Carl Icahn: Invest Like An Activist

Who is Carl Icahn?

Brutal honesty and a love of lucre: that short quotation contains the two essential elements of one of the 1980s’ most notorious “corporate raiders”. In fact, Gordon Gekko – the “greed is good” villain of the 1987 movie Wall Street – was reportedly modeled on one real-life figure in particular: Carl Icahn.

Born into humble circumstances in 1936 in Brooklyn, New York, Icahn went on to become one of the most successful investors in the world – and he’s got the bank statements to prove it. Business magazine Forbes estimates that Icahn is today worth almost $14 billion, with that wealth entirely self-made. Old age may have softened him somewhat – as a signatory to The Giving Pledge, Icahn has vowed to give away the majority of his money to philanthropic causes – but the man retains a fearsome and well-deserved reputation for aggressive dealmaking forged over several decades.

Icahn started out as a stockbroker in 1961. Seven years later, he used savings and an investment from his uncle to begin trading in his own right on the New York Stock Exchange under the name of Icahn & Co. The firm focused on options trading and “merger arbitrage” – the latter an investment strategy which seeks to profit from buying and selling shares of companies involved in potential mergers, acquisitions, and other structural shake-ups.

In 1978 Icahn stepped things up a notch. His investments in individual companies grew bigger and bolder, allowing Icahn to influence target firms’ decisions with the aim of maximizing shareholder value. Such ”corporate raiding” became big business in the following decade. Deep-pocketed investors acquiring majority stakes in companies, often through hostile (or uninvited) takeovers, could then use their dominant shareholder voting rights to manipulate executive decision-making in their favor. The idea is that the value of a firm’s shares rise by virtue of this interference – richly rewarding its investors, including the new majority owner.

While some see corporate raiders as greedy plunderers spoiling perfectly good companies in pursuit of personal profit, others view them as important catalysts for productive change, holding management teams accountable and ensuring heightened efficiency. As mild-mannered investment legend Warren Buffett once put it, there’d be no need for raiders if every business was well run – but at some companies, the managers forget who they’re working for. Regardless of your view, it’s worth taking a closer look at this approach – now more commonly known as “activist investing” – in order to discover both how Icahn so successfully implemented the strategy and the ways in which it can inform how you manage your own investments.

The activist playbook

As mentioned, the short-termist, profit-hungry attitude of some activist investors has led to them earning the moniker of “corporate raiders,” “greenmailers”, or “asset strippers”. Greenmail, by the way, is the practice of buying enough shares in a company to threaten a total hostile takeover and then forcing the firm to repurchase those shares at a premium. But activism can also engender broader positive impacts.

Icahn’s words here reference the typical activist investing approach we mentioned before: one which involves buying a large proportion of a company’s shares, using the resulting voting power to control the board of directors and/or appoint sympathetic people to it, and then trying to effect changes in the company that the activist believes will be positive for its share price. These can be good or bad for the company’s prospects, depending on whether the activist’s plans promise to create long-term value or just a short-term stock surge.

Examples of changes activist investors often seek to implement include replacing the company’s management team, selling off some of its assets, borrowing more money, splitting up business lines, and returning cash to shareholders. Icahn’s efforts on this last front even contributed to convincing tech giant Apple to increase its stock buybacks in 2015.

Apple’s buybacks have only increased in the intervening years

Icahn’s words here reference the typical activist investing approach we mentioned before: one which involves buying a large proportion of a company’s shares, using the resulting voting power to control the board of directors and/or appoint sympathetic people to it, and then trying to effect changes in the company that the activist believes will be positive for its share price. These can be good or bad for the company’s prospects, depending on whether the activist’s plans promise to create long-term value or just a short-term stock surge.

Examples of changes activist investors often seek to implement include replacing the company’s management team, selling off some of its assets, borrowing more money, splitting up business lines, and returning cash to shareholders. Icahn’s efforts on this last front even contributed to convincing tech giant Apple to increase its stock buybacks in 2015.

But it’s not only by amassing shareholder votes or seats on the board that activists try to effect change. The war is frequently waged through high-profile media campaigns against a company’s management. Icahn, for example, often follows up his stake-taking by publishing open letters to firms’ directors and shareholders on his website and complaining loudly live on air. Sometimes this can turn ugly – like in Icahn’s epic on-screen altercation with fellow activist investor, Pershing Square Capital Management founder, and Finimize Pack subject Bill Ackman. If you haven’t seen it already, we’d really recommend you check out what eventually became known as the “Battle of the Billionaires”.

The two activists fell out over nutrition company Herbalife. Ackman believed the multi-level marketing company was a fraud and consequently “shorted” its stock – basically betting that Herbalife’s share price would fall. Icahn disagreed, instead snapping up large chunks of the company’s stock. As he said at the time: “Our investment in Herbalife is a quintessential example of our activist investment strategy. In late 2012 and early 2013, the stock was meaningfully out of favor for a number of reasons. We studied the business and assessed the risks. At that time, we concluded that the risk/reward ratio was very favorable. We amassed a large position and joined the board. Our directors worked closely with management to stabilize the company.” Icahn would eventually win the argument – as well as a billion dollars in profit.

Access to activism

All this raises an inevitable question: how has the average activist fund actually performed? It’s fair to say that the track record is mixed. While there’s no single universal metric measuring the strategy’s success, an examination of several activist hedge fund indexes shows that the average fund’s return underperforms that of the US S&P 500 stock market index. Once you factor in fees, a cheap S&P 500 index tracker looks even more attractive.

Unfortunately, there’s no easy way to avoid those hefty fund fees and implement your own activist investing approach. In order to get a company’s attention, you need to first purchase a significant shareholding – and that obviously requires a huge amount of money.

You can potentially profit by buying some shares of companies that are subject to activist interest as soon as news breaks of, say, Icahn’s involvement. There are two potential pitfalls, however. First, by the time you come to trade the news, the company’s share price may have already risen by as much (or nearly as much) as it’s going to. Rumors of an intervention may have been circulating for a while, and the activist investor itself may have pushed up prices as it assembled its stake. Second, the medium-term returns from following activist investors in this way are inconclusive. The chart below shows the relative returns (compared to the S&P 500) of the best- and worst-performing quartiles of activist campaigns between 2007 and 2017.

Activist investing has a mixed track record

Of course, you can also invest directly in and with Icahn via his publicly listed investment conglomerate, Icahn Enterprises (ticker: IEP). Over the years, IEP has become Icahn’s principal means of making activist moves, and he retains ownership of around 90% of its own shares. As ever, make sure you do your research before deciding whether or not you think IEP is a good investment.

Regardless of whether or not you’re interested in investing in activist funds, however, the good news is that there’s plenty of lessons to be drawn from the successes – and failures – of major activists’ careers.

What you and Icahn learn from Carl

You might be surprised to learn that Carl Icahn’s investment style and philosophy aren’t all that dissimilar to those of Warren Buffett. His approach is essentially a version of the classic “long-term value” play: Icahn tends to invest in companies whose stocks are trading at low valuation multiples relative to the market, as measured by price-to-earnings (P/E) or price-to-book (P/B) ratios. By purchasing a large number of shares and voting power, the activist hopes to unlock more of the stock’s true value. That naturally takes a bit of time, however – hence Icahn’s generally long-term mentality.

Another parallel with Buffett is Icahn’s belief that investors should view buying a stock as buying a business, not just a piece of paper. That’s why he advocates taking the time to properly understand a company’s business model – and avoiding the tendency of investment bank analysts to focus too much on quarterly earnings. As Icahn once said, “I buy assets and potential productivity. Wall Street buys earnings, so they miss a lot of things that I see in certain situations.”

What exactly does this “potential productivity” involve? In a formal sense, a company’s productivity is how well it converts input costs – the costs of producing its goods or services – into revenue. Icahn believes that “pricing power” is one of the best indicators of this. In other words, the better a company's ability to raise its prices without reducing demand, the more it can grow sales without losing business to competitors. Icahn believes it’s important to get to grips with a company’s pricing power and how it changes over time before investing. Once again, this is similar to Buffett – who once called assessing pricing power the “single most important decision in evaluating a business”.

As well as things to look for when investing, Icahn also has a list of things investors should avoid – the first being herd mentality. “Some people get rich studying artificial intelligence,” says Carl. “Me, I make money studying natural stupidity.” An investment that’s trending among the masses may not always be the best idea, and Icahn cautions against following the crowd. He instead recommends investors seek out shares of companies that have fallen out of favor with the market – but which continue to post solid operational performance.

Icahn also believes people should steer clear of what he calls the “two cardinal sins” of investing: acting impulsively and not acting at all. An investor should remain patient and impassive, rather than making decisions in the heat of the moment. At the same time, however, they should move decisively when they spot attractive opportunities. While having a plan may make it easier to handle unexpected situations, Icahn thinks investors should always be flexible and ready to adapt – after all, markets are inherently unpredictable.

Finally, Icahn believes in embracing and enjoying your investment journey, rather than just thinking solely about making money. And if the activist’s own experience is anything to go by, that could end up being a very profitable approach indeed…

In this Pack, you’ve learned:

🔹 Carl Icahn is one of the most successful investors in the world – and during the 1980s, he was one of the most fearsome “corporate raiders” in America.

🔹 Icahn is an activist investor: he takes sizeable stakes in companies and then uses that leverage to push for changes that could improve their share prices.

🔹 Most people can’t act as activists themselves – but you can buy shares of target companies or invest directly in activist funds.

🔹 Icahn’s investment approach isn’t unlike Warren Buffett’s, with a focus on undervalued assets, long-term business models, and – crucially – pricing power.

🔹 Icahn recommends shunning the herd mentality and instead looking for underappreciated gems. He also warns against acting impulsively, or not acting at all.

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