What Investors Can Learn From Carl Icahn’s Debacle

What Investors Can Learn From Carl Icahn’s Debacle
Chairman of Icahn Enterprises Carl Icahn participates in a panel discussion at the New York Times 2015 DealBook Conference at the Whitney Museum of American Art in New York on Nov. 3, 2015. (Neilson Barnard/Getty Images for New York Times)
Fan Yu

Even a legendary corporate raider could face his comeuppance one day.

Shares of Icahn Enterprises dropped off the cliff last week after the company announced a loss of 72 cents a share and declared that it will halve its dividend going forward.

With that, the stock price of Icahn Enterprises (IEP) has fallen by more than 50 percent year-to-date.

It’s a stunning fall for the company managed by legendary financier and activist investor Carl Icahn, whose personal wealth has also declined by $2.7 billion according to Bloomberg’s Billionaires Index.

Icahn developed a reputation in the 1980s as a corporate raider, profiting from hostile takeovers of publicly traded companies such as Trans World Airlines.

Over the last two decades, his firm has been engaging in activist investing, taking minority stakes in companies and challenging existing board and management.

The irony is that Icahn Enterprises today is itself the victim of an activist investor. The firm’s challenges worsened in May after noted short-seller Hindenburg Research released a critical report on Icahn Enterprises, alleging that the firm is overvalued and its dividend is unsustainable.

It turns out that Hindenburg might have been partially right, as Icahn cut the firm’s quarterly dividend by half from $2 per share to $1 per share.

In a letter to shareholders on Aug. 4, Icahn issued a mea culpa and said the company would “reset” its strategy going forward.

“While we made money on the long side through our activism efforts, our returns have been overwhelmed by our overly bearish view of the market and related oversized short (hedge) positions… Going forward, we intend to stick to our knitting and focus on our activist strategy while remaining appropriately hedged,” he wrote.

What can investors learn from Icahn’s turmoil? Plenty.

When a company’s dividends are too good to be true, they usually are.

The biggest benefit of owning shares in IEP is its huge dividend. Around the time the Hindenburg research report dropped, IEP was paying an annualized dividend yield of 24 percent, the biggest dividend yield of any publicly traded company. What this means is that if an investor put $100 in IEP stock, they would receive $24 in dividend (or almost a quarter of the money back) by the end of the following year, assuming the company’s dividend policy doesn’t change.

That’s obviously extremely attractive if you’re an investor. But Hindenburg was right to question whether it was sustainable, going so far as calling IEP a Ponzi scheme.

IEP is unlikely to be a Ponzi scheme, but the dividend turned out not to be sustainable.

IEP had been paying dividends not from investment gains or its own dividends received from other companies it invests in, but from cash on balance sheet.

A Wall Street Journal examination of a recent IEP investor’s statement showed that 80 percent of dividends paid to shareholders were a “return of capital,” meaning that the nature of the cash is not from investment gains.

Whether the dividend is sustainable is an analysis most investors can do without the benefit of Hindenburg’s report. You should look at the income statement and cash flow statement, filed quarterly, and see whether cash flows from operations and net income can cover the quarterly dividend. If not, it means the company is just drawing from its cash coffers and it would either run out of cash or need to cut its dividend in the future.

Another red flag is that Icahn himself owns roughly 80 percent of the company. This means that Icahn has full control and voting rights on key decisions and usually firms that have such a high concentration of ownership in the hands of the founder or CEO are less transparent regarding their decision making and governance. This is not always a bad thing, as it means the founder and CEO is aligned, at least economically, with shareholders.

In this case, ownership in IEP makes up a significant portion of Icahn’s personal net worth, and he has staked his shares in IEP as collateral on various personal loans he had taken out. This level of leverage also made it very easy for Hindenburg to target the company by selling short.

Another one of Hindenburg’s criticisms is that IEP is overvalued—at the time of its short sellers’ report IEP was trading at a “218 percent premium” to its last reported book value—meaning IEP’s market cap is worth more than its net asset value on the books. Companies typically don’t trade close to their book value, but many investment firms do and several of IEP’s key competitors (such as Daniel Loeb’s Third Point and Bill Ackman’s Pershing Square) trade below their respective book values.

This is another characteristic that any investor can do without the benefit of Hindenburg’s report. If an industry typically is valued close to its book value yet one particular company stands out as an outlier, there must be a reason for it. And if there’s no good reason, then it means the company is either overvalued, or potentially is undervalued and thus a buying opportunity.

The Justice Department has an ongoing investigation into IEP following Hindenburg’s report.

Any company can spin a web of positivity regarding its business. But as an investor, it’s better to have a mindset of a short-seller.

Fan Yu is an expert in finance and economics and has contributed analyses on China's economy since 2015.
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