Is Icahn Enterprises a Ponzi Scheme?

Or Is The Hindenburg Report Full of Hot Air?

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Editor’s Note:

This is an update on one of the stocks currently held in our model portfolio for The Big Secret on Wall Street. We’re releasing this piece to all our readers – both free and paid – as a special, situational alert.

We first recommended Icahn Enterprises (IEP) to our paid subscribers in December 2022, in a report we called “Better Than Buffett, Plus A 16% Dividend.” Carl Icahn has generated one of the best long-term investment track records in history, but he has also made a lot of powerful enemies over the years. Earlier this week, short-selling firm Hindenburg released a report targeting Icahn and his company – and shares of IEP plunged 40%.

We have the full story for you today – one you won’t hear from Hindenburg, or from the news – and an update on why we’re not recommending selling shares of IEP.

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Shares of Icahn Enterprises have collapsed over the last few days following a sharply critical report from a well-regarded activist short seller, Hindenburg Research. Their practice is to take a short position in a stock – which means that if the stock falls in value, they make money – and release a report explaining why they think the stock is worth less than its current market valuation.

Hindenburg’s report on Icahn was particularly unwelcome news for Porter & Co.

In December 2022, we added IEP to the The Big Secret on Wall Street portfolio on the basis of Icahn’s investment acumen and the company’s hefty 16% dividend.

And while we don’t typically comment on short-term moves in share price (most market volatility is merely “noise”), the accusations that Hindenburg is making against Icahn are serious.

To summarize, Hindenburg is, more or less, calling Icahn a fraud. They allege he’s been losing money for investors for nearly a decade and making up the difference by selling units of his partnership at inflated prices. Hindenburg describes this strategy as “Ponzi-like.”

Those are weighty claims to make against anyone. But saying those things about Icahn is going to provoke a holy war on Wall Street. Talk about poking the bear!

Icahn has generated one of the best long-term investment track records in history. But he has also made a lot of powerful enemies over the years because of his aggressive shareholder activism, and his close association with former President Donald Trump.

So… how much of what Hindenburg is saying is true… and how much is substantial and concerning? Is Icahn one of the greatest investors of all time… or a fraud? Is IEP a legitimate holding company – or is it a Ponzi scheme?

How Hindenburg’s Claims Are Full of Hot Air

Hindenburg Research is named after the famous 1937 crash of the Hindenburg zeppelin, which the research firm describes as “a man-made, totally avoidable disaster.” The firm’s goal is to foresee (and short) similar disasters in the investing world. (Hindenburg earlier this year unleashed a report on Adani Group, one of India’s biggest conglomerates, resulting in upwards of $100 billion in lost market value in the group’s component companies.)

In this case, though, most of the accusations go up in smoke upon closer examination.

Hindenburg claims that Icahn’s investment portfolio is down 53% since 2014 and that the company has “burned” almost $5 billion in cash since then.

That’s only partially true. Hindenburg’s analysis tracks IEP’s current publicly traded investments, which make up less than half of the company’s assets. There’s nothing mentioned about the performance of the majority of the assets at IEP.

That’s misleading, because Icahn is a turnaround expert. The things that he still owns are “in the shop” –  they’re in the process of being fixed. The more appropriate way to measure the outcome of his shareholder activism is the return that is earned when Icahn sells. And, measured on that basis, there’s hardly a better investor in history.

Before the short report caused the recent sell-off, IEP had compounded investor capital at 14.5% per year since the year 2000 – handily outperforming the S&P 500’s 6.5% return over the same period.

IEP has also outperformed the 9.9% compounded returns of Warren Buffett’s Berkshire Hathaway over the same period.

Likewise, Hindenburg’s claims of Ponzi-economics are completely overblown.

Icahn Enterprises functions much like an investment company. It borrows money and it raises equity capital to invest in undervalued companies. It then applies pressure (by taking board seats or talking with management teams) to get the companies to treat shareholders better, or to make strategic changes to unlock value.

It’s rational to use a mix of both debt and equity to finance these operations, especially given the large premium to net asset value at which  Icahn’s shares trade  (and have historically so traded). Most companies will use their shares to buy other companies, when their shares are richly valued. Doing so doesn’t mean they are a Ponzi scheme.

Finally, Hindenburg’s most exaggerated claims focus on the 25% dividend (higher than previously due to the decline in the share price) that IEP pays, and has paid, for 71 straight quarters.

Hindenburg says the dividend isn’t sustainable. We disagree. The fact is, IEP currently holds $2.3 billion in cash and the dividend only costs $226 million per year. Hindenburg is exaggerating the impact of the “dividend rate” because it’s ignoring the fact that Icahn takes his share of the dividends (of the 85% of the company that he owns) in more shares, not cash.

It seems particularly malicious to use the word “Ponzi” to describe Icahn’s operations, because he’s actually doing the opposite of what a Ponzi would do.

Ponzi operators smooth out the never-ending losses of their frauds with a regular dividend to create the appearance of stability and success. Meanwhile, they secretly take money out of the fraud until it fails.

In contrast, Icahn Enterprises uses its dividend to create a regular flow of income for its investors to smooth out the enormous volatility of an activist hedge fund – a fund that’s earned billions in profits over the last 20 years. And Icahn, instead of taking money out of the fund, has instead been accepting more shares in lieu of the cash dividend that he’s been paying outside investors.

Would a Ponzi operator continue to take shares in a fraud? No way. But that’s exactly what Icahn does, demonstrating his confidence in his firm.

The other issues in the Hindenburg report focus on issues that are mostly immaterial – arguments about marking assets to market, for example. We are familiar with Icahn’s arguments on these issues and we think they’re reasonable.

Hindenburg’s claim that the shares are highly overvalued might be true. As of Thursday’s close, IEP trades at a total market capitalization of roughly $11 billion, or a roughly 100% premium to its last reported net asset value (NAV) of $5.6 billion for year-end 2022 (before the recent sell-off, it traded at about a 200% premium to NAV).

Typically, closed-end funds trade at a slight premium or discount to NAV. But we think it's reasonable to expect investors to value IEP more highly than similar investment companies, such as Bill Ackman’s. First, Icahn is a better investor. Second, he owns 85% of the company, a higher total than the others. And third, he pays a substantial dividend, upon which investors have relied for more than a decade.

In short, we see virtually all of Hindenburg's report as a baseless attack on Icahn.

As such, we would normally recommend buying more shares to take advantage of the opportunity to buy a great investment manager at a deeply discounted price.

We think that a big rebound in the shares could occur next week, following IEP’s Wednesday earnings announcement.

But… there was one serious allegation in the Hindenburg report… and that one is worth discussing.

Icahn Has “Personal Debts” – And His Company Is The Collateral

As reported by Hindenburg, Icahn has taken out a huge margin loan against 60% of his shares in IEP. This is like putting up his house (or, most of his house) as collateral in a bet. (We don’t know the details of what Icahn bet on, only that it was “personal.”)

Hindenburg’s eagle-eyed researchers spotted this information buried in footnote C on page 124 of the company’s annual report. Of Icahn’s 299 million shares of IEP, footnote C explains:

[It] includes 181,439,167 depositary units pledged as collateral to secure certain personal indebtedness. The number of depositary units pledged to secure these loans fluctuates in certain years and from time to time as a result of changes in the amount of outstanding principal amount of the loans, the market price of the depositary units, and other factors.

This is concerning, to say the least. But Hindenburg conveniently ignores information from the rest of the footnotes. (We, too, know how to read fine print.)

In a different footnote, on page 8, IEP discusses the risks of having one shareholder with such a huge position in the stock.

Sales of a substantial number of depositary units held by Mr. Icahn and his affiliates could have a negative impact on the market price of our depositary units. Likewise, the market may anticipate sales by Mr. Icahn or his estate even if Mr. Icahn or his estate is not selling, or has no plans to sell, depositary units.

To make it clear that Icahn has mitigated such risks, the company then says unequivocally, also on page 8:

Mr. Icahn’s estate has been designed to assure the stability and continuation of Icahn Enterprises with no need to monetize his interests for estate tax or other purposes.

That would seem to preclude any forced selling for tax reasons (in the event of his death), or for reasons like a margin loan being called.

And, most importantly, Carl Icahn himself has pledged to never allow these shares to be called away from him. As footnote C continues,

Mr. Icahn has advised that he and his affiliates have sufficient additional assets to satisfy any obligations pursuant to these loans without recourse to the depositary units, he has no need or intention to allow foreclosure on such collateral, and that he is current on all principal and interest payments with respect to the loans, and there has never been an event of default or a default under any of the loans.

The Hindenburg report omits this statement entirely. And, to date, we haven’t seen any reporting about it (except ours).

The fall in the IEP share price means the integrity of Carl Icahn will be tested. Will Icahn allow his enemies to see him driven out of business, with his legacy destroyed? Will he be forced to sell shares, giving credence to claims that he was running a Ponzi scheme?

We doubt it. Over the decades, Icahn’s enemies have been carried out on their backs.

But… we also think these facts present extraordinary risks for outside investors. We’re left trusting the word of one of Wall Street’s greatest legends. That’s a risk that’s impossible to handicap.

As such, we can no longer recommend you buy IEP.

If you already own shares, you could walk away now with a major loss if you were to sell. Or you could wait until next week. On Wednesday, IEP will report quarterly earnings. If Icahn has alternative funding for these margin loans, the picture should become much clearer. His detractors will look foolish and the stock could rally sharply.

On Thursday afternoon, IEP published a second press release responding to the Hindenburg allegations, and noted that it maintains the liquidity and commitment to continue paying its $2.0 per unit quarterly distribution. Carl Icahn issued the following comments in the press release:

The fundamentals of our business, and our belief in the activist paradigm that has served us well for decades, remain unchanged. We obviously disagree with the inflammatory assertions in the Hindenburg report and intend to respond at length – and to vigorously defend IEP and its unitholders.

For the purposes of our model portfolio, we are siding with Icahn. Of course, in the end, it might be us who end up looking foolish, but we are going to stick with the horse we rode in on.

For your own position, whether you sell or hold through at least next week probably depends on the size of your exposure. In general, we don’t recommend allocating more than 5% of your portfolio into any individual position.

For more on this situation, look for a full update in The Big Secret on Wall Street, which will be sent to all paid-up subscribers next week (Friday).

Porter & Co.
Stevenson, MD

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