious financial position, the news could have caused a run on what was left of the fund. Ackman claimed that Gotham was unexpectedly forced to sell in order to meet the flood of redemptions and that they simply had little choice.27

  “David and I talked about it,” Ackman said. “We decided to sell, and we sold.”28

  Though the investigation would ultimately find no wrongdoing, the whole ordeal left Ackman reeling, professionally and personally. He sold whatever of Gotham’s assets he could—as quickly as he could—to help pay back his investors. One such investment was called Hallwood Realty, a Dallas-based REIT whose shares were trading near $60. Ackman believed they were worth $140, but since the firm was facing a wave of redemptions, he wasn’t in a position to stall for a comeback. So, the thirty-something investor picked up the phone and cold-called a man nearly thirty years his senior—a man considered one of the most powerful investors on Wall Street.

  His name was Carl C. Icahn.

  Icahn had built a reputation over his decades in the business as one of the shrewdest dealmakers on the Street. He chewed people up and spit them out for a living, and was always looking for his next score.

  Ackman asked Icahn if he could help, a tinge of desperation in his voice.

  Perhaps sensing Ackman’s weakened position, Icahn said he was interested, and the two quickly struck a deal for Hallwood.

  The agreement, dated March 1, 2003, stipulated that Icahn would pay Ackman $80 a share29—a generous premium from the current stock price, but still below what Ackman thought the investment was really worth.

  Knowing the elder investor’s penchant for making money, Ackman had Icahn’s lawyer, Keith Schaitkin, write in a provision the men called “schmuck insurance” to protect Ackman from looking like an idiot if Icahn quickly flipped the stock for a much higher price. The deal said that if Icahn sold the shares “or otherwise transfers, or agrees to sell or otherwise transfer, any of the Sale Units,” within three years, Icahn and Ackman would split any profits above a 10 percent return, with the money due within two business days. In addition, Ackman added a clause that said if the deal became contentious, the loser would cover the other’s legal fees.

  Schaitkin had pulled a near all-nighter drawing up the agreement.

  Ackman considered the two men partners, hopeful that the older investor would turn Hallwood into more money for both of them.

  On July 29, 2003, the deal was done. Icahn put out a press release at 1 p.m. Eastern time proposing to buy Hallwood himself in a hostile bid of $132.50 per share, or $222 million. The price was a stunning 87 percent premium over where Hallwood shares had closed trading in March when he and Ackman had drawn up their agreement.30

  Hallwood rejected the offer and in 2004 agreed to merge with another firm for $137 a share, which Icahn, as a shareholder, voted against. Nevertheless, Icahn scored a windfall, pocketing the difference of the $80 a share he’d paid Ackman for the stock and the final merger price in the $130 range.31

  Ackman thought he was entitled to a piece of that money, but after the two-day timeframe required in his original contract with Icahn, no wire transfer had been made.

  Ackman called Icahn to check on his share of the profits, detailing the conversation in the New York Times in 2011.

  “First off, I didn’t sell,” Ackman said Icahn told him.

  “Well, do you still own the shares?” Ackman said he asked.

  “No,” Mr. Icahn said. “But I didn’t sell.”

  The conversation quickly devolved, with both men threatening to sue each other.

  In 2004, Ackman did just that, contending breach of contract.

  In a statement, Icahn said, “Hallwood was acquired in a merger transaction that we voted against. We did not believe that the agreement covered such a situation, based on cases in a number of states, and it was very clear from my negotiations with Bill that he was not to be paid under these circumstances.”32

  But in 2005, a New York court disagreed with Icahn, as did an appeals court the following year.

  The two men did try to come to a resolution, meeting at Icahn’s favorite Italian restaurant, Il Tinello, an old-school joint on West 56th Street where waiters still wear tuxedos and a dish called Pasta alla Icahn sits on the menu. Over Caesar salad and Dover sole, Icahn offered to give $10 million to a charity of Ackman’s choice to settle the tiff for good. But Ackman refused, arguing that the money belonged not to him but to his investors.33

  The battle remained in the courts for another half-dozen years until finally, in October 2011, Icahn was ordered to pay Ackman $9 million—the original money he was owed, plus interest.

  Icahn was none too happy. He tore into Schaitkin. Admittedly, in his haste to draw up the deal quickly that evening eight years earlier, Schaitkin had clumsily left the contractual definition of a “sale” open to a court’s interpretation. The careless mistake gave Ackman a legal opening and left Icahn fuming. “He started to lecture me,” Mr. Icahn told the New York Times. “And I said, I’ve been in this business for 50 years, and I’ve done OK without your advice.”34

  After reluctantly paying Ackman his money, Icahn, who could hold a grudge with the best of them, quietly advised Schaitkin to keep his eyes open for an opportunity to get Ackman back.

  Aside from the legal squabble with Icahn, 2004 was a milestone year for Ackman. He had rebounded from the Gotham blowup, and with $50 million in new seed money from his old buddy at Leucadia National, Joseph Steinberg—the man he’d partnered with on the old Rockefeller deal—Ackman launched Pershing Square Capital Management and named the firm for the area in Manhattan near Grand Central Station where its first office was.

  Fancying himself an activist, Ackman followed a standard modus operandi: take a large stake in a publicly traded company, then loudly push for change through the media and elsewhere in hopes the company would cede to his demands.

  In early July 2005, Pershing Square took a 9.9 percent stake in the fast-food chain Wendy’s International and sent a letter to the company’s management urging them to spin off the Tim Horton’s doughnut chain. Ackman argued that a new publicly traded listing of Tim Horton’s would help Wendy’s stock go up in value by giving the company more control over its performance.

  On July 29, only weeks after Ackman’s first letter, Wendy’s agreed to a spin-off, with its chairman and CEO, Jack Schuessler, saying in a conference call, “We really believe the two brands are moving apart. I think Tim’s is growing faster and Wendy’s is maturing.” Ackman, who was also on the call, said, “I think management did an excellent job.… We’re excited to be shareholders.”35

  Wendy’s shares spiked 14 percent on news of the spin-off of Tim Horton’s to a new fifty-two-week high of $51.70.36 The stock had been barely above
$30 when Ackman initially invested.

  That same year, Ackman took a $500 million stake in Wendy’s competitor McDonald’s, urging it to follow a similar strategy and spin off some of its company-owned franchises. The plan was roundly rejected by McDonald’s management that November.

  Undeterred, in January 2006 Ackman upped the ante and unveiled his plans for the company during a live presentation at a conference in Midtown Manhattan called “A Value Menu for McDonald’s.” Ackman served up his plan, along with McDonald’s hamburgers, to the audience, making many of the same arguments he’d made the previous fall.

  Once again, McDonald’s said no, but it did agree to buy back $1 billion worth of stock and license fifteen hundred of its restaurants to franchisees. In 2007, Ackman cashed out of the Golden Arches, selling his entire stake in the chain while pocketing a return of almost 100 percent.37

  The victories in Wendy’s and McDonald’s, along with other high-profile plays in the department store chain Sears and bookseller Barnes and Noble, had made Ackman a celebrity on Wall Street. As more people began following his every move, Pershing Square’s assets grew, and grew rapidly. By 2007, they had ballooned to almost $5 billion. The legend of Bill Ackman was growing with both the public and his peers. It would lead to one of the biggest bets of Ackman’s career.

  On July 16, 2007, Pershing Square unveiled a position in the retailer Target, claiming in the filing that the stock was undervalued.38 Ackman had accumulated a 9.6 percent position in the company, proclaiming that shares, which he’d bought in the high $60s, were worth more than $100.39

  On the surface, the investment appeared to follow others Ackman had made up to that point, focusing on an undervalued name with a strong real-estate presence. But the structure of the investment was different, most notably for who was involved. For starters, Ackman had hit up many of his friends in the hedge-fund industry for the capital, including Daniel S. Loeb of Third Point, Greenlight’s David Einhorn, and York Capital’s Jamie Dinan. The plan was to start a separate fund called Special Purpose Investment Vehicle, or SPIV, that Ackman said would only invest in a single yet unannounced company.