Carl Icahn has had a long career in markets, starting out as a stockbroker in 1961, later
becoming a risk arb and options trader.
In the 70’s and 80’s he was a notorious corporate raider.
He was accused of being an asset stripper (the worst kind of stripper) in his dealings
with TWA.
Today he is a notorious activist investor known for forcing even the most respected
CEOs to bend to his will, like Apple's Tim Cook, who he pressured to return capital to
shareholders through a share buyback in 2014.
Some of Icahn’s earliest arbitrage trades involved investing in closed-end mutual funds,
a type of investment company which often trades at a discount to the value of the assets they
hold.
He would then agitate for the fund to liquidate, yielding a profit.
Icahn, who has spent his whole career on offence, now finds himself playing defense, as another
activist investor Hindenburg Research is claiming that Icahn’s $18 billion dollar market cap
holding company Icahn Enterprises has a Ponzi-like economic structure that is sustained only
to the extent that new money coming in is willing to risk being the last “holding
the bag”.
In brief, Icahn is accused of using money taken in from new investors to pay out dividends
to old investors and he is accused of doing this to keep the stock price high, stock that
he has pledged as collateral for a margin loan.
Hindenburg is a short selling activist hedge fund run by Nate Anderson and earlier this
year I covered their allegations against Adani Group.
Anderson is most famous for having released a video of Nikola’s electric truck prototype
being towed up a hill in order to be pushed down to make a promotional video showing that
the technology was fully operational.
Trevor Milton, the CEO of Nikola ended up being convicted of fraud based partially upon
this evidence.
Hindenburg have recently been in the press for taking aim at beard enthusiast Jack Dorsey’s
payments company Block.
At the end of 2022 the net asset value of Icahn Enterprises was marked at $5.6 billion
dollars, while its market value was $18 billion dollars.
This is quite a surprising premium.
Icahn Enterprises has two unusual features.
One is that it has a very high dividend yield, and the other is that around 88 per cent of
its shares, or, units – are held by Carl Icahn and his son Brett, who typically take
their dividends in shares rather than in cash.
The dividend is only paid out in cash to the twelve percent or so of outside investors.
Hindenburg says that Icahn Enterprises funds this dividend through continuous share sales,
rather than the cash flow of its investments.
Hindenburg describe their view of this alleged arrangement as “Ponzi-like”.
Prior to the release of the Hindenburg report, Icahn Enterprises had a 15 per cent dividend
yield.
The Stock fell 40 per cent when the report was released earlier this week.
The declining share price means that the yield has rocketed to over 25 per cent.
The fall in the unit price has knocked around five billion dollars off the net worth of
Carl Icahn.
Carl is 87 years old right now and losing five billion dollars at this stage in career
is likely to severely impact his retirement.
Now before we dig into the Hindenburg accusations, let me tell you about today’s video sponsor.
Brilliant.org is the best way to learn math and computer science interactively through
their user-friendly app.
brilliant has thousands of lessons from foundational and advanced math to AI data science neural
networks and more with new lessons added monthly.
They have a great range of Statistics and Finance courses which I have been exploring
over the last few days.
You tell the app how much time you want to devote to your lessons each day, the app works
out your level of competency and starts giving you lessons – apparently it is six times
more effective learning from an interactive app than just watching a lecture.
whether you’re learning math, computer science or data analysis brilliants thousands of bite
sized interactive lessons help you master key concepts and build to more advanced topics.
To try everything brilliant has to offer free for a full 30 days visit brilliant.org/Patrick
or click on the link in the video description.
The first two hundred of you to sign up will get 20% off of brilliant’s annual premium
subscription.
OK, so, most investors in trying to work out if a stock is overvalued or not firstly check
if Cathie Wood has a large position in the stock, and secondly check to see if Jim Cramer
has recently called it a buy.
We get mixed signals here as Cathie doesn’t seem to own it, and Cramer says [] I dunno…
Is a can’t recommend from Cramer good or bad – it’s hard to say - maybe he wants
to recommend but just can’t...
We'll never know.
I guess we will have to look in greater detail at the accusations.
No short cuts today…
The main three claims being made by Hindenburg are firstly that the units are overvalued,
relative to their reported net asset value.
And this has happened because retail investors are dazzled by the high dividend yield.
Secondly, Hindenburg are implying that the dividend itself is somewhat fraudulent, because
it is not funded by earnings but instead by selling new stock to retail investors.
Thirdly they claim to have uncovered evidence that Icahn Enterprises overvalues some of
its less liquid assets when calculating the net asset value – I mean what is it?
A Blackstone Real Estate fund??
Finally they are saying that Icahn makes poor investments that have negative operating cash
flows which further shrink the asset value and makes the dividend unsustainable.
Hindenburg claim to have uncovered evidence of inflated valuation marks being used for
some of the less liquid and private assets included in the holding company.
They give the example that IEP owns 90% of a publicly traded meat packaging business
that it valued at $243 million dollars at year-end when the listed company had a market
value of only $89 million at the time.
Hindenburg claim that IEP were marking the value of this illiquid stock whose stock price
can be observed in the market 204% above the prevailing public market price.
The report states that, IEP marked its “Automotive Parts” division at $381 million in December
2022 and that its key subsidiary declared bankruptcy a month later.
You are not really meant to do that…
They take shots at Icahn’s stock picking too saying “our analysis of Icahn’s latest
December 2022 13-F filing indicates that IEP’s long holdings have lost approximately $471
million dollars in value year to date, despite the S&P gaining approximately 9.2% over the
same time frame”.
They estimate that IEP’s current NAV is closer to $4.4 billion dollars, or 22% lower
than its disclosed year-end indicative NAV of $5.6 billion dollars.
Suggesting that units were trading at a 310% premium to NAV, with an annual dividend rate
of 64% of NAV.
In their report Hindenburg called out Jefferies, the only brand-name investment bank that publishes
research on Icahn Enterprises — they highlight that Jeffries also helps the company sell
its stock.
Where is Credit Suisse when you need them??
The report says in essence, Jefferies is luring in retail investors through its research arm
under the guise of IEP’s ‘safe’ dividend, while also selling billions in IEP units through
its investment banking arm to support the very same dividend.
They say that Jeffries has run all $1.7 billion dollars of Icahn Enterprises At-The-Market
stock offerings since 2019.
Icahn Enterprises responded to the criticism by saying that it stood by its disclosures.
The press release says “We believe the self-serving short-seller report published by Hindenburg
Research today was intended solely to generate profits on Hindenburg’s short position at
the expense of I.E.P.’s long-term bag holders.”
Sorry unit holders, not bag holders.
They are holding units…
The Hindenburg report highlights that Icahn has taken out margin loans on Icahn Enterprises.
Meaning that he has borrowed money using his stock as collateral.
The report says that he has pledged around 60% of his IEP holdings, for personal margin
loans.
If the stock were to continue to fall, Icahn could be forced to sell stock to meet those
margin calls, which could push the stock price down even further.
They point out that Icahn has not disclosed the details of these margin loans like loan
to value maintenance thresholds, so there is no way of knowing when he could be forced
to sell.
In many ways, the allegations against Icahn are very similar to the allegations Hindenburg
made against Adani group earlier this year.
A company that is mostly family owned - which is being accused of manipulating up its price
in order to borrow money, and to issue stock at inflated values.
Hindenburg additionally points out that IEP is highly levered, with $5.3 billion dollars
in debt and maturities of $1.1 billion, $1.36 billion, and $1.35 billion due in 2024, 2025,
and 2026, respectively.
They point out that most closed end holding companies trade close to their Net Asset Value
or at a discount to their NAVs.
The report highlights for comparison, that vehicles run by other star managers, like
Dan Loeb and Bill Ackman, trade at discounts of 14% and 35% to NAV, respectively.
As I mentioned earlier – Icahn used to break up this type of company to extract the value
associated with these discounts.
Conglomerate companies, or really any Holding Company entity that is a grab-bag of many
other businesses, including structures like closed-end funds, typically trade, and often
trade for decades of time, at a discount to their Net Asset Values – this is the case
even in situations where the portfolio itself is holding clearly identifiable assets with
known market-valuations (sometimes they are holding shares in publicly listed companies)
. There is in fact an entire valuation method
used in corporate finance, called Sum of the Parts valuation, which exists to value conglomerate
style holding entities’ – and it is well understood that Market Valuations are often
well below the Sum of the Parts Valuations – in part because investors apply a discount
to these businesses due to concerns about management waste, concerns that management
might misuse retained earnings for mal-investment to retain control over as large a business
as possible.
Investors are also concerned about the timing of capital returns to shareholders, the timing
of sales of elements of the underlying portfolio too – worrying that the holding company
management will sell at the worst possible time in the future, or about tax uncertainty
around future dispositions.
When Hindenburg compared Icahn Enterprises to all 526 U.S.-based closed end funds in
Bloomberg’s database.
IEP’s premium to NAV was higher than all of them and more than double the next highest
that they found.
So, look, the term Ponzi like economic structure sounds bad.
It’s frankly over 100 years since we’ve heard anyone really speaking well of a Ponzi
like economic structure –and that’s because it’s over 100 years since Charles Ponzi
was put in prison for his scheme.
Essentially the accusation Hindenburg is making is that the shares trade for more than they
are worth, and for this reason Icahn is selling additional shares for more than they are worth
to the public in order to pay a big dividend to his shareholders.
I mean it’s basically just a meme stock.
If people will pay more for your shares than they are worth – it probably makes sense
to sell additional shares to people who are willing to overpay for them.
At least Icahn has restrained himself from behaving like Adam Aron and doing interviews
in his underwear to keep the stock price elevated.
Matt Levine from Bloomberg argues that the way this structure works, Carl Icahn is the
majority owner of a bag of cash, and he keeps giving other people some of the cash in exchange
for an increasing ownership stake in a shrinking bag of cash.
Levine points out that Carl is himself taking the risk of being the last one holding the
bag. – of course he has borrowed against the overvalued units.
If the stock fell enough in value to the point at which it started trading at a discount
to NAV, Carl could stop selling new shares (as he wouldn’t want to sell them at a discount
to NAV) but he could keep paying shareholders a dividend and paying himself in shares in
order to increase his ownership in the now undervalued bag of cash.
It’s quite a game.
We shouldn’t forget the management fees associated with this structure either: Carl
Icahn and his management team are charging around 2% annually on the fund’s NAV, or
over $100 million per year for running the holding company.
I was a bit amused by how hard it was to dig the management fees out of the investor presentation
that’s available online, but I found an SEC filing – where they avoid the use of
the term ‘fees.’
Instead they use the term “special profits interest allocations” which range from 1.5%
to 2.25% per annum and then there are the incentive allocations (which must be a performance
fee) which ranges from 15% (in some cases subject to a preferred return) to 22% per
annum.
So let’s call it a two and twenty fee structure.
You can hopefully see how with such a fee structure; management might be tempted to
exaggerate the NAV of the partnership – as that is what they charge fees on.
Hindenburg’s argument is that “this stock trades at a 200 - 300% premium to its net
asset value, which is surprisingly high,” (especially for something that has not been
identified as a meme stock) and it’s hard to argue with them on the point that there
has been remarkably little discussion of this premium.
Now that this is being widely discussed I think the stock can reasonably be expected
to start trading - either closer to its NAV which might mean margin calls for Carl, or
he could start doing Meme stock CEO stuff to pump the price back up – we have learned
over the last few years that there is no need for a price to be grounded in economic reality
if the CEO can Meme well enough.
This is possibly the best strategy for Carl right now.
Issuing an NFT seems very 2022 to me, but the stock has fallen around 40% since the
report came out, leaving lots of room to sell more units at a premium to NAV to fund maybe
a dividend hike.
Icahn Enterprises isn’t a standard meme stock, it’s a boomer meme stock and so 420
jokes and NFT’s might be badly suited to that generation, but a dividend hike might
just do the trick.
I’m not sure though, I’m a bit out of date on the mechanics of meme stock pumping,
but if you have any suggestions – do let me know in the comments section.
Hindenburg did find one prominent endorser of their report: Bill Ackman, of Pershing
Square who famously clashed with Icahn over the prospects of Herbalife, the supplements
company that Ackman had shorted many years ago.
The two billionaires famously argued about it on CNBC in 2013.
They appeared to have since made peace, but Bill Ackman tweeted about Hindenburg’s report
when it came out “There is a karmic quality to this short report that reinforces the notion
of a circle of life and death.
As such, it is a must-read.”
If you found today’s video interesting, you should watch my video on the US debt ceiling
next.
Don’t forget to check out our sponsor Brilliant using the link in the description below.
Have a great day and talk to you again soon.
Bye.