NEW YORK--(BUSINESS WIRE)--Fitch Ratings does not yet see pressure on Pershing Square Holdings, Ltd.'s (PSH) 'BBB+' Issuer Default Rating (IDR), senior unsecured debt rating or Stable Outlook, despite the asset value declines experienced over the last several months, capped off by the recent and precipitous drop in PSH's investment in Valeant Pharmaceuticals International, Inc. (Valeant).
Ratings remain supported by very low levels of debt-to-total capitalization relative to assigned ratings, the absence of restrictive covenants associated with PSH's outstanding debt, increased cash on hand following the partial sale of PSH's holdings in Mondelez International, Inc. (Mondelez) and increasingly active involvement in Valeant on the part of Pershing Square Capital Management, L.P.'s (PSCM) executive management team.
Between June 30, 2015 and March 22, 2016, PSH's net asset value declined by 42.4% to $3.9 billion from $6.8 billion, driving an increase in debt-to-total capitalization to 20.4% from 12.9%. Asset value declines have been driven by underperformance of several investments, most notably Valeant, which declined 85.6% over this time period, including a 52.8% drop month to date (through March 24, 2016) following Valeant's lowered earnings guidance and continued delays in filing its financial statements.
Fitch estimates that if Valeant's share price were to go to $0, PSH's debt-to-total capitalization would increase to approximately 23% holding all other investment values constant. From a quantitative perspective, this level would still be viewed as consistent with the current ratings, although Fitch would also consider what breakdowns in the investment and risk management framework led to such an outcome, as well as the degree of franchise damage incurred.
At the current debt-to-total capitalization level, PSH could withstand an overall portfolio market value decline of approximately 38.8% before tripping its incurrence-based debt-to-total capitalization covenant of 33.3%. Furthermore, it would require a market value decline of 79.6% before asset coverage of debt would be less than 1.0x. Declines of these magnitudes would certainly have negative rating implications, but they underscore the degree of asset coverage debtholders continue to benefit from.
PSH's unsecured debt includes a covenant restricting the incurrence of additional indebtedness (excluding margin leverage of up to 10% of total capitalization) in the event that debt-to-total capitalization exceeds 33.3%. As mentioned, PSH continues to maintain sufficient cushion relative to this covenant, and regardless, as an incurrence-based test a breach would not materially restrict PSH's operational or financial flexibility. Nevertheless, the covenant represents a financial operating metric within which the company felt reasonably comfortable it could operate at the time of the debt issuance. As such, were PSH to begin to approach this threshold on a sustained basis, it would be viewed negatively by Fitch.
PSH's announced sale of $331.4 million of its investment in Mondelez on March 16, 2016 is viewed as an appropriate response to recent events, in terms of reducing an outsized exposure and, more importantly, increasing cash available to support debt. Although elevated cash may not be a permanent feature of PSH, Fitch views the current retention of cash as an important mitigant to potential negative rating pressure in the near term.
Fitch also notes PSCM's increased involvement in Valeant, as evidenced by its CEO, William Ackman, and Vice Chairman, Stephen Fraidin, both assuming board positions at Valeant. These steps do not guarantee a stabilization or improvement in Valeant's financial condition, but they certainly provide a platform to undertake a more active role in attempting to address the current challenges while aligning with PSCM's core competencies as an activist investor.
Negative rating action for PSH could be driven by continued investment underperformance which results in debt-to-total capitalization exceeding 25% on a sustained basis. Fitch would note that although PSH is not exposed to redemption risk, its sister funds are, which could create second-order price pressure on PSH's investments were these funds to experience redemption pressure. A reduction in current elevated cash balances before more clarity is available with respect to Valeant could also adversely impact PSH's ratings.
Additional information is available on www.fitchratings.com