One of Wall Street’s most high-profile hedge fund managers, Bill Ackman, has made his next high-stakes bet: burritos. Chipotle Mexican Grill, Inc. (ticker: CMG) is officially under assault from a corporate raider.
Ackman’s Pershing Square Capital Management announced in a Securities and Exchange Commission filing on Tuesday that it had taken a 9.9 percent stake in CMG stock for about $1.2 billion. The purchase instantly made Pershing Square CMG’s second-largest investor (Fidelity is the first) overnight, giving it major influence over the board and the direction of the company.
Activist investors like Ackman are characterized by making large, short-term bets on companies, agitating for quick changes to add value, and then cashing out. They often stick below the 10 percent ownership threshold due to securities laws requiring 10 percent shareholders who sell out within six months to forego any profits made in that time period.
Shares of Chipotle shot nearly 6 percent higher on Wednesday, as investors cheered the vote of confidence from Ackman. But what, if any, significance should retail investors assign to this move?
[Read: The Pros and Cons of Hedge Fund Investing.]
A brief relief. It’s a welcome bounce for CMG stock, which has been hammered to the tune of 40 percent in the last year as a series of foodborne illness outbreaks (E. coli, salmonella, and norovirus) hit stores across the country, spooking customers and investors alike.
As it turns out, Ackman’s Pershing Square is no stranger to miserable financial performance either.
Two of Ackman’s largest investments, Herbalife (HLF) and Valeant Pharmaceuticals International (VRX), went against him quite publicly over the last year. Investors in Pershing Square’s hedge funds also took a roughly 40 percent hit between August 2015 and August 2016, equating to more than $7 billion in losses. Shareholders pulled an additional $600 million from Pershing in the first half of the year in an effort to flee weak performance.
For individual investors, let’s take a quick look at this new dynamic and how it could — for better or worse — pan out for the CMG stock price down the road.
The bull case. Franchising may be on Ackman’s agenda. The franchise model allows companies to expand rapidly without much capital. Chipotle’s former parent company McDonald’s Corp. (MCD) is a pro at this. Simply put, you can expand your store base much more quickly if franchisees put up the money to build new locations instead of the company itself.
Franchising is a low-risk way to build up a stream of generally reliable, recurring revenue; franchisees have to buy nearly everything directly from the parent company: food, napkins, utensils, kitchen equipment, uniforms — the whole lot. On top of that, the parent company gets a percentage of all sales off the top for lending its brand out to the franchisee.
You can see why it’s a pretty sweet deal for the franchisor, and why Ackman may end up pushing CMG for this change.
Ackman may also shake up the board, which is not an uncommon move for activist investors seeking to make big changes. Ackman does have some success doing this sort of thing; in August, Pershing sold its $1.5 billion stake in Canadian Pacific Railway Limited (CP) in August at around $150 per share. The fund began buying into the railroad stock in 2011 for less than $50/share, then rode shares higher as it pushed for (and got) new board members and a new CEO who shared Pershing’s vision for executing a successful turnaround.
“Shareholders have and should welcome the ‘vote of confidence’ from Bill Ackman’s 9.9 percent stake,” says K C Ma, professor of finance at Stetson University. Ma even has a prediction about what, aside from franchising, Ackman could be interested in pushing for.
[Read: The 7 Smartest Acquisitions of All Time.]
The legendary fund manager is “set to take a hard look at the ‘strategic value’ of the scheduled launch of ‘Tasty Made,’ a burger chain, by Chipotle, a taco chain.” He may decide the two restaurants aren’t compatible, ditch the Tasty Made idea, and try to boost the bottom line by cutting those expenses.
The bear case. On the other hand, Ackman has had a remarkable ability to get things dead wrong this year.
Sure, Ackman’s losing streak isn’t the most rational reason to avoid CMG stock, but it’s a valid reason to ask yourself a few questions about Pershing Square’s recent troubles before viewing the fresh CMG stake as an unqualified bullish indicator:
1. Is Ackman simply “seeing the market wrong” right now? His fund’s embarrassing multibillion-dollar losses in Valeant Pharmaceuticals have been particularly egregious this year, as shares of the drug maker plunged from more than $250 a share to as low as $18 amid questions about opaque accounting and sketchy business practices. In February, Pershing announced it had increased its Valeant stake at the beginning of the year, when it presumed the stock was trading at bargain-bin prices in the $95 to $100 range. Today VRX stock hovers around the $30 level. His billion-dollar bet against the nutritional supplement company Herbalife also hasn’t panned out. Ackman has repeatedly said HLF stock is going to $0; instead, shares are up about 16 percent this year.
2. The second, arguably more pressing question is whether Ackman is buying CMG shares out of haste, in a desperate effort to recoup his fund’s significant year-to-date losses. We already saw Ackman throw good money after bad with Valeant earlier this year; Chipotle may be yet another not-so-thinly-veiled attempt to claw back gains from a formidable hole.
[See: The 9 Best Investors of All Time.]
At the end of the day, piggybacking on the moves of activist investors may seem like a sexy way to invest, and sure, it has the potential to reap some big rewards. But unless you want to carefully watch Ackman’s every move and announcement regarding CMG until he ultimately sells his stake, it’s probably better to just leave these sort of investments to the “pros” — who can still manage to lose 40 percent in a year.
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Chipotle Mexican Grill, Inc. (CMG) Stock: Should You Follow Ackman’s $1.2 Billion Lead? originally appeared on usnews.com
