On 2 May this year, analyst firm Hindenburg Research published a report accusing Icahn Enterprises, a company owned by investment legend Carl Icahn, of using excessive leverage and employing pyramid-like schemes, taking advantage of Icahn's reputation. Following the publication of the report, Icahn Enterprises (IEP) shares fell by 40%. It is worth taking a look at what could be learned from the report and why confidence is not always a good tool in investing.
Who is Carl Icahn?
Carl Icahn is an investor who started his career as a stockbroker in the 1960s. He worked at various companies for several years before setting up his own, Icahn Enterprises, in 1987. Initially he invested in smaller companies, but soon began to deal with large companies as well. He gained a reputation as a relentless negotiator and a man who can use his investment power to take control of a company and make changes that would improve its financial performance.
Icahn was one of the most vocal proponents of the idea that companies should focus on short-term returns for their shareholders, rather than long-term goals and investments. His tactics were often based on using his stake in the company to force management to make decisions that favoured investors - such as increasing dividends or buying back shares.
In the 1980s and 1990s, Icahn became one of the world's best-known investors and appeared on many television programmes, where he was interviewed about his investments and strategies. Throughout his career, he often generated controversy and criticism from the boards of the companies he targeted. Icahn currently manages approximately US$21 billion in capital, with 71% of his portfolio being the aforementioned Icahn Enterprises, jointly managed with his son Brett.
Source: Tradingview
The Hindenburg Research report, a fictional success story in a bull market?
We were able to learn from the Hindenburg Research report that IEP units, according to the analyst firm, are overpriced by more than 75% for three key reasons:
- The IEP is trading at a 218% premium to its last reported net asset value (NAV), which is significantly higher than all comparable investment firms.
- Hindenburg Research announces that it has clear evidence of overvaluation for the firm's less liquid and private assets.
- The firm has incurred additional losses due to higher operating expenses since the last report.
Most closed-end holdings (such as IEPs) trade at share prices close to or below their NAV. By comparison, similar funds managed by other well-known managers, such as Dan Loeb's Third Point and Bill Ackman's Pershing Square, are trading at a discount to NAV of 14% and 35% respectively.
Source: https://hindenburgresearch.com/icahn/
In addition, the analyst firm compared the IEP to all 526 closed-end mutual funds in Bloomberg's databases. Icahn Enterprises' premium over net asset value was higher than all comparable funds and more than double that of the second-ranked fund.
One reason for the extreme IEP premium over net asset value, according to a media analysis targeting retail investors, is that average investors are mainly interested in two factors:
- The high and ever-increasing dividend yield of the IEP.
- The opportunity to invest alongside Wall Street legend Carl Icahn. What may seem interesting is that institutional investors have virtually no holdings in IEPs.
Prior to the release of the report, Icahn Enterprises' dividend yield was around 16% (after the fall it is over 20%), making it the highest among large US companies, while the next on the list records a ratio of around 10%.
This is because the company's unit price is excessive and its annual dividend rate is an absurd 50.5% of its recently reported net asset value.
In addition, the IEP's financial performance has been deteriorating, which has negatively impacted its share price growth. The company's investment portfolio has lost about 53% since 2014, and its free cash flow was negatively $4.9 billion over the same period. Despite this, IEP has raised its dividend three times since 2014. (most recently in 2019), from a quarterly payout of $1.75 to $2 per share. In the same year, free cash flow was negative $1.7 billion.
Source: https://hindenburgresearch.com/icahn/
Is Icahn Enterprise a financial pyramid scheme built on name trust?
According to the report's authors, Icahn uses the funds of new investors to pay dividends to old investors, which resembles a financial pyramid scheme that is only sustainable until new investors decide to keep joining. By contrast, Jefferies, the only major investment bank with research on IEPs, keeps giving positive recommendations on IEP units, even in a worst-case scenario, assuming that the dividend would be safe 'forever', without justifying such an assumption.
The authors of the report estimate that the investment firm's recently announced net asset value of $5.6 billion is overstated by at least 22%, due to overly aggressive valuations of IEP's less liquid and private investments and further deterioration in performance this year. For example, the IEP holds a 90% stake in a meatpacking company that was valued at $243 million at the end of last year, while its market value was only $89 million. Investors believe that Carl Icahn and his son Brett have long delayed selling their IEP holdings, allowing them to continue to reap dividends.
This example highlights the importance of taking a cautious approach to investment information and that the fame of investment legends alone should not be trusted unreservedly. Regardless of their past successes, there is always a risk that subsequent investments will not yield as much.
It is worth realising that it is the numbers that are important in investing, not the opinions or fame of a particular investor. It is important to thoroughly research the venture in question and assess the potential ability to generate profits and positive cash flow.
Grzegorz Dróżdż, CAI, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
Materials, analysis and opinions contained, referenced or provided herein are intended solely for informational and educational purposes. Personal opinion of the author does not represent and should not be constructed as a statement or an investment advice made by Conotoxia Ltd. All indiscriminate reliance on illustrative or informational materials may lead to losses. Past performance is not a reliable indicator of future results.
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