Fitch Affirms Pershing Square Holdings, Ltd.'s 'BBB+' Ratings; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed Pershing Square Holdings, Ltd.'s (PSH) Long-Term Issuer Default Rating (IDR) and senior unsecured debt rating at 'BBB+'. The Rating Outlook is Stable.

KEY RATING DRIVERS - IDR AND SENIOR UNSECURED DEBT

The rating affirmations reflect the strong franchise, scale advantages and proven long-term performance track record of PSH's investment manager, Pershing Square Capital Management, L.P. (PSCM), combined with PSH's conservative capitalization levels, lack of redemption risk as a permanent capital vehicle, liquid portfolio, appropriate levels of transparency and regulation, and alignment of interests between management and PSH via co-investments.

Rating constraints include elevated key man risk associated with PSCM's founder, William Ackman, high investment portfolio concentration, evolving portfolio composition, potential second-order effects of redemptions at sister funds, an undefined liquidity policy and lack of a formalized quantitative risk management overlay.

Fitch also notes PSH's recent and significant investment underperformance including a net return of -20.5% in 2015 and an additional net return of -18.0% through the first four months of 2016, driven primarily by the material price decline in Valeant Pharmaceuticals International, Inc. (Valeant). Although underperformance has not yet pressured ratings, it has served to reduce the amount of cushion PSH has to withstand additional market value declines before ratings could be impacted. In addition, the long-term impacts on PSCM's franchise and open-end flows remain to be seen.

The equalization of the senior unsecured debt rating with PSH's IDR reflects the lack of senior secured debt and the availability of meaningful unencumbered asset coverage.

LONG-TERM TRACK RECORD REMAINS STRONG

PSH benefits from the proven long-term track record of the broader PSCM platform, which has been in operation since 2004. PSCM's longest-tenured fund, Pershing Square, L.P., delivered a 15.2% annualized return since inception through April 30, 2016 despite underperformance over the past year.

There is also continued alignment of interest between management and PSH, as management and affiliates had approximately $1.0 billion invested in PSCM-managed funds (8.6% of total gross assets under management [AUM]) at April 30, 2016 according to PSCM. Of this, approximately $161 million represented investment in PSH (3.8% of PSH's AUM), of which $143 million is locked up until October 2024. Management ownership of PSCM-managed funds has declined over the last year to 8.6% from approximately 10.0%, driven primarily by liquidation of investments to cover taxes associated with large incentive fees earned in 2014.

KEY MAN RISK MODERATED BY REDEMPTION TRIGGER

Fitch attributes a significant amount of PSCM's long-term outperformance to Ackman, which suggests that key man risk is elevated. Positively, senior unsecured debt holders have the right to put the debt to PSH for redemption at a price of 101% plus accrued and unpaid interest within 120 days of the occurrence of Ackman's death, permanent disability or withdrawal as managing member of the general partner to the investment manager. Fitch views this feature as an important mitigant to key man risk, given the likely uncertainty that would surround PSH's future strategic direction upon such an event.

STRONG CAPITALIZATION

Between June 30, 2015 and April 30, 2016, PSH's AUM declined by 37.2% to $4.3 billion from $6.8 billion, driving an increase in debt to equity to 0.23x from 0.15x. Although asset collateral available to support creditors has meaningfully declined, ratings remain supported by very low absolute levels of debt to equity relative to assigned ratings.

For example, Fitch calculates that as of April 30, 2016, PSH could withstand a market value decline of 33.1% of gross assets before exceeding Fitch's quantitative downgrade trigger of debt/equity greater than 0.35x, a market value decline of 43.2% of gross assets before tripping PSH's incurrence-based debt to capitalization covenant of 33.3% and a market value decline of 81.1% of gross assets before asset coverage of debt would be less than one. Declines of these magnitudes would certainly have negative rating implications, but they underscore the degree of asset coverage debtholders continue to benefit from.

EVOLVING, CONCENTRATED PORTFOLIO COMPOSITION

PSH's investment portfolio is highly concentrated, with 11 long positions greater than 1% of net asset value and one short position greater than 1% of net asset value at April 30, 2016.

Holdings in PSH as of the same date included Air Products & Chemicals Inc. (gas and chemicals), Canadian Pacific Railway Limited (Canadian Pacific, railcar operator), Fannie Mae and Freddie Mac (government sponsored entities), The Howard Hughes Corporation (real estate), Mondelez International, Inc. (Mondelez, snack foods), Platform Specialty Products Corporation (chemicals), Nomad Foods Limited (frozen food manufacturing), Restaurant Brands International (fast food), Valeant (pharmaceutical) and Zoetis, Inc. (Zoetis, pet/livestock medicine). The company also maintains a short position in Herbalife International (nutritional supplements).

PSH's portfolio composition is expected to be evolving with little advance insight provided to external parties with respect to potential changes. While PSCM typically aims to hold investments for several years, there can be no assurances that this will always be the case and all portfolio holdings are effectively subject to daily review based on market opportunity.

In recent months, PSH has reduced its positions in Mondelez, Canadian Pacific and Zoetis for portfolio management reasons. Given the absence of subsequent reinvestment, PSH has built substantial unrestricted cash, totaling $776.3 million at April 30, 2016. The cash balance, combined with PSCM's statements in its 2015 annual letter that it would expect to add a major new investment in the near-term, suggest an acquisition could arise shortly subject to market conditions.

From a risk management perspective, PSH does not employ a formalized quantitative risk management overlay, but rather, relies on fundamental risk analysis of individual portfolio companies. This is viewed by Fitch as appropriate and feasible given the limited number of portfolio holdings, but it does introduce the risk of escalating commitment amongst key decision makers which a quantitative risk overlay could potentially counterbalance.

With respect to Valeant, PSCM has publicly acknowledged that it overvalued the company's acquisition platform and underestimated the political and regulatory risks associated with the business model. Fitch views the investment as a deviation from PSCM's traditional investment strategy of focusing on industries with more stable/predictable cash flows. Nevertheless, Fitch acknowledges the steps PSCM has since taken in an attempt to stabilize the investment including obtaining two seats on Valeant's board of directors and being actively involved in facilitating Valeant's obtainment of bank waivers for its credit facilities, filing its 2015 10-K and appointing Joseph Papa, former CEO of Perrigo Company plc, as successor to Valeant's former CEO, Michael Pearson.

ASSET LIQUIDITY PLUS ELEVATED CASH

PSH's closed-end structure allows it to avoid forced selling to meet redemption requests and is expected to produce higher returns relative to open end funds (all else equal) given less cash drag. However, PSH is exposed to second-order redemption risk associated with sister funds, which represented approximately 58.8% of total strategy gross AUM at April 30, 2016. If these funds were to experience redemptions (subject to the fund redemption terms) asset sales emanating from those funds could pressure PSH's asset valuations and reduce PSCM's overall ability to exert influence on portfolio companies.

PSH maintains a liquid portfolio, with 84.8% of its net assets comprised of cash and Level 1 assets at April 30, 2016. Individual investment holdings typically represent minority ownership percentages but may exceed 10% of portfolio companies' outstanding securities. Minority investments reduce the potential adverse market impact of rapid selling, relative to majority investments, but nevertheless, rapidly selling large minority blocks is likely to result in valuation discounts.

PSH does not maintain a defined liquidity policy, such as minimum cash and committed liquidity facilities relative to interest expenses and near-term debt maturities. When combined with the expectation of variable levels of balance sheet cash and dividend income from portfolio companies, this may require PSH to periodically liquidate modest portions of investments to service debt obligations. This moderately erodes capitalization levels and potentially reduces the ability to exert influence on portfolio companies. Fitch calculates that PSH's dividend and interest income coverage of interest expenses was 0.74x for the trailing twelve months ending April 30, 2015. Interest coverage is viewed as weak for the rating, but is mitigated by strong asset liquidity.

EARNINGS AND PROFITABILITY LOW INFLUENCE

Fitch views PSH's earnings and profitability as a lower influence rating factor given the analytical focus on asset overcollateralization relative to debt and the fact that earnings can be periodically influenced by unrealized gains/losses as a result of market price changes in underlying investments. Evidencing this dynamic, PSH's $1.1 billion net income in 2014 was driven primarily by $1.1 billion of unrealized gains, while PSH's $1.3 billion net loss in 2015 was driven primarily by $2.0 billion of unrealized losses.

RATING SENSITIVITIES - IDR AND SENIOR UNSECURED DEBT

Negative rating action for PSH could be driven by:

--Continued investment underperformance which results in permanent franchise damage, material outflows from open-end sister funds or debt to equity approaching or exceeding 0.35x on a sustained basis.

--A sustained increase in portfolio concentration, particularly if such investments are in less liquid securities and/or are not accompanied by reduced leverage.

--An adverse regulatory or legal outcome which materially impairs the management, reputation and/or financial resources of PSH.

--Upon the occurrence of a key man event, Fitch would likely place PSH's ratings on Rating Watch Negative until more clarity was present with respect to the liquidation of the portfolio and the redemption of debt. Fitch would also consider the portfolio composition/performance at such time and the level of asset coverage available to debt holders, either of which could translate into more immediate or pronounced negative rating action upon the occurrence of a key man event.

Recent investment underperformance and the impact on PSH's leverage levels limit the likelihood of upward rating momentum for the foreseeable future, in Fitch's opinion. However, the following could be potential drivers of upward rating momentum over a longer-term horizon:

--Sustained leverage below 0.15x;

--Introduction of a more formal liquidity policy with respect to coverage of interest expenses and near-term debt maturities;

--Improved investment performance, including the long-term stabilization or improvement in the Valeant investment;

--Mitigation of perceived key man risk via expansion and tenure of the investment management team over an extended period of time;

--A material increase in the amount of overall AUM that is held within permanent capital vehicles and thus not subject to redemption risk;

--Evolution of the investment strategy towards a more permanent, investment holding company-type structure, which exhibits materially longer holding periods and increased dividend upstream predictability.

PSH's senior unsecured debt rating is equalized with PSH's IDR, and therefore, would be expected to move in tandem with any changes to PSH's IDR. The introduction of material secured debt in front of the unsecured debt, although not expected, could also result in the unsecured debt being notched down from the IDR to reflect weakened recovery prospects.

PSH is a publicly-traded closed-end fund externally managed by PSCM, which generally co-invests alongside other PSCM-managed investment vehicles. With $5.3 billion of gross assets, PSH represented approximately 41.2% of PSCM's total strategy AUM of $12.8 billion as of April 30, 2016. The firm's investment capital is directed towards implementing an activist investment strategy primarily with respect to a highly concentrated portfolio of North American large capitalization companies that PSCM views as misvalued. Investments are typically in the form of long equity positions, although short positions are periodically undertaken via equity shorts, derivatives or the purchase of credit default swap protection. The company is listed on the Euronext Amsterdam N.V. exchange under the ticker PSH.

Fitch has affirmed the following ratings:

Pershing Square Holdings, Ltd.

--Long-Term IDR 'BBB+';

--Senior unsecured debt 'BBB+'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351

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Fitch Ratings
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Nathan Flanders
Managing Director
+1-212-908-0827
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
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Senior Director
+1-212-908-0642
or
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[email protected]

Source: Fitch Ratings

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