Carl Icahn Buying Profitable Auto Holdings as Energy, Returns Struggle

Investor's auto holdings became second most profitable as low oil helps boost sector

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Jun 22, 2016
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Activist investor Carl Icahn (Trades, Portfolio) made his second bid to acquire the remaining shares of long-time investment Federal-Mogul last week as he seeks to add a third company to his auto segment, one of the most profitable in his fleet, as his oil holdings and returns decline.

Federal-Mogul (FDML, Financial) represents one of Icahn’s many distressed investments. In 1998, Federal-Mogul had acquired Fel-Pro and Turner & Newall, two of the leading companies whose use of asbestos caused a wave of asbestos-related claims from workers and those exposed to its products.

Federal-Mogul expected the $2.1 billion it set aside to pay for the lawsuits, but the cost exceeded the reserve, causing the company to go bankrupt. Icahn purchased $1.1 billion in bonds of the company prior to its Chapter 11 bankruptcy in 2001.Â

Later, Icahn converted the bonds to 25.1 million shares, according to filings from 2007. At the same time, he nominated himself and four of his associates to its board.

As part of an agreement, Icahn also received options to buy 50.1 million shares owned by Federal-Mogul’s Asbestos Personal Injury Trust, which when exercised would give him shares of the company amounting to 75.2% control. He exercised the options in February 2008, also paying $900 million for the shares from the trust.

In 2013 and 2015, Icahn increased his shares of Federal-Mogul until he had 82% of those outstanding as of March 31. In February, he offered to buy the remaining shares of the company for $7 per share, a 40% premium from the trading day prior. After the company rejected the offer, he increased it to $8 per share on June 17, under its trading price of $8.15.

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The new interest in acquiring Federal-Mogul appears as a distressed investment that would allow him greater control over the company. Icahn's strategy is to find undervalued companies "in the Graham & Dodd tradition" and often becoming actively involved.Â

"That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve shareholder value, to acquiring a controlling interest or outright ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating and expanding that business," the first quarter Icahn Enterprises presentation said.

Federal-Mogul's revenue per share slid at a rate of 8% on average for the past five years. It has $2.96 billion in long-term debt, $252 million in cash, and its stock price was down 58% before Icahn made his bid.

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Icahn explained the potential he saw in the company in a third-quarter presentation. Icahn touted the company as having “leading market positions” across product categories in both of its segments and “a long history of strong brand names.”

Icahn also sees a growth for Federal-Mogul and for the broad auto industry. In the August presentation, he said there was “solid vehicle production growth projected through 2018," and that the “aftermarket benefits from the growing number of vehicles globally and the increasing age of vehicles in Europe and North America.”

Elsewhere, he connected his growing interest in auto directly to the decline of oil, which has hurt several of his other businesses. In his first quarter 10-Q filing, Icahn attributed positive auto segment growth, among other global trends like increased vehicle and auto parts sales, to low oil pricesÂ

“The volatility in recent oil prices, which are generally at historic lows, results in lower fuel prices for consumers,” he said. “However, on an aggregate level, the losses from these lower prices have been larger and quicker than expected as energy companies cut back on investment and lay off workers, while the gains are smaller and slower to materialize, as the majority of this extra discretionary income has been applied to debt reduction, precautionary saving, and offset by slower income growth.”

The section continued: “But for some households, lower fuel prices do provide more discretionary income for a variety of purchases, including new vehicle sales, which increases demand for production parts from OEMs. That additional income can also support vehicle repairs which tends to encourage more driving miles, which in turn accelerates wear on vehicle components, thereby accelerating the need for replacements.”

In the first quarter, the adverse impact of low oil was seen in Icahn Enterprises' (IEP, Financial) energy segment, which comprises oil refining and nitrogen fertilizer company CVR Energy (CVI, Financial), CVR Refining (CVRR, Financial) and CVR Partners (UAN, Financial).

The  energy segment lost $343 million attributable to Icahn Enterprises in the first quarter, with a profit of $43 million the same quarter last year. Net sales also declined to $906 from $1.4 billion.

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Energy was Icahn’s worst-performing sector -- next to investments, down 12.8% in the first quarter after two years of losses -- of the first quarter, with losses of $614 million, second to his investment segment, which lost $983 million. In contrast, automotive was his second best-performing sector, adding profit of $28 million, second to railcar at $50 million.

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(Three months ended March 31)

Federal-Mogul would be Icahn’s third automotive acquisition in about a year. He also bought IEH Auto in the second quarter of 2015 and Pep Boys in December.

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Though having some long-term declines in operations, Federal Mogul has recently shown some improvement in financial results. For the first quarter, it increased net sales 3% year over year to $1.897 billion, with higher gross margins due to increased auto sales in the U.S. and Canada, restructuring and improvements in both segments.

In the most recent quarter, Federal-Mogul came in third in sales growth among its auto supplier peers, behind Dorman Products Inc. (DORM, Financial) and Motorcar Parts of America (MPAA, Financial).

The company's shares also appear inexpensive by some metrics. Federal-Mogul had the lowest trailing 12-months P/E of any auto parts supplier at 8.7x when its price traded at $4.52 before his acquisition bid, according to Jan. 31 data from BB&T Capital Markets. Its P/E for calendar year 2016 is estimated at 5.9x and at 5.3x for 2017. Icahn’s first offer for the company also came near the stock’s all-time low.

Federal-Mogul’s stock closed at $8.45 Tuesday, between a 52-week low of $3.81 and high of $12.68. It has a P/B ratio of 1.68 and P/S of 0.19.

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