Talking Business: Betting against a perfect credit rating
“Im going to try to give shorter answers,” William Ackman said, with an awkward smile. It was Wednesday, and Ackman, a 41-year-old hedge fund manager, had just finished an hour-long presentation at an investment conference in New York. But if the presentation and ensuing press conference proved anything, it was that Ackman was incapable of giving short answers. Obsessives rarely are.
Ackman is an emerging star in the “shareholder activist” division of the hedge fund big leagues. In the past few years, he has targeted McDonalds, Wendys and, most recently, Target, usually emerging with profits for his hedge fund. His firm, Pershing Square Capital, which he founded in 2004, now bulges with over $6 billion in assets. “If I think Im right, I can be the most persistent and most relentless person in America,” he said.
But for sheer, obsessive doggedness, nothing compares to his pursuit of MBIA, a once-obscure company that is the largest U.S. bond insurer.
Ackman has been short-selling MBIAs stock since 2002, when he first became aware of it while running an earlier hedge fund. He began his assault with a highly unusual move for a short: he posted a 66-page report on the Internet, laying out his case against MBIA. He purchased credit default swaps as a way to profit in the event of an MBIA bankruptcy. He talked to regulators and held hours of meetings with analysts at Moodys and Standard Poors, the two big bond rating agencies, trying to persuade them to lower MBIAs triple-A credit rating. He once buttonholed the chief executive of PriceWaterhouseCoopers, MBIAs accountant, at a charity dinner, and sent him his report.
Yet despite the fact that MBIA, at one point, had to restate five years of earnings - after being tripped up on an accounting problem that Ackman brought to light - its stock continued to do well. The analysts and ratings agencies continued to side with the company.
And then came the subprime crisis, which has wreaked havoc on MBIAs stock price and raised questions about its business model. Sean Egan, the co-founder of Egan-Jones, an independent bond rater, believes that MBIA and the other big bond insurers will be saddled with billions of dollars in losses as the collateralized debt obligations, or CDOs, stuffed with subprime debt they have insured continue to go south.
Ackman now stands to make hundreds of millions dollars on his bet against MBIA - so much money that he is now saying he will donate his share of his winnings to a charitable foundation he recently established. If you sense some defensiveness in that gesture, youve sensed correctly. The question - and its the one that always seems to crop up often when short-sellers are involved - is whether Ackmans single-minded pursuit of MBIA is something he should feel defensive about.
Theres no doubt about what drives Ackman crazy about MBIA: its triple-A credit rating, the highest any company can get - indeed, a rating more normally associated with Treasury bills, which are backed by the full faith and credit of the government. As Gary Denton, the companys chief executive, told me recently, “Our triple-A rating is the fundamental driver of our business model.” No triple-A, no business.
This fact has been widely accepted on Wall Street and in the marketplace. “The model is the model,” shrugged one person who keeps close tabs on the company (and who declined to be quoted by name because he isnt supposed to talk to the press.) Ackman, however, thinks it is lunacy - and hes right.
Think about it. If a company needs a triple-A rating just to stay in business, it probably doesnt deserve the rating. If General Electric or Exxon Mobil, two of the handful of companies with triple-A ratings, got a downgrade, would it really affect their business? Companies that merit triple-A ratings are those that are impervious to small or even medium-sized bumps in the road. Besides, MBIA takes on a lot of risk for a company with a triple-A rating.
It wasnt always thus, which explains how MBIA got its triple-A in the first place. MBIA began life in the early 1970s guaranteeing nice, safe municipal bonds; its initials originally stood for Municipal Bond Insurance Association. But while municipal bonds rarely default, most dont get triple-A ratings - and the lower the rating, the more a municipality had to pay in interest. By “wrapping,” or packaging, such bonds, MBIA could envelop them in its triple-A rating, and in so doing save money for towns and cities all over the United States.
