Will Bill Ackman Go After Express Scripts Next?

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Jun 30, 2015

Bill Ackman (Trades, Portfolio) of Pershing Square, the second most well known activist investor only after Carl Icahn (Trades, Portfolio), just raised more money by issuing a billion worth of bonds. The NY Post reported that according to a source on an investor's call: Ackman plans to use the debt proceeds to help his $20 billion fund take on a big target. Ackman gets his fair share of headlines, and his targets usually quickly get bumped up a few notches. That makes it both fun and potentially profitable to speculate on his next target. With his fund getting bigger and bigger targets are becoming scarce which helps.

To try and deduce what company Pershing Square will target, the first thing I did was set up a screen that excludes companies based on Ackman’s likely preferences. My screen excluded companies below $50 billion because he is going after a big target. It also excluded various industries like retail, energy and basic materials that I think he is unlikely to invest in right now based on his historic preferences and public comments he made. In addition I only included companies with a multiyear stable operating cash flow record and finally also excluded companies that analysts are extremely optimistic about because these are not logical targets for an activist. Finally, I expect Ackman will not invest outside the U.S. because of the additional legal issues and because of all the additional travel he and his team would need to do which could hurt the overall portfolio.

That whittled down the list considerably, and I was left with a manageable number of companies to examine quantitatively:

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Source: Morningstar screener

This is a useful list to use as a starting point to guess Ackman’s target. I will briefly describe why I removed names from this list. If you don’t care why I removed names, you can skip ahead to the paragraph: short list.

Altria Group (MO, Financial): I’m not sure if Ackman will invest in Tobacco. It does not fit his profile very well. He is openly involved in charities, and I think he enjoys it when his investment are both profitable and do good for society. His battle with Herbalife (HLF) comes to mind. On top of that there is not that much to do at Altria. It makes cigarettes and churns out dividends, quite efficiently. If he gets involved with tobacco I would put my money on Philip Morris (PM) over Altria.

AT&T (T, Financial): This one may be a size too large for Ackman to take on. It is also in an industry he has less experience tackling.

Bristol-Myers Squibb Company (BMY, Financial): Is already cutting costs and improving. Market prices that in, nudging from Ackman, is not going to have as much effect. He probably prefers another target.

Caterpillar (CAT, Financial): Would be a surprising target to me as it is quite a bit different from the companies that he usually engages. Its performance is also tied to the commodity markets, and Ackman can not influence those to much. It is not impossible but highly unlikely he targets this company.

Coca-Cola (KO, Financial): Coca-Cola’s size lowers the odds; this is the one. It is also a Buffett holding which in most cases makes me eliminate the company immediately. That is because Ackman and Buffett have conflicting investment strategies. Buffett tends to look for companies that are in capable hands while Ackman actively seeks out companies that are not managed as well as they could be. Thing is, Coca-Cola has been a long term holding of Buffett and his curent position does not reflect much of a judgement on management. Buffett did not get behind the activist David Winters (Trades, Portfolio) who went after the company’s management last year. All considered I think this is highly unlikely to be Ackman’s next target.

Colgate-Palmolive (CL, Financial): Colgate-Palmolive has good management and appears to be doing just fine. It is probably not a terrible investment but does not fit the “fix problems” profile Ackman looks for.

Ford Motor Co (F, Financial): Family has 40% voting power. Easy elimination.

IBM (IBM, Financial): Big Blue is on the large side, which is a strike against, and it is a recent Buffett buy, which is a second strike against, as explained with Coca-Cola.

Johnson & Johnson (JNJ, Financial): I think this a size too large to be Ackman’s next target.

PNC Finacial Services Group I (PNC, Financial): This company just did a cost-cutting round. Unlikely to be a lot of fat left for Ackman to cut.

Procter & Gamble (PG, Financial): Although previous involvement does not make me eliminate companies, it does so in this case. I think Ackman is at this time unlikely to go back to P&G after his previous involvement.

Texas Instruments Inc (TXN, Financial): This is outside his usual circle of competence. It is also a complicated industry which Ackman does not like. A very unlikely target.

Time Warner Cable (TWC): Just got sold. Not a good target.

U.S. Bancorp (USB): This company has solid management who appear to be doing a good job. Does not fit Ackman’s M.O.

United Parcel Services (UPS): I could see this as a target if it were badly managed, but it is not. So I think this will not be it.

Wells Fargo & Co (WFC): Too big and a Buffett holding.

Short list

After looking at all candidates in a qualitative way I am left with seven candidates which are in my opinion the most likely candidates for Ackman’s next campaign. Here is why:

American Express Co (AXP): This company looks kind of cheap but operating margins are excellent compared to its historical average. The company is already working to lower operating expenses. Why I think it is unlikely that Ackman gets involved is because of the possiblity of a seismic shift in the payment industry. He likes simple, predictable companies where Pershing Square can be the catalyst of change. Conclusion: Unlikely

Eli Lily and Co (LLY): It does not appear to be much undervalued. It is a huge and complicated company and I do not immediately have an idea what Ackman would be able to accomplish here. Conclusion: Unlikely

Express Scripts Holding Co (ESRX, Financial): This pharmacy benefit manager Ackman likes. Kind of simple but dominant in what it does. Between 2006-2009 the company achieved much better gross margins than it does today. Possibly Ackman thinks he can do some work there. In a best-case scenario he can increase net profits by 5%-6% but Express trades at 32x earnings so that could still net him a large capital gain. Conclusion: Credible

General Motors (GM, Financial): Ackman has held General Motors in the past so he is well acquinted with the company. He sold it fairly quickly at the time. Meanwhile, management changed. The company has a much better cost structure than pretty much ever which makes it an unlikely target. It also is kind of conservatively financed. In addition Sergio Marchionne is pushing for a merger between GM and Fiat Chrysler Automobile (FCAU). Working to make that happen seems right up Ackman’s alley. Unfortunately, Harry Wilson is already involved and seems to be on the side of GM’s management which is ignoring Fiat. Wilson appears to be satisfied with buybacks. Will Ackman be satisfied with that? Conclusion: Credible

MetLife (MET): This is a possible target. Ackman has gotten involved with insurers and financials before. His track record is especially good on the short side though. In addition the company has quite a bit of leverage. Given that Ackman takes very large concentrated bets that may not be a good match. Conclusion: Possible.

McDonalds Corp (MCD): Back in December Bloomberg wrote: Ackman said the world’s largest restaurant chain could be managed better, fueling speculation that he’ll buy a stake and push for changes. On the other hand, he has 10% of his long portfolio in Restaurant Brands International (QSR) which includes Burger King. If you are an activist pushing for change and improvement it may not be ideal to do so at your main competitor. It may also make things more difficult with regards to relationships towards management teams at both companies. My money is not on Mc Donald’s. Conclusion: Unlikely

Philip Morris: See Altria, I don’t think he will invest in tobacco, but it is not impossible. Outside of it not fitting his white knight profile I think it is a good target. In my opinion it is an undervalued company. Not sure how Ackman would broker value creating change, though, except cut costs. Although, that has worked for him many times. Conclusion: Very Unlikely.

Gun to my head: I am picking Express Scripts as Ackman’s next target. But I think General Motors is almost equally likely.