Carl Icahn Confronts a New Reality

The former corporate raider and current activist investor has fallen behind in his quest to deliver the outsized returns of earlier years

Author's Avatar
Nov 16, 2017
Article's Main Image

Few investors are better known than Carl Icahn (Trades, Portfolio), a legend for some 40 years. But he is becoming a faded legend, with results dragging downward since early 2014.

In a sense, he is a deep-value investor, looking for beaten-down companies—especially those in bankruptcy— he believes he can turn around. That makes him not only a contrarian, but also a deep-value investor.

His usual modus operandi has been to buy a significant, but not necessarily controlling, stake in an out-of-favor company, gain a seat or more on the board and push for changes. Such changes often include lobbying for a new, more effective board of directors, selling assets and cutting back CEO salaries.

Who is he?

The founder of Icahn Enterprises was born in New York City in 1936. He earned a Bachelor of Arts in philosophy at Princeton University in 1957 and went to New York University School of Medicine, but dropped out after two years.

Next, it was on to Wall Street, where he began working as a stockbroker in 1961. Seven years later, in 1968, he launched Icahn & Co., which focused on risk arbitrage and options trading. In 1978, he began acquiring controlling positions at various companies.

It was also around this time he began developing a reputation as a corporate raider. In particular, he is known for his controversial takeover of Trans World Airline (TWA) in 1985. Critics accused him of stripping the company's assets to personally enrich himself. That's an accusation that would follow him for decades as he waged numerous proxy battles.

Icahn also had a prominent place within the orbit of President Donald Trump. He endorsed Trump and donated $150 million to a super PAC that would push for corporate tax reform. At one point, he was in contention to become treasury secretary, but instead became a special advisor to the president on regulatory reform. However, in August, he stepped down shortly before publication of a New York Times article that detailed alleged conflicts of interest.

Icahn is a larger-than-life character who has had a dominant role in a host of major American business decisions over the past 40 years. His most prominent role has been that of an activist investor, buying stakes in companies and then seeking to change them. Whether that is for the good of all investors, or mostly for Icahn, is a question that remains definitively unanswered.

What is Icahn Enterprises?

In its most recent 10-Q, Icahn Enterprises LPĂ‚ (IEP, Financial), a master limited partnership, describes itself as the owner of several other businesses, all bearing the Icahn name.

Beyond that, it further describes itself as a diversified holding company, one that owns subsidiaries involved in the following 10 sectors:

  • Investment
  • Automotive
  • Energy
  • Railcar
  • Gaming
  • Metals
  • Mining
  • Food packaging
  • Real estate
  • Home fashion

According to NASDAQ.com, Icahn himself is by far the biggest owner of the firm's shares. Other entities with sizeable stakes include Citigroup Inc. (C, Financial), Horizon Kinetics LLC, UBS Group AG (UBS, Financial) and Morgan Stanley (MS).

The firm stays busy buying and selling other companies. According to Wikipedia, its transactions so far this year include:

  • Buying Pep Boys (PBY).
  • Acquiring Federal-Mogul.
  • Buying Precision Auto Care (PACI).
  • Selling what was known as the Fontainebleau Resort Las Vegas.
  • Acquiring American Driveline Systems.

GuruFocus says Icahn and his firm invest through:

  • Icahn Partners, a hedge fund.
  • American Real Estate Partners (AREP), a publicly traded private equity firm.
  • Icahn Management LP, another hedge fund.

It also describes the firm as buying assets that no one else wants, often out of bankruptcy, gets them back on their feet and sells them when they are back in favor.

Icahn regards consensus thinking as generally wrong. He likes companies that are out of favor, especially those in whole industries that are out of favor.

While the firm has a relatively complex structure, including a couple of hedge funds, it is essentially a value investing platform. And, in keeping with Benjamin Graham and the young Warren Buffett (Trades, Portfolio), Icahn and his firm are essentially “cigar butt” investors, buying into deeply discounted companies.

Strategy

Investopedia reports Icahn began as a “corporate raider,” but by the late 1990s or early 2000s, he became more of an “activist investor.”

It also says that as an activist, Icahn was often followed by investors who bought what he bought, providing what is called the "Icahn lift." Further, it notes he is a contrarian and a value investor, interested in companies that have poor price-earnings (P/E) ratios or book values above current market valuations.

Once he has identified and selected one of those companies, Icahn takes a significant stock position. Then he asks for a new board of directors or for asset divestitures that will deliver more value to shareholders. Also among his targets: the compensation of CEOs, because in many cases he believes executives are grossly overpaid, and that their pay does not reflect stock price performance.

His first target was Tappan Co., where he gained a seat on the board and organized the sale of the company. That doubled his initial investment. Another of his early, controversial takeovers involved Trans World Airlines. Various financial maneuvers led to the airline's bankruptcy, while he recovered his initial investment.

Interestingly, he received airline vouchers in exchange for writing off $190 million that the airline owed him. The terms of the deal blocked Icahn from selling the tickets through travel agents, so he created LowestFare.com, which became a pioneer in online ticket sales.

Another unique situation involved USX, a descendent of U.S. Steel (FRA:USX1). He managed to spin off the steel manufacturing business, while keeping Marathon Oil (MRO), an oil and gas major. Ultimately, both companies share prices increased by 28%.

Icahn has also been called a greenmailer because target companies would buy back the shares he held, at a premium, to avoid the kinds of restructurings described above.

In a 2016 article, The Motley Fool summed up Icahn's financial career in three key points:

  • He is more of a trader than a long-term investor. Their analysis of his holdings showed most had been in the portfolio for no more than 18 months.
  • A concentrated, or high-conviction, investor. That is backed up by data at GuruFocus: More than 60% of his portfolio is made up of just three stocks (including one of his own).
  • His strategy is centered on activism. The Fool points out activism requires large pools of capital, enough to make an investment that gets the attention of the board of directors. Icahn has been building his pool, plus access to capital through third parties, for years.

Icahn’s strategy has evolved over time, but is still a sword hanging over the heads of underperforming CEOs and boards. That threat is perhaps of more value to the overall investing community than to the specific companies within which he has intervened.

Holdings

As can be seen in this GuruFocus chart, Industrials dominate his holdings in the Icahn Capital:

1784840862.jpg

These are the top 10 holdings in that portfolio, as of Sept. 30:

Icahn Enterprises is yet another portfolio, part of the stable of interconnected companies built around the original firm. A high proportion of industrials, with a unique mix of other sectors.

Performance

For the nine years of returns available to GuruFocus, this table shows Icahn Capital beating the S&P 500 in eight of those nine years:

263993776.jpg

In another article from The Motley Fool, Adam Levine-Weinberg notes Icahn lost 18% in 2015 and 20% in 2016 (GuruFocus data shows Icahn Enterprises has lost 11% year to date for 2017).

He also compares Icahn’s performance with that of Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A) (BRK.B) and the S&P 500’s index (SPY). I followed his lead and created this chart in GuruFocus:

603146509.jpg

Note how Buffett generates better results, while taking on far less volatility. Also worth noting: Levine-Weinberg points out that as a master limited partnership, Icahn Enterprises does not pay corporate taxes; instead, profits flow through to shareholders who become responsible for taxes.

While the chart above shows the SPY above Berkshire Hathaway, that is something of an illusion caused by the SPY starting above Berkshire at the chart’s origin. Look instead at the legend in the top left corner, which shows Berkshire up 100%, the SPY up 76% and Icahn Enterprises down 57% (all based on closing prices from Nov. 15, 2007 and Nov. 15, 2017).

While Icahn produced outsized returns for clients in the past, recent performance must have deeply disappointed them. Clients who began investing on this date in 2007 and stayed with the guru would now have lost some two-thirds of their capital (without accounting for compounding).

Conclusion

Like many legends of the 1990s and the first half of the 2000s, Icahn seems to have lost his touch. Perhaps it will return when the market turns bearish again, perhaps not. But he has suffered losses that will affect his five- and 10-year cumulative returns for some time to come.

By comparing Icahn the hare with Buffett the turtle, The Motley Fool reminded us there is more at stake than just one year’s returns. Consistency over time matters more than occasional spectacular years.

For value investors, the Icahn story also reminds us it is all very well to buy cigar butt stocks, but it takes more than patience to turn those butts into consistent winners.

Disclosure: I do not own shares in any of the companies listed in this article, and I do not expect to buy any in the next 72 hours.