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Welcome to the deep dive. Today we're tearing through some fascinating investment reports to really understand one of the most well remarkable corporate turnarounds in recent memory. We are we're looking deep inside the strategy of Persing Square Holdings or PSH right after a very necessary and as we'll see a very successful strategic reboot.
That's exactly right. We're working from a set of source documents, mainly uh recent shareholder reports, right? And they really tell a story of well extreme volatility. PSH had navigated a choppy 2018, ending the year down just a tiny bit, negative.7%. Which was actually better than the S&P 500, right?
That was down over 4%. Exactly. They actually outpaced the market's decline. But the real story, the one we're diving into, it really kicks off in the winter of 2019. Okay, let's zoom in on that moment because the velocity of the change here, that's what's so astonishing. In just the first quarter of 2019, I think through March 19 specifically, PSH reported an astounding return of plus 31.9%.
It's an incredible number. And just to put that into perspective for you, the S&P 500, which had a fantastic start to 2019 itself, was up only 13.5% over that exact same period. Wow. The firm actually went on the record calling it the best start in their entire 15-year history. So, this wasn't just a market bounce.
It signaled that a fundamental structural change was finally bearing fruit. And before we get into the, you know, the nuts and bolts of what actually changed, I think we need to set the stage a little. Put this in a long-term context. Yeah, that's important. Even with all that recent turbulence, PSH's underlying strategy, if you look at their original LP track record, it shows a 14.0% 0% compound annual return since 2004.
And that really outstrips the S&P 500's 8.5% over the same long-term period. So, you know, they know how to generate alpha. Something had clearly gone wrong and they had to fix it. So, what was the fix? Well, the fix was profound. I mean, they didn't just change a few stocks in the portfolio. They basically rebuilt the entire platform from the ground up.
How so? They went back to their core philosophy, investing only in simple, predictable, free cash flow generative businesses. And crucially, business is protected by these large sustainable competitive modes. I see. They even stated that because of this refocus, they now own one of the highest quality collections of businesses they have ever held since the firm's inception.
And this is where it gets really interesting because that strategy shift, it was completely tied to capital stability. One of the biggest decisions was just halting [snorts] the process of raising new capital for their core private funds. That decision was foundational. I mean truly PSH the publicly traded vehicle now represents the vast majority of the manager's core assets.
We're talking about $6 billion out of $8 billion. That matters because it's all about alignment. Total alignment. The investment manager and the whole team, they now own more than 20% of PSH's shares outstanding. That's over a billion dollars of their own equity. That is more than just putting your money where your mouth is.
I mean, that completely changes the calculus for every single decision. M if they suffer a loss, it hits their personal wealth immediately and well hugely. Precisely. If they're thinking about a risky move, they are taking that risk directly with their own capital. But there's a second huge benefit.
It's an operational advantage. Right? That stable permanent capital base. It's not subject to quarterly redemptions or the whims of nervous clients. It lets them be an opportunistic buyer when the market panics. Wait, I want to pause on that. If the firm's long-term track record is so strong, why would private fund clients have panicked in the first place?
Isn't that the definition of having bad capital? You'd think so. And historically, yes, good managers should be able to retain their capital. But the reality of running a traditional hedge fund is that institutional clients, you know, pension funds, they often have internal risk metrics, right? And those metrics can trigger mandatory redemptions if volatility hits a certain threshold.
No matter what the manager's long-term view is, they might literally have to pull their money out. I see. So, by shifting to PSH as the main vehicle, that risk just vanishes. They control their own capital structure. It's a gamecher. And we saw that advantage play out almost immediately. You just have to look at December 2018 when the market had that big downdraft.
What did they do? They went shopping. They capitalized on the volatility by making a large opportunistic new investment in Hilton Worldwide Holdings. If their capital had been structured the old way, they might have been forced to sell things to meet redemptions. Instead, they got to buy highquality assets on sale.
So, this all means we really have to rethink what PSH even is. They're explicitly saying, "Don't view us as a short-term equity hedge fund." Exactly. They want PSH to be seen as a taxefficient, publicly traded in investment holding company. So, think of it less like trading stocks and more like what?
A public private equity firm that never actually has to sell its winners. That's a a perfect way to put it. Their strategy is what they call the influence model. They buy large minority stakes, often less than 20%, and that gives them substantial influence without having to pay the massive premium for legal control.
They're relying on persuasion and strategy, not just brute force ownership, right? And that structure, it seems almost tailor made for the kind of painful long-term turnarounds that companies like Chipotle and Lowe's needed because they can recruit top tier CEOs who want to run a public company, but they appreciate having this stable, influential investor backing them up for the multi-year changes they need to make.
It gives them a real runway. That stability and that ability to influence without controlling. It's just invaluable. and the results we saw in early 2019, they're a direct reflection of this new structure finally allowing those portfolio changes to mature. Okay, so let's get into those catalysts. Let's look at the four specific companies that drove that massive reversal.
We have to start with Chipotle, CMG. We do. The performance attribution in the reports shows it was a massive contributor both in 2018 and especially at the start of 2019. This was a classic leadership change story. Absolutely. Chipotle success is a textbook example of installing influence and operational knowhow.
The CEO Brian Nickel, he came from Taco Bell and joined in March 2018. The changes were almost immediate. And for years before that, Chipotle had been struggling, right? Bureaucracy, slow innovation, the food safety issues. It was a mess. So Nickel came in and was just ruthless in streamlining the operations.
He eliminated two entire layers of management to flatten the hierarchy, which would improve speed and responsiveness. Exactly. He moved the headquarters to Southern California to attract better talent. And this is key. He instituted a really rigorous stagegate process for product innovation. For anyone listening who hasn't heard that term, what does a stagegate process mean for a company selling burritos?
It's basically a disciplined step-by-step approach to new products that minimizes risk. So instead of just launching a new item nationwide on a whim, you break it down into stages. Ideation, testing, right? Testing in a few markets, refining it, and only then going for a national launch. It ensures new things like their lifestyle bowls hit the market with maximum efficiency and minimal risk of some operational failure, which is exactly what Chipotle needed.
And the results really do speak for themselves. We saw that huge 6.1% same store sales growth in Q4 2018. And crucially, that included transaction growth. More customers were actually walking in the door, a number that had been negative since mid 2017. The stock just exploded. It was up 54% in the first few months of 2019 alone.
Wow. And that momentum just kept going with the launch of their loyalty program and those lifestyle bowls. It's a simple story. PSH saw a company that was broken operationally, brought in proven leadership, and unlocked massive value just by fixing the processes. Okay, let's shift gears from fast food to uh back office payroll, automatic data processing or ADP.
PSH's involvement there came from a really different angle. A hard-fought proxy contest back in 2017. It did. A proxy contest is when an activist shareholder like PSH tries to convince all the other shareholders to vote their way, usually to get their own people on the board to force change. And they didn't actually win that fight outright, did they?
No, they didn't. But the battle itself forced ADP's management to agree to a very ambitious long-term operational objective, which was the goal was to hit $7 in earnings per share EPS by fiscal year 2021. And that was a huge jump from about $4 in EPS when PSH first invested. That's a massive increase in underlying profit.
It would have to translate into a higher valuation. It has to. And the transformation is still underway. The key drivers are things like accelerating their service alignment initiative and a big early retirement program to trim costs. And they brought in new people, too. Yes. They strengthened the management team with a new chief transformation officer and a new CFO.
It just shows that the influence from that proxy fight is still dictating the corporate direction today. What's really fascinating there is that activist mindset. PSH believed even that $7 EPS goal, which management finally agreed to, was only a fraction of ADP's real potential. That's the influence model in action.
They don't need to control the board. They just need to make sure management is held accountable for achieving worldclass results. All right, moving on to Lowe's. Well, Low W, this was a classic closing the gap investment. Exactly. The entire investment premise was built on the massive performance gap between Lowe's and its main competitor, Home Depot.
Right? When PSH invested, Lowe's profit margins were nearly 500 basis points less than Home Depot. And for our listener, when we say 500 basis points, we mean five full percentage points. That is an enormous gap in profitability for two companies selling basically the same stuff. It's staggering. It represented billions in potential value if Lowe's could just become a little more efficient.
And the catalyst was again management change. They recruited Marvin Ellison who had been a senior exec at Home Depot during its own turnaround and installed him as CEO in July 2018. Right. And Ellison moved fast. He brought in a whole new senior executive team. A lot of them were former colleagues ready to basically run the Home Depot playbook all over again.
And by December of that year, the plan was public. Yeah. Aiming for a 12% operating margin, up from just 9.2%. And the sources draw this really helpful analogy here. They compare Lowe's to the Canadian Pacific Turnaround PSH was involved in where they brought in a best-in-class manager to fix systemic underperformance against a rival railroad.
It's a proven playbook. The final big catalyst is United Technologies, UTX. This one feels different. It's less about operations and more about corporate structure. Yeah, the value creation thesis here was very straightforward. PSH believe UTX's three distinct divisions. You have aerospace, Otis elevator, and then climate controls and security were being penalized by being stuck together under one corporate umbrella.
The idea being that the sum of the parts is worth way more than the whole. Precisely. They argued that if the divisions were separate, each would get a higher valuation because investors could specialize. You'd have aerospace investors buying the aerospace business and so on. And their pressure on that front paid off really quickly.
It did. UTX announced a three-way separation of the company in November 2018 set to complete by early 2020. And this was even though the stock was trading pretty cheaply around 15 times earnings, the market, you know, it eventually comes around to intrinsic value. Which leads us to the biggest paradox in this whole turnaround story.
If the portfolio companies making all this progress and PSH had its best start in 15 years, why is PSH itself still struggling with this structural issue, the NAV discount? That's the major hurdle. PSH shares trade at a significant discount to their net asset value or NAV. In early 2019, that discount was at 28%.
Which was the widest in the company's history. You could basically buy a dollar of PSH assets for 72 cents. And you would think naturally the solution would be massive share buybacks, right? Reduce the supply of shares at that steep discount. But they've been really cautious about that. Extremely cautious.
It sounds counterintuitive. If the market is giving you a dollar for 72, why wouldn't you buy back every single share you can afford? So why not? Because they see potential downsides that could actually damage the long-term structure they've just fought so hard to rebuild. They're worried about liquidity and leverage.
Explain that. Okay. So, if they aggressively buy back shares, they reduce the trading liquidity. That makes it much harder for new large institutional buyers to build a position. It could actually narrow their universe of potential investors and the leverage part. When you buy back shares, you reduce shareholder equity, which increases the company's financial leverage.
That increase in risk can paradoxically cause the discount to get even wider if the market sees PSH as a riskier company. So they believe there's a point where that kind of financial engineering just becomes less profitable than finding the next great investment. They even cite a specific comparison in the documents.
They do. They compare a hypothetical buyback to their actual investment in Starbucks. The Starbucks deal generated a 476 basis point gain in NAV. The hypothetical buyback. It would have only generated about 236 basis points. So simply investing in the next great business generated nearly twice the return of buying back their own discounted stock.
Exactly. It just reinforced their core belief. Their highest and best use of capital is strategic investment and operational activism, not financial engineering. But they still have to address the discount somehow. Which brings us to the dividend. They started a quarterly dividend in February 2019, 10 cents per share.
And that dividend, it's a strategic play. It's not just about returning cash. The specific goal is to attract a whole new broader universe of long-term investors. The ones whose mandates only let them buy stocks that pay a dividend. They're trying to make PSH accessible to a totally different type of buyer who couldn't even consider it before.
It's a patient strategy. They're trying to solve a liquidity problem and a perception problem at the same time. Betting that the performance of the underlying businesses will eventually force the market to rerate PSH higher. This whole deep dive is just a powerful lesson. The central takeaway for me is that PSH's dramatic turnaround wasn't just luck.
It wasn't just market timing. It was the direct result of painful structural changes, right? Stable permanent capital, a razor sharp focus on their core strategy and that active influential involvement in driving these deep multi-year turnarounds at companies like Chipotle, Lowe's, and UTX. They essentially transformed themselves into an infinite lifeolding company.
That patient capital allowed them to execute changes that required a long runway, like finding the right CEO or forcing a massive corporate breakup. And that in turn allowed them to capitalize on market volatility when everyone else was being forced to sell. So what does this all mean for you, the learner?
Well, the source material makes a really strong case that the strategy of finding undervalued public companies and installing real effective operational change, the kind we saw at Chipotle and Lowe's, is currently far more valuable than just trying to financially engineer a higher stock price with buybacks.
Right? So for you, the question is this. How long will the market continue to ignore the intrinsic value being created by these fundamental strategic changes, especially when compared to the short-term focus on things like stock liquidity and dividends? Does real structural change always take longer to be rewarded than a financial gimmick? Something to consider as you watch the next corporate turnaround unfold.
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