Icahn v. Hindenburg: Who’s Right?

Today’s issue of The Spill takes a different tact.

We’re looking into a recent report issued by noted short-seller Hindenburg Research, who makes some bold claims about Icahn Enterprises (IEP), Carl Ichan’s publicly traded company.

With the stock down more than 43% at one point, EVERYONE wants to know the truth. Especially with a 25% dividend yield at stake.

How do we know?

It’s been one of the most searched stocks by financial pros and retail investors in the last few days, save for a couple of troubled banks.

The report rests on three key claims:

• Overvaluation
• Ponzi-like dividend payout scheme not backed up by corporate performance
• Inflated asset valuations within the portfolio

We’re going to address each claim independently.

Icahn Enterprises’ Business

To get us started, it’s helpful to understand Icahn Enterprises.

Essentially, it’s a holding company like Berkshire Hathaway with interests in different sectors.

Source: Ichan Enterprises Investor Presentation

They own companies you know well, like Pep Boys and others less recognizable.

Claim #1: Overvalued

Hindenburg compares Icahn Enterprises to other companies like Bill Ackman’s Pershing Square and Dan Loeb’s Third Point Capital.

Source: Hindenburg Research

This simply states facts.

Hindenburg further explains the inflated value is driven by the constant and high-paying dividend issued by IEP.

Again, also true.

Net asset value is the current value of all the investment holdings.

Others like Third Point and Pershing likely trade at a discount because they charge fees to invest with them.

IEP pays a dividend stream, which is worth something. So, that gets tacked onto the share price.

This is only a problem if the dividend stream isn’t sustainable. Which takes us to the second claim.

Claim #2 – Ponzi-like dividend payout scheme not backed up by corporate performance

Hindenburg cites to major points here.

First, it says the free cash flow doesn’t justify the dividend payout. The company instead used dilution to fund the payout.

Second, Hindenburg says the corporate performance is terrible and doesn’t support the dividend, which in turn, doesn’t support the share price.

These claims are kind of true but misleading.

IEP allows shareholders to take dividends in the form of stock or cash.

Carl Icahn owns 85% of the company and always takes stock. That’s largely why the total shares outstanding have gone from 116 million in 2013 to 354 million today.

That’s true if the dividend is unsustainable.

Hindenburg points to a lack of free cash flow.

However, if only 15% of shareholders take cash, the amount needed to pay the dividend is far less than if Icahn took the cash.

In fact, it only amounts to around $100 million to $200 million a year with operational cash flow that’s typically well in excess of that amount.

And you don’t need operational cash flow to pay dividends, either. Selling assets works just as well.

The question is, why haven’t the share prices dropped to account for the dilution?

We assume that the company’s valuation at any given point in time is comprised of the value of its assets and the expected stream of cash flows. 

Therefore, the stock was likely undervalued years ago when much of the retained earnings were held by Ichan.

Really, the dividend payouts hurt him more than anyone else, as the shareholder equity has dropped with the increase in share count.

But the only person taking those extra shares is Icahn. So as an investor, why do we care?

If he wants to dilute his own wealth for our gain, go right ahead.

Now, all of this falls apart if the assets in the portfolio are garbage.

Claim #3 Inflated asset valuations within the portfolio

IEP’s investment portfolio looks like this:

Source: Ichan Enterprises Investor Presentation

Hindenburg cites several examples of inflated valuation, which are probably true to some extent. But unless it’s wildly off, it’s not a problem.

One of the more interesting points it makes is on the holding company’s investment funds.

This fund, “invests in public equities and debt, employing an activist strategy.”

The next part from the Hindenburg report is rather amusing:

Icahn disclosed that on December 31, 2022, the investment fund had net short notional exposure of 47% and 71% short equity. Given the S&P’s return of about 9.2% year-to-date, we estimate the non-notionalized short equity book has lost at least $272 million year to date.

That’s pretty rich coming from a company that makes money betting against companies.

Plus, Hindenburg has no idea what those positions are. For all we know, Icahn could have made huge bets against regional banks.

In the same filing Hindenburg cited, the following is stated:

Of the Investment Funds’ 94% long exposure, 74% was comprised of the fair value of its long positions (with certain adjustments) and 20% was comprised of single name equity forward and swap contracts and an option contract. 

Of the Investment Funds’ 140% short exposure, 71% was comprised of the fair value of its short positions and 69% was comprised of short broad market index swap derivative contracts and short credit default swap contracts.

Essentially, the fund is 20% short one specific name on its long side exposure.

On its short side exposure, only half is short the market. The rest is short individual equities.

And this was as of December 31, 2022. A lot can change between now and then.

Our Verdict – Icahn 80%, Hindenburg 20%

Most of what Hindenburg cites is supported by incomplete math or assumed information.

Where they do have a point is the dividend payout scheme. Clearly, there is going to be a problem if Icahn decides not to take shares at some point.

And the more he dilutes the stock without subsequent asset improvement, the lower the share price goes.

That said, the 50% haircut more than covers any and all of the problems cited.

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