Learn From The Masters - The Disruptive Contrarian

By Larissa Fernand
Morningstar India
September 22, 2015
Text Size : A A


Once upon a time, there was an American airline named TWA, which had a nice red logo. And then a big bad wolf came and destroyed it. Long a public company, he made it private, drafting a share buyback programme that helped him. When the company ultimately filed for bankruptcy he earned some good bucks. The predator in this version has a name - Carl Icahn. And in the midst of a very public battle with Icahn, Marc Andreessen promoted the story of Icahn's role in the airline's downfall on his blog.

Now for the introductions.

Icahn is a hedge fund manager and one of the world's richest men. (His most recent claim to fame is Donald Trump's offer to make him Treasury Secretary, obviously conditional on the former being elected president.)

Andreessen is a prominent venture capitalist and established Silicon Valley entrepreneur.

Their battle took place when Andreessen was on the board of eBay. Icahn, a shareholder, believed that the company should not have gone ahead with the sale of Skype and wanted eBay to sell PayPal. When the company finally gave in and decided to break off its online payments unit, Andreessen resigned.

As you might have guessed, Icahn is an activist investor known for his disruptive investment style. His takeovers have often led to epic clashes with existing management. He has been called a ruthless corporate raider, the ultimate corporate predator, vulture capitalist, the Wall Street agitator, one of Wall Street's most vocal investors, the Breakup Master, an icon of '80s greed and, most dramatic of all, "an evil Captain Kirk".

Icahn‘s strategy is a combination of contrarianism and shareholder activism.

He looks for companies when nobody else wants them. This entails journeying deep into value territory scouting for stocks that are out of favour. He tilts towards companies whose stock prices reflect a poor P/E ratio and whose book values exceed market valuation.

Up to this position he can be branded as a contrarian on the hunt for value.

Once he has narrowed down on a target, he begins to build upon his positions till he has a controlling stake. That done, he starts to push for changes which he believes would result in tremendous shareholder value. This would involve appointments on the board, management shakeups, rallying shareholder support, pushing for turnaround strategies, changes in CEO compensation, stock buybacks, divestiture of assets, and so on and so forth.

He then benefits from obscene amounts of money when he finally exits.

A distillation of his strategy into an investment memorandum was distributed to prospective investors in the mid '70s.

He started off with Tappan Stove Company at a time everyone was chasing Magic Chef. Icahn stayed away from the latter because the multiples were too high and set his sights on the former which was still reeling from the stock market crash in 1974.

Icahn believed that Tappan was an attractive candidate for strategic acquisition by the likes of General Electric and Westinghouse. With a book value of around $20/ share, he figured his potential upside was around $12.50/ share, or about 170%.

Icahn began acquiring the stock in 1977. A few years later he won a proxy vote to take over Tappan Co. He proceeded to give himself a seat on the board and orchestrate the sale of the company, which quickly doubled his original investment.

After that there was no looking back. That pattern became his template and he would employ various strategies to get what he wanted.

  • Pick up a deeply undervalued stock. One where the real or liquidating value was not reflected in the market value of the common stock.

    According to Zero Hedge, he recently invested $88 million (8.46% stake) in the Phoenix-based copper mining giant Freeport-McMoRan. Despite the company battling with major cash flow problems, it only has 3.0x debt/EBITDA which to Icahn means it can lever up at least 2-3 more turns, and use the proceeds to be more shareholder friendly. That the resultant company will inevitably go default is a different matter.

  • Acquire a shareholding in the company sufficiently large to influence management and bring about changes and hopefully control the company‘s destiny.

    A few years ago, he built up a large position in Chesapeake Energy and managed to get its long-time CEO removed. After investing in The Manitowoc Company, he pressurized the management to break the company in two, by spinning off its restaurant and kitchen equipment business in a tax-free separation from its crane business. He won. And he gets to appoint a person to the board of both Manitowoc, and the new company when it is formally spun off in 2016.

  • Draw the market's attention to the wide discount between market price and intrinsic value.

    A year ago, he wrote a letter to the CEO of Apple asking him to make a tender offer for shares on the premise that the tech giant is undervalued and believed it to be "an amazing opportunity to take further of this valuation disconnect by accelerating share repurchases." At the time of the letter, he valued the company at$203/share today—more than double the then market price of around $100.

  • Push management for a catalyst. This could be done by liquidating or selling the company to a "white knight" - more friendly enterprise that the target company approaches to make a higher bid, thereby starting a bidding war.
  • Wage a proxy contest. Shareholder activists may be dissatisfied with a particular aspect of the company but run into resistance from the company's current board members. These shareholders persuade other shareholders to allow them to use their proxy votes on a proposed change to the company‘s board positions. In this way, the board members opposing the change can be replaced.

    Around 7 years ago, Icahn engaged in a proxy battle with Motorola and sued the company.

  • If management stayed resolute and the proxy contest didn't draw the attention of other bidders, move to put the company in play by making a tender offer. (To induce the shareholders of the target company to sell, the bidder contacts shareholders and offers a price usually at a premium over the current market price.)

    Two days ago he unveiled a tender offer to buy up all of drugmaker Vivus' convertible notes.

  • Offer to sell back the acquired stock position to the company.

    In the last quarter of 2013, video game publisher Take-Two Interactive Software bought back its stock held by Icahn. In the very same quarter, WebMD Health Corporation repurchased all of the shares of WebMD common stock beneficially owned by Icahn and certain of his affiliates.

  • Wait to see if any other buyer stepped in with a higher bid. If no other bidder emerged, Icahn could take the company private himself, and, presumably, getting it for cheap after demonstrating that no other bidder wanted it.

He has always been unapologetic of the fact that he makes money by launching hostile takeovers. But it is this very disruptive and contrarian investment style that helped him build a net worth that places him at #31 in the Forbes world's billionaire list.

But at times, he just gets "lucky" and does not have to dirty his hands. An example is Netflix. In three years, he made nearly $2 billion by buying and selling Netflix, the world's largest online subscription video service.

In 2012, he bought an initial stake worth $321 million. By the very next year, he sold almost half. "When you are lucky and/or smart enough to have made a total return of 457% in only 14 months, it is time to take some of the chips off the table."

After he offloaded the last of his shares in June this year, the stock price climbed to higher levels on a strong second quarter. But he had no regrets. He was quoted in Forbes saying that it was a valuation call. "I'm not crying about it. I try to buy them cheap and sell them. I made all this money selling too early or too soon. You're never going to get the top. Once in a while you get the timing right, but that's like Vegas."

Wise words indeed!

This article was also published in Morningstar on 22nd September 2015.