Pershing Square Q3 2008 Inv

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          Pershing Square Q3 2008 Investor Letter
          In Bill Ackman, Insurance, Security Analysis on November 15, 2008 at 11:44 pm

          These are extraordinary times particularly for active participants in the capital markets. While I do not
          normally choose to write about macro and regulatory events, I thought it would be useful for you to
          understand how we think about recent events and their impact on our portfolio.

          We are currently witnessing the greatest deleveraging event in history. What began as a credit bubble
          bursting has now spread to the equity markets as banks, investment banks, hedge funds, structured products,
          mutual funds, pension funds, endowments and other leveraged and unleveraged market participants have
          been forced to liquidate assets by their counterparties, leverage providers, redeeming clients, and as a result
          of downgrades, other debts or other commitments that need to be funded.

          These actions have led to forced and indiscriminate selling in security markets around the world, which in
          turn has caused other investors to panic or simply to sell, to get out of the way of other forced sellers.

          As a fund which is generally substantially more long than short, we have also suffered large mark-to-market
          declines in our long investments. Year to date, however, our performance has substantially exceeded that of
          the broader equity markets, which at this writing have seen a more than 34% decline. Our outperformance is
          largely due to large gains on our investments in Longs Drugs and Wachovia Corporation as well as profits on
          our credit default swap and other short exposures. Our market losses have been further mitigated because we
          operate unleveraged and have substantial cash balances. Currently, we have cash and near-cash (Longs
          Drugs and Wachovia/Wells Fargo long/short) equal to approximately 39% of our capital.

          When, you might ask, will the selling end? While I don’t proclaim to be a market prognosticator, I will make
          a few observations. Unlike the deleveraging that takes place when banks and other financial institutions sell
          assets to meet regulatory requirements, which is typically a longer term process, the forced deleveraging that
          is now taking place in the equity markets is being implemented largely by the prime brokerage firms and
          margin account managers at broker dealers around the world. Prime brokers are not known to be laggardly in
          their approach to liquidating an account that no longer meets margin requirements. This is likely to be even
          more true in the current environment. As such, it may be reasonable to conclude that the forced liquidation
          that is now taking place may not be a prolonged process.

          Security prices around the world have come down tremendously. In the larger capitalization U.S. markets,
          which are the focus of our strategy, the reductions have been substantial. As of the market close on October
          31st, the S&P 500 is down 34.0%, year to date, and down by 37.5% from its high on October 31, 2007; and
          this is after last week’s rally in which the S&P 500 rose more than 12% from the lows. Unlike the bear
          market of 1973 and 1974, in which stocks declined by 45% from the highs, this bear market was not preceded
          by the “Nifty 50” bubble in which large capitalization growth stocks traded at extraordinary valuations.
           While valuations were not cheap one year ago, in a long-term historical context, the market as a whole
          (particularly if one were to exclude financials) was not particularly expensive either.

          As such, in today’s market, we are finding extraordinary bargains, the kinds of opportunities that are normally
          associated with market bottoms. While there are still weak and poorly capitalized businesses that are likely
          still overvalued, the high quality, well-capitalized, larger capitalization businesses which are the focus of our
          strategy look very cheap to us.

          While this means that now is likely to be a much better time to be a buyer rather than a seller, it does not
          mean that the market will not continue to decline, even substantially, from current levels, particularly in the
          short term. In fact, because of tax-loss selling over the next 60 or so days, there will likely be additional
          selling pressure. At some point, however, the forced selling will come to an end. Large amounts of cash are
          sitting on the sidelines waiting to be deployed when investors feel the coast is clear. In the event the market

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          sitting on the sidelines waiting to be deployed when investors feel the coast is clear. In the event the market
          were to start to rise again, it would not be a surprise to see institutional, retail, and hedge fund investors
          rapidly deploy capital so as not to miss a, perhaps, explosive market rally.

          What does this all mean for Pershing Square? Despite the fact that we occasionally have an opinion, we
          spend little time trying to outguess market prognosticators about the short-term future of the markets or the
          economy for the purpose of deciding whether or not to invest. Since we believe that short-term market and
          economic prognostication is largely a fool’s errand, we invest according to a strategy that makes the need to
          rely on short-term market or economic assessments largely irrelevant.

          Our strategy is to seek to identify businesses and occasionally collections of assets which trade in the public
          markets for which we can predict with a high degree of confidence their future cash flows – not precisely, but
          within a reasonable band of outcomes. We seek to identify companies which offer a high degree of
          predictability in their businesses and are relatively immune to extrinsic factors like fluctuations in commodity
          prices, interest rates, and the economic cycle. Often, we are not capable of predicting a business’ earnings
          power over an extended period of time. These investments typically end up in the “Don’t Know” pile.

          Because we cannot predict the economic cycles with precision, we look for businesses which are capitalized
          to withstand difficult economic times or even the normal ups and downs of any business. If we can find such
          a business and it trades at a deep discount to our estimate of fair value, we have found a potential investment
          for the portfolio. Next we look for the factors that have led to the business’ undervaluation, and judge –
          based on our assessment of the company’s governance structure, management team, ownership, and other
          factors – whether we can effectuate change in order to unlock value. When the price is right, the business is
          high quality, the management is excellent, and there are no changes to be made, we are willing to make a
          passive investment.

          Our assessment of the short-term supply and demand for securities plays almost no role in our determining
          whether to invest capital, long or short. If we believed that it was possible to accurately predict short-term
          market or individual stock price movements and we had the capability to do so ourselves, we might have a
          different approach. Below I quote Warren Buffett in his 1994 Letter to shareholders where he perhaps says it
          best:

                We will continue to ignore political and economic forecasts, which are an expensive distraction
                for many investors and businessmen. Thirty years ago, no one could have foreseen the huge
                expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a
                president, the dissolution of the Soviet Union, a one-day drop in the Dow of 508 points, or
                treasury bill yields fluctuating between 2.8% and 17.4%.

                But, surprise - none of these blockbuster events made the slightest dent in Ben Graham’s
                investment principles. Nor did they render unsound the negotiated purchases of fine businesses
                at sensible prices. Imagine the cost to us, then, if we had let a fear of unknowns cause us to defer
                or alter the deployment of capital. Indeed, we have usually made our best purchases when
                apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the
                friend of the fundamentalist.

                A different set of major shocks is sure to occur in the next 30 years. We will neither try to
                predict these nor to profit from them. If we can identify businesses similar to those we have
                purchased in the past, external surprises will have little effect on our long-term results…

                Stock prices will continue to fluctuate – sometimes sharply – and the economy will have its ups
                and down. Over time, however, we believe it is highly probable that the sort of businesses we
                own will continue to increase in value at a satisfactory rate.


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          I believe we will look at the current U.S. stock market valuations for high quality mid and large capitalization
          businesses as presenting perhaps the best investment opportunities of our lifetimes.

                                                           Portfolio Update

          The last quarter and, in particular, the last few weeks have been an extraordinarily busy and productive time
          for Pershing Square. During this time, we have made considerably more buy and sell decisions than usual,
          taking advantage of the liquidity of our holdings, the enormous volatility of the market, and new opportunities
          that have presented themselves in recent weeks.

          In the third quarter, we disposed of our investments Cadbury PLC, Canadian Tire, and Austrian Post at prices
          generally higher than current levels. We also disposed of the substantial majority of our investment in Sears
          Holdings. We hold a residual interest in Sears (which represents approximately 1.5% of fund capital) as its
          price declined to a level at which it made no sense to continue to sell. We redeployed the capital from these
          sales into Wachovia Corporation, which I will discuss further below, as well as a new investment in which we
          are in the process of accumulating a position.

          We sold these positions not because we thought they would be poor investments, but rather because we
          believed that we could redeploy the capital in investments that offered a more attractive risk-reward profile.
           As we have often stated, we are always willing to sell an existing holding at a profit or a loss, if we can find a
          better use for the funds. For our taxable investors, sales at a loss have the additional benefit of offsetting
          taxable gains.

          Our sales were also motivated by the fact that three of the above companies – Sears, Canadian Tire, and
          Austrian Post – each have a controlling shareholder. Because we believe that one of our important
          competitive advantages is our ability to effectuate change at companies in our portfolio, other than in special
          circumstances, we do not expect to make investments in controlled companies in the future.

          As a result of recent changes in the portfolio and strategic developments with respect to Longs Drugs and
          Wachovia Corporation, our long portfolio is now comprised of higher quality, more economically resilient
          businesses, companies for which we can be a catalyst to create value, and a large amount of cash and
          soon-to-be cash that we can redeploy in new opportunities.

          On the short side of the portfolio, we have been opportunistic in unwinding single-name credit default swaps
          in cases where spreads have increased significantly, and have covered certain short positions where stocks
          have declined substantially as a result of company-specific as well as market-related events. We recently
          repurchased CDS on the investment grade credit index as certain technical factors have made this
          investment/hedge attractive once again.

                                                             Longs Drugs

          In last quarter’s letter, I alluded to a new position on which we expected to file a Schedule 13D shortly. That
          position was Longs Drugs, a West Coast based drugstore retailer. While Longs’ was valued in the market as
          an underperforming drug store retailer, we valued the business based on its component parts which included:
           (1) owned and long-term, below-market, leasehold real estate, (2) RxAmerica, a rapidly growing pharmacy
          benefit manager (“PBM”) which generated more than 20% of the company’s trailing operating income, and
          (3) an underperforming, low-margin drugstore retailer. At our cost, we believed that Longs real estate value
          alone more than covered our purchase price and we were getting the PBM and the retailer for less than free.
           We estimated the fair market value of the company to be $85 to $95 per share assuming each of the
          company’s assets was sold to the buyer who could pay the highest price.

          Unlike many of our previous active investments, we concluded that Longs had reached the end of its strategic
          life and should be sold to one of its larger competitors, namely CVS or Walgreens. While it has been rare for

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          life and should be sold to one of its larger competitors, namely CVS or Walgreens. While it has been rare for
          us to buy a stake in the company with a view that a strategic sale was the right exit opportunity, we have done
          so in the past. For example, our original investment in Sears Roebuck & Company was predicated on a
          strategic outcome at the company which was ultimately achieved when it was acquired by Kmart.

          In the current weak (to use a euphemism) credit environment, we are particularly wary of investments which
          are predicated on a sale. However, in this case, we were comforted by the fact that Longs Drugs would be a
          must-have acquisition for CVS and Walgreens and that both companies, which are many times the size of
          Longs, could easily finance the acquisition. Even in the event a sale did not go through, we had purchased
          Longs at an attractive price which offered a substantial margin of safety against a permanent loss of capital.

          Within one week of our 13D filing, Longs announced that it had entered into a transaction to be sold to CVS
          for $71.50 per share in a cash tender offer, an approximately 44% premium to our average cost. While we
          were happy with the deal, we were somewhat unhappy with the purchase price, particularly when we learned
          that the company had not run a competitive auction. Thereafter, we hired the Blackstone Group with whom
          we have worked successfully in past transactions in an attempt to achieve a better outcome for all
          shareholders.

          We and Blackstone were successful in attracting a bid of $75 per share from Walgreens; however, the greater
          regulatory risk and potential time delay in a transaction with Walgreens led Longs’ board to reject the
          transaction in favor of the CVS offer. Walgreens subsequently withdrew its offer citing market conditions,
          and a day later, the CEO of Walgreens stepped down. We anticipate that we will be fully cashed out of our
          investment in Longs’ by the close of trading today.

                                                      Wachovia Corporation

          Wachovia is a good example of the types of opportunities that have emerged in the current highly volatile
          environment. On Monday morning September 29th, Wachovia Corporation announced that it had entered
          into an agreement in principle to sell its banking subsidiaries to Citigroup. The transaction was structured in
          an unusual manner. In the deal, Citi was paying $2.1 billion of its own stock to Wachovia Corporation (the
          publicly traded holding company for the Wachovia banking subsidiaries) and assuming $53 billion of senior
          and subordinate holding company debt in addition to the debt and other liabilities of the Wachovia banking
          subsidiaries. The description of the transaction was limited to a several paragraph press release and a
          conference call presentation by Citigroup that morning. Wachovia stock opened later Monday afternoon at
          approximately $1.80 per share, down 82% from Friday’s close.

          The market’s reaction to the Citi transaction was severe, particularly as the transaction was announced only
          four days after Washington Mutual’s subsidiary banks were seized by regulators and sold to J.P. Morgan. In
          that transaction, WaMu’s holding company filed for bankruptcy, wiping out shareholders and materially
          impairing holding company creditors.

          The Wachovia transaction, however, was structured in a materially different manner from the WaMu seizure.
           It appears that the government, in order to protect bank holding company bondholders from losing their
          investment and perhaps to avoid triggering a CDS credit event, structured this deal so that Citi would assume
          the holding company debts. Interestingly, as part of the Citi transaction the government provided an excess-
          of-loss guarantee on Wachovia mortgages to protect Citi, which the government could likely have avoided if
          it had not required Citi to assume $53 billion of holding company debt. It appears that the government had
          concluded that additional bank holding company debt defaults would create systemic risk or reduce the ability
          for bank holding companies to access this important source of capital, and therefore chose to protect the
          Wachovia banking subsidiary and the holding company bondholders.

          The unusual structure of the transaction created an interesting investment opportunity. By removing the
          holding company debts, Wachovia Corporation, now orphaned from its bank subsidiaries was left with some
          very attractive assets. Based on our reading of the public filings, conference call transcripts, and internet

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          very attractive assets. Based on our reading of the public filings, conference call transcripts, and internet
          research over the course of Monday morning and afternoon, we estimated that Wachovia was left with the
          following assets: approximately $2 billion or more of cash, $2.1 billion of Citigroup Stock, the Wachovia
          Securities wealth management operation, A.G. Edwards (which had been purchased one year ago for
          approximately $7 billion), Evergreen Asset Management (a mutual fund manager with $245 billion in assets
          under management), Wachovia Insurance Services, and other ancillary assets.

          In light of the Citi debt assumption, the only material liability of Wachovia Corporation was $9.8 billion of
          non-cumulative, perpetual preferred stock. Because this preferred is both non-cumulative and perpetual,
          Wachovia has no obligation to ever pay a dividend on these securities making these liabilities effectively a
          free form of equity financing. These types of preferred securities are typically structured to qualify as an
          attractive form of bank holding company equity which gets favorable regulatory and rating agency treatment.
           Now that they were orphaned by the transaction, at best these liabilities were worth less than 50 cents on the
          dollar.

          We also determined that the structure of the transaction would create a large tax asset for the holding
          company. By selling the bank subsidiaries for less than their net tangible asset value, we estimated that a $26
          billion tax loss would be created. This tax loss could by carried back two years enabling the holding
          company to recover approximately $7.5 billion of cash taxes that had previously been paid.

          Our conservative estimate of value of New Wachovia was in excess of $8 per share even assuming that the
          preferred stock was redeemed or valued at par. We began buying the stock shortly after it opened on
          Monday afternoon. My instructions to our traders Ramy Saad and Erika Kreyssig were to buy every share we
          possibly could, including pre- and post-market trading. They did a superb job.

          Between Monday afternoon and late Thursday we acquired 178 million shares, or approximately 8.3% of the
          company, at an average price of $3.15. On Friday morning before the open, Wells Fargo announced a
          definitive agreement to acquire Wachovia for 0.1991 shares of Wells common stock, or more than $7.00 per
          share based on Friday’s trading price. We began selling our Wachovia stock on Friday. We could not,
          however, hedge the Wells Fargo stock price because the short selling ban was still in effect.

          Citi, which thought it had an exclusive to complete the transaction with Wachovia, brought litigation later that
          Friday to enjoin the Wells Fargo deal. By late the following week, Citi, likely as a result of pressure from the
          government, had agreed to allow the Wells transaction to go forward while retaining their lawsuit for damages
          against Wells Fargo.

          As of this date, we have hedged 100% of our exposure to Wells Fargo shares, and have been opportunistic in
          unwinding a substantial portion of the position. Assuming we waited until transaction closure and taking into
          consideration Wachovia shares already sold, we have locked in a 67% profit on this $560 million investment.

          The government and all of the parties appear to be doing everything they can to consummate the transaction
          promptly. The transaction received HSR approval in one day and the Treasury and banking authority
          approvals over the following weekend. Wells has been issued 39% of the voting stock of Wachovia and
          transaction closure is anticipated by year end. The transaction requires the recently filed form S-4 to be
          approved by the SEC and the completion of the mechanics of the shareholder meeting in order to be
          consummated. It is an excellent deal for Wells Fargo and for Pershing Square.

                                                               A Mistake

          While most of our long investments are comprised of great businesses or assets at fair prices with a catalyst to
          create value, we occasionally are willing to invest a small amount of fund capital in situations which offer the
          potential for a many-fold profit at the risk of a large or near-total loss of capital invested. I typically call these
          investments mispriced options. Our CDS investments fit this profile. While not all mispriced options will be
          profitable for the funds, I expect our collective experience in these commitments to be quite favorable over
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          profitable for the funds, I expect our collective experience in these commitments to be quite favorable over
          time.

          We purchased stock in American International Group, Inc. (AIG) after the announcement of the government
          bailout. In summary, we did so because at the price paid, we purchased AIG at a substantial discount to book
          value, and we believed that book value was a conservative estimation of the value of AIG’s underlying
          businesses net of derivative losses. We also believed that there was the potential for a renegotiation of the
          government’s extremely harsh financing commitment to AIG which provided for 80% dilution, enormous
          commitment fees, and a high interest rate.

          In particular, we believed that if AIG could pay back the government promptly through a combination of
          asset sales, termination of certain CDS contracts at potentially less than fair market value, and equity
          investments from existing and potentially other investors, that there was a chance to renegotiate the 80%
          zero-strike warrant package to the government. If the warrant dilution could be mitigated, it would be
          possible for AIG shareholders to make a many-fold return on investment. Initially, we believed that the
          potential for return outweighed the risk of loss. Because of the inherent leverage of AIG, the risk of a
          permanent loss of capital on this investment was material. As such, we limited the size of our investment to
          2.5% of fund capital.

          After acquiring our position, we met with other large holders, policymakers and contacted Berkshire
          Hathaway and other potential investors about a proposed recapitalization of AIG. Unfortunately, the
          collection of shareholders that were attempting to restructure the government deal was exceedingly
          disorganized and some large holders were conflicted by a desire to buy certain assets from the company.

          We ultimately concluded that the return on invested brain damage from this investment exceeded the
          probability-weighted opportunity for profit, and we decided to fold the tent. We sold our stock and incurred a
          modest loss to the funds.

          Our Business Model

          In order to achieve long-term success, Pershing Square must make good investments and operate with a
          robust business model. With much media attention focused on hedge fund failures, I thought it would be
          worthwhile reviewing the characteristics of our business model and explaining why we will withstand
          industry-specific and overall environmental threats to the investment and hedge fund businesses. The
          principle factors which contribute to the robustness of our business model are as follows:

                Our portfolio management approach is inherently low risk (where risk is defined as the probability of a
                permanent loss of capital), particularly when compared with other hedge fund business models. An
                important distinguishing factor about Pershing Square compared to most other hedge funds is that we
                do not generally use margin leverage in our investment strategy. The lawyers prefer that I put in the
                word “generally” to give us the flexibility to use margin to manage short-term capital flows, but,
                to-date, we have not used any but an immaterial amount of margin, and only for a brief period of time,
                and we have no intention of changing this approach,
                We generally invest in higher quality businesses with dominant and defensive market positions that
                generate predictable free cash flow streams and that have modestly or negatively leveraged (cash in
                excess of debt) balance sheets. We buy these businesses at deep discounts to our estimate of intrinsic
                value giving us a margin of safety against a permanent impairment of capital. I say “generally” again
                here because we do make exceptions in certain limited circumstances; that is, we may buy a more
                leveraged or lower quality business if we believe the price paid sufficiently discounts the risk.
                We often seek investments where we can effectuate positive change to catalyze the realization of
                value. This serves to accelerate the recognition of value, helps us avoid “dead money” situations, and
                protects us somewhat from managerial actions which can destroy value.
                We are diversified to an adequate but not excessive extent. This has further benefits for risk and

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                We are diversified to an adequate but not excessive extent. This has further benefits for risk and
                operational management which I will discuss below.
                There is an inherent balance to our long/short investment approach. Historically, when equity or credit
                markets weaken, our shorts become more valuable, and occasionally materially more valuable,
                offsetting somewhat the mark-to-market declines in our long portfolio. If we choose to unwind these
                short positions during market downturns, we can generate capital to invest in a now less expensive
                market. These short investments generally stand on their own in that they do not typically require a
                stock market or credit market decline to be successful. That said, they have served as a useful hedging
                tool during periods of dramatic market declines.
                We have been paranoid about counterparty risk since the inception of the firm. First, we trade with
                counterparties which we believe to be creditworthy. Second, we have negotiated ISDA agreements
                which provide us with daily mark-to-market cash and U.S. Treasurys equal to the previous day’s market
                value of our derivative contracts. In cases where we are required to post initial margin and therefore
                have some exposure beyond the market value of our derivative contracts, we have typically purchased
                CDS on our counterparties to further mitigate counterparty risk. While our approach to counterparty
                risk has protected us from any counterparty losses to date, please be forewarned there is no perfect
                approach to avoiding counterparty risk.

          Our simple approach to investing also allows us to avoid complicated approaches to risk management. Our
          investment strategy does not require us to open offices all over the globe. As such, we don’t need traders
          working around the clock. We can go to sleep at night and sleep. Our weekends are largely our own (Ok. I
          admit it. I am writing this letter in the office on Sunday.) Our risk management approach is to: (1) put our
          eggs in a few very sturdy baskets, (2) store those baskets in very safe places where they cannot be taken
          away from us and sold at precisely the wrong time due to margin calls, and (3) to know and track those
          baskets and their contents very carefully. We call this approach the sleep-at-night approach to risk
          management. If I can’t, we won’t.

          I am extremely skeptical of more automated, algorithmic, Value at Risk, and other business school sanctioned
          approaches to risk management. None of these approaches saved Lehman, Bear Stearns, Fannie, Freddie,
          AIG, WaMu, Wachovia or any of the other institutions that used these and other ostensibly more
          sophisticated risk management strategies.

          Our investment strategy and approach to counterparty risk serves to limit the risks inherent in our individual
          investment selections, our counterparty risk, and the portfolio as a whole. There are, however, other
          important risks to our business, principally operational, reputational, and regulatory risk.

                                                         Operational Risk

          Our investment approach is largely straightforward and relatively simple. This, coupled with the concentrated
          nature of the portfolio, allows us to run our business with a limited number of personnel. We have five senior
          investment professionals including myself. Shane Dinneen, still officially a junior investment professional, is
          fast earning his stripes as an eventual senior member of the team.

          We could manage our portfolio with less human talent than we have. For members of the investment team
          reading this letter, don’t be concerned because I have no intention of shrinking the team, but I make the point
          nonetheless. Simplicity in our investment approach allows for a simpler back office and a smaller overall
          staff. We have 31 people total at Pershing Square. It could be fewer, but one of Tim Barefield’s (our COO)
          important risk management principles provides for back-up talent for every role in the firm.

          Our Noah’s Ark approach to personnel duplication makes for a good analogy for the ship we have designed.
           We have worked hard to build a business that can withstand the Great Deluge, and this goes beyond
          counterparty risk. For example, it is not yet clear this year whether there will be any incentive allocation to
          be shared at the firm. That said, whether or not the funds’ finish the year in the black, it will be extremely

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          be shared at the firm. That said, whether or not the funds’ finish the year in the black, it will be extremely
          unlikely that a member of our team leaves by choice, and I have no intentions of letting anyone go. This is
          due to several factors:

                Pershing Square’s large amount of assets under management per investment principal and per overall
                employee are important ratios to consider when evaluating the sustainability of Pershing Square or any
                hedge fund for that matter. The economics of a high Asset per Employee ratio attract and allow for the
                retention of top talent. Our team can be compensated appropriately even in times of short-term
                underperformance. Hedge funds which barely (or don’t even) cover their costs with management fees
                are inherently unstable enterprises because in an unprofitable year they cannot pay their people and are
                likely to lose their most talented professionals to other firms.
                Pershing Square is a nice place to work. While this sounds like an obvious approach to retaining talent,
                many and perhaps most hedge funds don’t fit this description. We are big believers in taking care of
                our team not just financially and with attractive benefits, and we have those in spades. We consider
                every employee at the firm a member of our extended family, and we treat and care for them
                appropriately. We do this not for business reasons, but it has important long-term business benefits.
                Pershing Square is an extremely exciting place to work. We believe our work creates value beyond the
                profits we historically have generated for our investors. Our approach to value creation at businesses
                has created enormous value for investors who happened to own companies to which we contributed to
                the creation of value. Similarly, investors and counterparties who listened to our views on the bond
                insurers, Fannie Mae and Freddie Mac, etc. saved themselves from large losses or perhaps profited by
                short sales. The fact that our work creates value for the markets as a whole provides additional
                motivation to the team.

          Bottom line, we are built to last, and we will continue to work hard to deserve your continued support.

                                                 Reputational and Regulatory Risk

          Reputational risk is one of the key risk factors for a business that is subject to a high degree of regulatory
          scrutiny in an industry that seems to generate considerable public scorn. Our approach to assessing
          reputational risk is to apply the New York Times test. We ask ourselves whether we would be comfortable
          having our family and friends read a front page New York Times story about actions taken by Pershing
          Square written by a knowledgeable and intelligent reporter who has access to all of the facts. If we are
          comfortable with such an article being read by our close friends, our families, and the public at large, our
          action passes the test. If not, we reconsider our potential action.

          More recently, I have decided to participate in the public dialogue about hedge funds, agreeing to occasional
          appearances on television or otherwise talking to the press, speaking at industry events, meeting with
          Congressman, Senators, and other officials. I do so not for any desire for public recognition, but rather
          because I believe that it is important for the hedge fund industry to come out of the shadows and defend the
          importance of our work. If we and others (that includes hedge fund investors in addition to the managers)
          don’t do so, the industry, in my view, is at even greater risk of further regulatory, tax, and other legal changes
          that will materially harm our business models and industry.

          One does not need to look further than the recent short selling ban which was an extremely ill-advised
          regulatory change that contributed to market turmoil and the recent market decline. By imposing a ban on an
          investment approach that has been legal for generations with no warning or opportunity for public debate, the
          SEC caused a short squeeze and subsequent market disarray that wiped out large amounts of hedge fund
          capital, caused forced selling as long/short, market neutral, quantitative, and other managers had to sell long
          positions to rebalance their books. More significantly, it cost the U.S. capital markets its highly respected
          position as an exemplar free marketplace where the rule of law prevailed. It also contributed to hedge fund
          underperformance, thereby leading to investor redemptions, further reducing industry capital.

          I believe the short selling ban also contributed to continued market declines since the ban was put into place.

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          I believe the short selling ban also contributed to continued market declines since the ban was put into place.
           In that hedge funds are among the most opportunistic investors in the world, destroying large amounts of
          hedge fund capital likely contributed to market declines because of a dearth of opportunistic hedge fund
          buyers who would normally step in and purchase the compelling values created by falling markets.

          Even though the restriction on short selling has been eliminated, the longer-term consequences of populist
          regulatory actions will continue to be felt by the markets and its participants until such time as our securities
          regulator makes clear that the U.S. will never again change the rules of the game mid play.

          Specifically, the short selling ban was harmful to Pershing Square because we lost the opportunity to lock in
          even greater gains on our Wachovia investment by not initially being able to hedge our Wells Fargo exposure.
           I estimate this loss at approximately 3% to 4% of fund performance. This loss was somewhat offset by our
          ability to sell certain investments into the short squeeze at higher than anticipated prices. We were otherwise
          not materially affected because short selling equities has not been a material part of our investment program,
          although we did cover one large equity short at a loss which is now trading at a more than 40% lower price,
          another 4% to 5% potential loss of profit assuming we had not covered at higher prices.

          Hedge fund investors – the pension funds, state plans, charitable, healthcare and other institutions and the
          individuals who invest in hedge funds – are a much more appealing constituency to defend the industry than
          the managers themselves. I encourage you to consider becoming part of the public debate on the industry.
           We collectively need one another’s support.

                                                            Investor Risk

          The stability of a hedge fund’s capital base is critical to its long-term success. We have endeavored to attract
          high quality investors who have a deep understanding of our investment approach. We do our best to
          continually inform you of the progress of our holdings and business, and remind you of the inherently volatile
          nature of our concentrated strategy. Our investment strategy is also transparent. The nature of our approach
          requires most of our holdings to eventually be disclosed publicly. As such, it is easier for you to understand
          how we have made and lost money over the years, and to assess our ability to replicate our historic strategy
          and performance.

          Over the last nearly five years, we have delivered very little of the volatility that investors are concerned
          about, that is, downward volatility. As such and with strong historical performance, we have not “tested” our
          investor base. We hope never to “test” our investor base.

          While we have considered a longer-term lock-up structure, we chose not to modify our existing liquidity
          terms because we did not want our terms to be overly burdensome to investors and to present a hurdle to the
          reinvestment of capital, particularly during a period of temporary underperformance. Year to date, we have
          had minimal redemptions. New commitments have exceeded our redemption requests by approximately 3 to
          1. We have a pipeline of new prospects that are in the process of completing their due diligence. That said,
          the continuity of our investor base is a long-term success factor for the funds and for this we are relying on
          you.

                                         Is Now a Good Time to Invest in Pershing Square?

          I have never before suggested that one time or another would be a better time to invest in Pershing Square. I
          am going to take the risk of doing so now. At the risk of sounding promotional, I believe that now is perhaps
          the best time in our history to increase your investment in Pershing Square. A few thoughts to consider:

          When one invests in Pershing Square today, with respect to our current portfolio and potential opportunities
          in the market, the spread between price and value is the widest it has been since the inception of Pershing
          Square and likely over the last 30 or more years in our opinion. Investments like Target Corporation which
          we purchased initially in the mid to high $50s per share now sell at approximately $40 per share and there has

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           we purchased initially in the mid to high $50s per share now sell at approximately $40 per share and there has
           been no meaningful diminution in the per-share value of Target since our initial purchase 18 months ago. In
           fact, the probability of Target and other Pershing Square holdings implementing a value-creating transaction
           are higher today than before because of management and shareholder frustration with current share price
           levels. Consider that Target management options are nearly all out of the money, and a meaningful number
           of vested options will soon likely expire worthless if there is no change in the status quo.

           An additional investment in Pershing Square today also purchases a pro rata interest in our cash and
           near-cash investments. While purchasing cash indirectly is not an inherently attractive proposition, we are
           currently analyzing a number of long and short investments that appear extremely interesting, and subject to
           completion of our due diligence, may become large new commitments. While for the first nearly five years of
           our business, we found only a limited number of interesting opportunities, albeit a sufficient number to
           generate attractive returns, we are now presented with tens of intriguing situations that are worthy of careful
           review. One could reasonably conclude that the greater spread between price and value and a wider selection
           of attractively priced opportunities will lead to higher rates of return on these commitments than during
           previous periods of greater market efficiency which characterized the first four years of the funds’ existence.

           While many have portrayed the current environment as a highly risky time to invest, these individuals are
           likely confusing risk with volatility. We believe risk should be determined based on the probability that an
           investor will incur a permanent loss of capital. As market values have declined substantially, this risk has
           actually diminished rather than increased. Risk is high now for the leveraged short-term investor, but actually
           much lower for the unleveraged, long-term investor in high quality, mid and large capitalization, modestly
           leveraged businesses.

           Unlike levered hedge funds whose risk increases as NAV declines, Pershing Square’s risk has declined with
           the recent decline in the value of our portfolio. Why? This is due to the fact that a leveraged manager’s
           probability of being sold out by its prime broker increases as its portfolio’s equity declines. Many hedge fund
           strategies are confidence and credit sensitive because they require continued access to low-cost financing.
            Recent declines may also require leveraged hedge funds to post additional collateral on trades which did not
           require an initial down payment. Because our investment strategy does not require leverage to operate,
           recent increases in financing costs and reductions in leverage afforded to hedge funds have no impact on our
           current or future prospects. In our case, the margin of safety of our investments actually increases, the
           greater the decline in our holdings’ share prices. We, of course, also have no margin leverage creating the
           risk of a forced sale. So yes, I believe now is a good time.

                                             Pershing Square Advisory Board Addition

           Matt Paull joined the Pershing Square Advisory Board on September 1st. For some of you, Matt’s name may
           be familiar for he was formerly the CFO of McDonald’s Corporation before his retirement earlier this year. I
           have known Matt for about 10 years, and interacted with him intensively in mid to late 2005 and in early
           2006 when Pershing was advocating for change at McDonald’s.

           As CFO of McDonald’s, Matt was one of the most highly regarded public company CFOs in the country.
            Shareholders were the beneficiaries of superb capital allocation and strong share price appreciation during his
           tenure as CFO. I consider it one of Pershing Square’s greatest accomplishments that we were able to garner
           Matt’s respect and friendship even though there were occasionally contentious moments during our
           engagement with McDonald’s.

           Matt has already proved enormously helpful in our interactions with Target Corporation. As a former CFO,
           particularly one that has been on the other side of one of Pershing Square’s most significant engagements,
           Matt brings a uniquely valuable perspective to the firm and to the management teams of our portfolio
           companies.


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           In addition to his Pershing Square advisory role, Matt is currently serving on the business school faculty of
           University of San Diego.

                                                       Organizational Update

           We completed our move to the 42nd floor of 888 Seventh Avenue in August. The second time round, we
           really got it right. The space is beautiful, promotes communication, and is extraordinarily well organized and
           efficient.

           After the move, we made several additions to the team. Courtney Leonardo and David Robinson joined the
           IR team in administrative roles, roles which had previously been filled by temporary employees. Alex Song
           joined us from Goldman Sachs as the newest junior member of the investment team. Amy Stern joined the
           Finance and Accounting team from Tiger Global, and will focus her efforts on management company
           accounting. Amy is also attending the NYU Stern School of Business where she is working on a business
           school degree. Jill Skousen replaced Whitney Stodtmeister as the administrative assistant for the investment
           team after Whitney moved to Santa Barbara. Helena Tunner joined us to work with Dianna Baitinger at front
           desk reception.

           On other news, Alex Kaufmann of our IR team will be attending Columbia University’s Executive MBA
           program on Fridays and weekends. We are big believers in continuing education for our personnel.

           As always, we are extremely appreciative of your support, particularly during uncertain times. If there are
           any questions I have failed to answer above, please call Doreen, Alex, Ashley or myself.

                                                                                                                    Sincerely,
                                                                                                           William A. Ackman




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