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Welcome to the deep dive. [snorts] Today we're stepping inside the world of uh highstakes finance to analyze a really remarkable strategic turnaround and an investment philosophy that's centered on well what you might call financial self insurance. Exactly. We are ripping open the files of Persing Square Holdings, what they themselves are calling their 3.0 era.
And we're covering that crucial period from early 2021 right up through the market choppiness of early 2022. So our mission here is to really understand how one of the most high-profile investment firms engineered this stunning comeback. Right? We need to unpack their core thesis. It's about stability, a renewed focus, and this unique hedging strategy that isn't just about protecting capital.
It's about generating massive liquidity right when the world is panicking. Mhm. And we'll get into the major holdings, you know, Universal Music Group, Netflix, and of course, the high drama around their attempt to revolutionize the spa market. And before we get bogged down in, you know, the quarterly ups and downs, we have to start with the long view.
Yeah. Cuz the performance is just massive. It really is. If you track an investor who started in their predecessor fund back on January 1st, 2004 and then converted over to PSH, you're looking at a 17.1% compound annual return through March of 2022. Think about that. Over that same what, 18-year period, the S&P 500 returned 10.2%.
That 7-point gap, it might sound minor on paper, but it's the difference between doubling your money and nearly 17folding it. Cumulatively, it's a total return of 1,670% versus the S&P's 484%. It's the ultimate picture of compounding just working its magic over decades. But that conviction, it was seriously tested, wasn't it?
Oh, absolutely. We need to talk about that internal crisis point. In the mid2010s, they went through a period of really serious underperformance. So around 2017, there was this necessary moment of, let's say, reflection. They weren't just losing money, they were losing focus and reputation. That's the key part.
The turnaround wasn't just about tweaking a few trades. It was existential. They knew they had to pivot back to their core principles. And the results of that pivot are again just as stunning. From the end of 2017 to the end of 2021, a 35.4% compound annual return, which just blew away the S&P 500's 91.5% cumulative return over that same period.
So, how did they do it? How did they pull off this high-speed shift? They broke it down into four critical pillars. And the first one was maybe the most painful, exiting those problematic, very highly publicized investments. That meant selling Valent and maybe more significantly closing out that legendary yearslong short position on Herbal Life,
which was basically an admission that even if they thought those positions might, you know, eventually pay off, the capital was just stuck. It was tied up in a highmaintenance, noisy distraction. The wisdom there is don't try to make the money back the same way you lost it. Free up the capital. Yeah.
and the mental bandwidth. I mean, the psychological cost of abandoning that Hurbal Life short must have been immense given how public that whole battle was, for sure. But that fed directly into the second pillar, restructuring the whole firm to be purely investment ccentric, right? The lead principal realized he was spending way too much time acting as the chief marketing officer, you know, constantly fundraising and dealing with investor relations.
So, they just stopped. They stopped raising external capital and cut down on all that internal noise. That seems like a huge advantage in modern finance. If you're not constantly chasing quarterly numbers or calming down nervous investors, you can actually research and hold for the long term. Precisely.
And that's all held up by the third pillar, stabilizing their capital base. The firm and its affiliates just dramatically increased their own stake in Persing Square Holdings. But we're talking about real skin in the game here. Absolutely. Employees and affiliates own more than 25% of the shares. That's a total equity commitment of $2.8 billion.
So, the capital is highly permanent. No need to worry about redemptions. A quarter of the fund owned by insiders. That is a phenomenal alignment of interests. And finally, the fourth pillar was a return to first principles. They apparently codified it on what they call a physical stone tablet. It sounds a little dramatic, I know, but it was about refocusing on companies that meet these strict criteria.
durable growth, quality, simplicity, predictability, and strong free cash flow generation. So, if you connect all those dots, this defines what they call PSH 3.0, the quieter investor phase. They've retired from noisy activism, like activist shortselling. And now they focus on cordial, constructive talks with management, using their reputation as a long-term supportive owner to get things done privately.
This shift really sets the stage for their unique risk strategy, which they call asymmetric hedging. Right? We hear about hedging all the time, but this is not about protecting against a 5% market dip next week. No, not at all. They describe it as overinsuring the portfolio against a catastrophe. The hedges are designed to be cheap to maintain in calm markets, but to multiply in value during these extraordinary negative events.
So, it's like paying a small annual premium for flood insurance. But when that unexpected hundred-year flood hits, the payout is big enough to rebuild everything. So, what are the mechanics? Are we talking about just buying shortdated puts or something like that? Typically, no. It's more complex. They often use things like credit default swaps or more recently longdated interest rate swapions.
Okay. So, complex instruments, but the idea is simple. Exactly. They're betting on fundamental systemic breakdowns or these sudden massive shifts in inflation or credit markets. The cost to carry these positions is minimal if the market behaves. But the payoff during a crisis is designed to be gargantuan.
And the track record shows this isn't just a theory. It has performed exactly like an emergency liquidity generator. Let's look at the past crisis. Okay. During the global financial crisis, their predecessor fund outperformed the S&P 500 by 3,200 basis points between late 2007 and mid 2009. Okay, hold on.
Let's translate that 3200 basis points for you listening. 100 basis points is 1%. So 3200 basis points means they outperformed by 32 percentage points during that massive collapse. Exactly. And the pattern repeated in 2020 during the CO 19 pandemic. PSH outperformed the S&P by an astonishing 5,180 basis points.
So 51.8 percentage points for the year. That liquidity cushion let them buy aggressively right at the market lows. And now let's look at the period we're focused on. Early 2022, the market was getting hammered by inflation fears, the war in Ukraine, the core portfolio is under pressure, but the hedge kicked in again.
Correct. Through March 22nd of 2022, while the underlying stocks were down, the hedging gains generated 727 basis points of positive returns. So that 7 plus% gain basically offset the portfolio losses. And that liquidity didn't just sit on the sidelines. The real genius of the strategy is what they do with that cash.
Right in 2020 and 2021, they'd invested a relatively small amount, $188 million, into those interest rate swapions. As inflation fears spiked, they sold those instruments for cumulative total proceeds of $1.45 billion. Wow. And that cash was immediately recycled back into the portfolio used to buy more of what they already owned or to jump on new opportunities.
It's like their big investment in Netflix in January of 2022. Turning risk into opportunity. That's the whole game right there. Let's dive into those core holdings. Starting with what became their largest investment, Universal Music Group, UMG. UMG is a perfect example of the PSH 3.0 philosophy. They and their affiliates bought a 10% stake.
And the thesis is all about the music industry's successful long overdue transition to digital. Yes. They use a really strong analogy for it. What's that? They see UMG as this highquality capital light business that is in essence a rapidly growing royalty on global music streaming. They compare it to the move to a software as a service or saw model.
So instead of one-off CD sales, UNG is now collecting predictable recurring revenue from subscriptions all over the world. Exactly. Which are low churn and highly scalable. And they are the undisputed global leader. They hold a massive 32% global market share in recorded music and they got it at a good price.
a very attractive price. They thought about 21 times their estimated 2021 operating income, which for a business of this quality and with such a long growth runway was a great deal. Okay, let's talk about the position bought directly with those hedge proceeds. Netflix initiated [clears throat] in January 2022.
This was a direct result of market panic. The stock got hammered at the start of the year because of some subscriber guidance issues and that gave PS the entry point they were looking for. And their thesis rests on two pillars, secular growth and pricing power. They argue that Netflix is one of the cheapest forms of highv value entertainment you can buy.
Well, they calculated costs something like 30 cents per hour of engagement and that low cost per hour is crucial because it validates their argument for pricing power even when they hike their fees. It does. With an industry-leading subscriber base of over 222 million, Netflix can afford to just keep outspending its competitors on content.
It creates a virtuous cycle. So, the value for the consumer keeps improving, which justifies future price increases, right? And they estimate the total addressable market, you know, excluding China, is somewhere between 800 and 900 million households. So, Netflix is still less than a quarter of the way there.
Let's move to another example of durable growth and pricing power, Chipotle. In a period of massive labor and food inflation, how did they hold up? Superbly. Chipotle showed phenomenal resilience. The digital sales they built up during the pandemic proved to be sticky and intore ordering was getting close to prepandemic levels by early 2022.
But the key part is the inflation response. Absolutely. They put through a menu price increase of 3.5% to 4.0% in 2021 specifically to cover moving to a $15 national average hourly wage. And how did customers react? management reported very little customer resistance. That is the textbook definition of pricing power.
So now they're targeting long-term unit growth of at least 7,000 restaurants in North America, having already blown past their 2015 peak for average restaurant sales. Okay, let's switch gears to home improvement and Lowe's companies. This is presented as both a transformation story and a valuation anomaly.
The transformation under the new CEO since 2018 is key here. The focus is laser sharp on the professional or pro customer segment. And the numbers back that up. Oh, yeah. Yeah. They reported really strong pro growth, up 21% in Q2 of 2021 and 49% on a 2-year basis. The goal is to get Pro Penetration up to 30 or 35% of revenue.
But the real investment case hinges on the market recognizing its value compared to its main rival, Home Depot. That's it exactly. Lowe's trades at around 16 times Ford earnings. Home Depot trades at about 22 times. So, a 6x multiple discount, which PSH believes is totally irrational. They see Lowe's as having superior earnings growth potential and a clear path to closing that 260 basis point operating margin gap between the two companies.
They just see it as significantly undervalued. We have to talk about the structural challenges now. The thing that caused the biggest headwind, the high-profile failure and legal drama around Persing Square Tantine Holdings or PSTH. Yeah, the failure of that initial UMG deal via the spa because of regulatory push back on its unusual structure, that was a major setback.
It was a painful 6.5% negative detractor to performance in 2021. So, a reputational and financial hit. And then came the lawsuit claiming PSTH was operating as an unregistered investment company. Did that just kill the whole thing? Well, while PSH saw the lawsuit as having zero merit, they had to admit that the litigation could scare off any potential merger partners.
So it forced them to radically rethink the whole spa structure which resulted in the proposal for spark persing square spark holdings right and this spark concept is designed to fix the fatal flaw of conventional spaxs which is tying up investor capital in a trust for months sometimes years that's the innovation spark stands for special purpose acquisition rights company instead of you the investor tying up $20 per share in a trust
spark would just issue subscription rights or spar warrants for free to to the existing shareholders. And those rights let you commit to invest at the $20 price only if a merger is actually identified. So the investor gets a free option on a future deal without the opportunity cost of having their money sitting in a lowinterest trust account.
Precisely. The structure aims to be a template for reform for the whole industry. A simpler capital structure, zero underwriting fees, minimal costs, but it needs regulatory approval. Yes, it requires the NYC to adopt a new listing rule and get SEC approval, which they're actively pursuing. Okay, quickly before we wrap the portfolio talk, let's touch on a couple other key moves.
They got back into Canadian Pacific Railway late in 2021. The thesis there is pretty straightforward and fits their durability focus. It's operational excellence plus the transformative acquisition of Kansas City Southern, which creates the only direct rail route from Canada all the way down to Mexico.
Exactly. a high barrier to entry business that benefits from domestic logistics. And what about their long-term holdings in the GSSE Fanny May and Freddy Mack? Yeah, they took a beating in 2021 and early 2022. They did. An adverse Supreme Court ruling and other legal challenges caused a lot of volatility and a big share price drop.
So, what's the thesis now? PSH is sticking to its long-term belief that the reprivatization of these core parts of the US housing system is a matter of when, not if. So they see current shareholders as owning a perpetual option that will eventually pay off no matter the short-term legal drama. And on the exit side, they strategically sold Agyant to raise cash for that UMG acquisition and they also got out of Starbucks completely.
Strategic capital reallocation in action. So if we look at the defining themes from this really intense period, what stands out? It's the synthesis of three powerful ideas. First, the stability from that permanent capital base. Second, the strategic use of asymmetric hedging to generate cash in a crisis.
And third, that almost singular focus on highquality North American companies with real pricing power. Whether it's music royalties like UMG, fast food like Chipotle, or home improvement like Lowe's. So, what does this aggressive structural innovation mean for the future of finance, especially if this seller model actually succeeds?
Well, the potential impact is huge. If the SEPAR model gets approved and adopted, it could fundamentally change how mature private companies access public capital. It offers a route to market that bypasses the high costs of a traditional IPO or a conventional spa. So the question you should be mulling over is this.
Could the Spark concept truly launch a spa revolution by making the whole going public process cleaner, faster, and much more investorfriendly, ultimately benefiting all shareholders by cutting down on dilution and friction. a fascinating potential template for change. That's a wrap on this deep dive. Thank you for joining us.
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