Carl Icahn (Trades, Portfolio) is a legendary investor who is known for being Wall Street’s most feared corporate raider, or activist investor. Recently, his investment vehicle Icahn Enterprises (IEP, Financial) has gotten a taste of its own medicine from a scathing short seller report by the notorious Hindenburg Research. This has caused the stock price to plummet by 60% in just a few short weeks, wiping out $11 billion of market value (from its prior $18 billion market cap). In this article, we will take a look at the short seller report and related context; let’s dive in.
The bull case
The bull case for investing into Icahn Enterprises prior to the short seller report was simple. Investors got to invest alongside one of the greatest and most persistent corporate raiders of all time. Icahn owns 85% of his company, so there's no worries about him not having skin in the game. In addition, the company had enticed investors in thanks to it having the highest dividend yield of any large cap U.S. company at a staggering 15.8%. After the recent declines, the dividend yield is now an incredible 37%.
This dividend has increased over time and has consistently being paid for 71 quarters straight. Therefore, one would assume it was safe, and the only large bank which covers Icahn Enterprises, Jefferies (JEF, Financial), has consistently given a “buy” rating on the stock.
Short seller report
The primary spike in the short seller report alleges that Icahn Enterprises trades at a 218% premium relative to its reported net asset value of $5.6 billion, or ~$16 per share. Interestingly enough, even after its 59% plummet, the stock is still trading at a 25%-35% premium ($7.62 billion), or $20 per share.
In comparison, other similar iconic investor-run funds such as Daniel Loeb (Trades, Portfolio)’s Third Point (LSE:TPOT) and Bill Ackman (Trades, Portfolio)’s Pershing Square (LSE:PSH, Financial) trade at 14% and 35% discounts to net asset value. Prior to the short seller report, Icahn Enterprises also traded at a higher premium than all 526 U.S. based closed end funds, according to Bloomberg.
Icahn Enterprises released a statement that aimed to debunk some of the criticisms. First, a calculation of gross asset value indicates a $9 billion value, which means the stock would be trading at a discount from the ~$7 billion market cap at the time of writing. However, when I add the $1.869 billion in cash and cash equivalents and subtract $5.3 billion in debt, I get a figure of $5.58 billion. This still looks to be lower than where the stock trades at the time of writing.
The response also goes on to show that at least six of its past investments have been sold at a premium to purchase prices. The statement claims that comparing closed end funds (such as Pershing Square and Third Point) to its Master Limited Parternership (MLP) structure is like “comparing apples to oranges." The reason is these funds charge significant fees. For example, Pershing Square charges a 1.5% management fee and a 16% performance fee. Third Point charges a 1.25% management fee and a 20% performance fee. Icahn Enterprises doesn’t charge any fees and Icahn himself doesn’t even take a salary. Therefore I do agree it’s not a clear cut comparison as the Hindenburg report alleges.
The second major point made by the short seller report alleges that Icahn Enterprises' last year of outperformance was in 2013, after his successful Herbalife campaign (against Bill Ackman (Trades, Portfolio)) returned 30.8%. Since that point its public investment portfolio (45% of the firm's gross assets excluding cash and debt) has fallen by 53%, relative to the positive gain of 147% by the S&P 500. As an outside analyst, I would like to see the performance of Icahn’s whole business analyzed and reported more clearly for the benefit of shareholders.
The firm did respond with a statement which added that its performance in “more recent years” has been “lower than historical averages.” The company puts this down to its bearish view on the market and “large net short positions," which is quite ironic and has contributed to $272 million per year in losses. However, it has announced plans to “reduce the short position and concentrate for the mot part on activism."
The company also praises its “strong balance sheet with $1.9 billion of cash and $4 billion of additional liquidity” which is “ready to take advantage of all opportunities."
The short seller report points out that Icahn Enterprises has reported -$4.9 billion in free cash flow since 2014. However, during this period it has paid out close to $1.5 billion in cash dividends to investors. Its quarterly dividend has also been raised three times over the same period from $1.25 per share in 2013 to $2 per share in 2019, despite reporting -$1.7 billion in free cash flow.
The annual dividend rate equates to an absurd 50.5% of the last reported indicative net asset value. Due to these factors, its super-high dividend is deemed to be unsustainable by Hindenburg. This has only been sustained so far because Icahn owns 85% of Icahn Enterprises and has been taking his dividend share in units as opposed to cash.
Icahn has also used 60% of this holding as collateral for personal loans. The high valuation of the stock has enabled this process to be maintained, but now the stock as fallen, which could cause a “margin call” on his loans and the stock to fall further like a house of cards.
Surprisingly, I could not find a response from Icahn Enterprises regarding how sustainable the dividend is.
The report also alleges a mutually beneficial arrangement between Jefferies and Icahn Enterprises. Jefferies analysts give a consistent “buy” rating on the stock, but also benefit from selling “billions of IEP units through its investment banking arm."
Ackman's thoughts
Fellow activist investor Bill Ackman (Trades, Portfolio), who had a public battle with Icahn in the Herbalife saga, took to Twitter to fan the flames on the short seller report. Ackman summarized the report and stated its reminds him “somewhat of Archegos,” the famous blow-up which occured in 2013 due to a margin call on loans.
He said he was surprised to see Icahn hasn’t disclosed the “terms of his margin loans including who provided them," which he believes may be in breach of SEC 13D rules. Ackman continued to comment that he believes, “There is a karmic quality to this short report that reinforces the notion of a circle of life and death."
He also quotes Icahn’s favorite Wall Street saying, "If you want a friend, get a dog," which he famously said to Ackman during a public tirade on CNBC in 2013. Ackman goes on to say, “Over his storied career, Icahn has made many enemies. I don't know that he has any real friends. He could use one here... We are neither long or short. Just watching from a distance.”
Final thoughts
There is no doubt Carl Icahn (Trades, Portfolio) has been in many battles throughout his lengthy career, but this looks to be his biggest challenge so far. In this case, Icahn has had the fight brought directly to him, and given he owns 85% of Icahn Enterprises, this has got to hurt.
However, I believe the Hindenburg report is not as clean cut as it seems, and of course there is bias involved as the short seller benefits from the stock price falling. I would like to see further disclosures from Icahn regarding how sustainable the dividend is, for the benefit of investors, and if he starts to buy shares back (which I deem unlikely), then that would be a positive signal. If the stock continues to fall, there could be a contrarian opportunity, but currently there are too many unknowns to make a solid bet in my opinion.
I'd like to end this with a quote from Icahn describing Napoleon, which Hindenburg turned on Icahn in its short seller report: “He was a great strategist, no question. But then, he lost it all because of his arrogance. That’s one thing you have to remember. It doesn’t stay forever if you’re not careful.”
