Author Tobias Carlisle has presented a case for deep-value investing by looking at the contributions of Benjamin Graham, his student Warren Buffett (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio).
In "The Acquirer's Multiple: How the Billionaire Contrarians of Deep Value Beat the Market," Carlisle argued deep value can produce better returns than conventional value investing. Specifically, he said the strategy of “fair companies at wonderful prices” is better than “wonderful companies at fair prices”.
In chapter nine, he began introducing other deep-value investors, starting with Carl Icahn (Trades, Portfolio). Born in 1936, Icahn came to prominence in the late 1970s and early 80s as an activist investor and corporate raider. He enjoyed a great deal of success throughout his career and placed fifth on the Forbes’ list of top hedge fund managers in 2014. He is best known for his hostile takeover and subsequent “asset stripping” of Trans World Airlines.
As an aside, note Carlisle reported in chapter six that he got the idea for his Acquirer’s Multiple strategy from corporate raiders such as Icahn.
Icahn got his start as a corporate raider in 1976, when he wrote and distributed a message to potential investors in his new hedge fund. He called it “The Icahn Manifesto” and offered “a unique way to create large profit-making opportunities with relatively little risk.”
To achieve that, he noted most firms are reluctant to launch “unfriendly” takeover initiatives against a target company. But when a fight is started, it often leads to windfall profits for the activist firm. That’s because target companies facing a serious takeover attempt will look for a “white knight” to make a friendly and higher bid, which is likely to kick off a bidding war. Alternatively, the target may offer to buy back the activist firm’s shares at a premium or offer to liquidate itself. Whatever the target’s response, there is a good chance the activist will be well positioned.
As Icahn put it, “It is our contention that sizeable profits can be earned by taking large positions in 'undervalued' stocks and then attempting to control the destinies of the companies in question”. The biggest challenge, he wrote, was that managers of the takeover targets generally owned only small stakes and, therefore, were not interested in having their companies acquired.
His first target was the Tappan Stove Company, which operated in the shadow of a competitor, Magic Chef. An Icahn analyst said Magic Chef was at the top of its cycle and Tappan was at the bottom; Tappan was also overshadowed by the industry leaders General Electric (GE, Financial) and Westinghouse.
At the time, shares were trading at about $7.50 and Icahn believed they were worth about $20 per share; that provided an opportunity to almost triple his investment—if the company could be put into play. After buying an initial stake of 15,000 shares, Icahn called Tappan’s president, Donald Blasius, and subtly suggested he might buy more (leading to a takeover). According to Carlisle, Blasius chose to ignore the threat.
He also chose to ignore Icahn when the latter’s stake had growth to 70,000 shares. This time, Icahn bluntly informed Blasius of a potential takeover bid (as Carlisle noted, takeovers were not a common occurrence in 1977). So Icahn continued to buy shares until he owned more than 5% of Tappan and had to file regulatory notices with the Securities and Exchange Commission. That caught the attention of Wall Street and the stock price jumped dramatically. Icahn again asked for a seat on the board, was refused and then the company tried to issue stock to block the takeover.
Icahn responded with a media campaign, hoping to embarrass Blasius into stopping the new issue and to sell the company. The board of directors got the message and gave in almost immediately. Following up, Icahn sent a letter to shareholders asking for a seat on the board and to sell his shares at $20. He did get that seat and the company agreed to sell a couple of underperforming assets.
But the big news was Blasius recognized he had lost and went looking for a white knight; as a result, AB Electrolux (ELX, Financial) agreed to buy out shareholders at $18. At this price, Icahn almost doubled his money in a couple of years, since his average cost had been $9.60 per share.
Impressed by Icahn’s work, Chairman Dick Tappan decided to become an investor in the hedge fund. As this table, from the book “King Icahn,” shows, that was a wise investment:
As we know in retrospect, Icahn went on to challenge the managers of many underperforming companies, including an unsuccessful shot at U.S. Steel (X, Financial) that had a market cap of $6 billion at the time. He also became a founding father of the corporate raiding community, which flourished, controversially, until the 1987 stock market crash.
This case study illustrates another approach to deep-value investing—creating your own opportunities rather than waiting for them to appear, at least for deep-pocketed investors.
It also shows an example of profiting handsomely from “a fair company at a wonderful price.” The stock’s intrinsic value was around $20, while Icahn started at $7.50 and averaged $9.60. Although readers were not given the specifics, risk appeared to be low given the wide margin of safety ($20 – $9.60 = $10.40).
An individual value investor might not have done as well as Icahn. The hedge fund guru was able to force change on a management team that did not want to make changes because he had enough capital.
And that leads to warnings about the “agency problem” or “principal-agent problem.” This refers to management that acts in its own interests, rather than interests it is supposed to represent—shareholders. Entrenched management can hold back needed changes, since their salaries mean more to them than their holdings in the company.
Still Carlisle has made his point there are profits to be found by following Graham and the young Buffett in their quest to find cheap stocks with more asset value than liabilities.
(This article is one in a series of chapter-by-chapter digests. To read more, and digests of other important investing books, go to this page.)
Disclosure: I do not own shares of any company listed, and do not expect to buy any in the next 72 hours.
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