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I have shaken up boards and managements at many companies in which I have invested, including Blockbuster, ImClone, Stratosphere, Philips Services, Federal-Mogul and many others. Generally, but not always, the net result has been very positive for the company and the shareholders.

Carl Icahn, The Icahn Report

For Herbalife's (NYSE:HLF) defenders, Carl Icahn is the proverbial knight in shining armor. "Uncle Carl has our back!" is the current leitmotif of HLF bulls. This rather cavalier attitude substantially misrepresents the nature of Icahn's play. On Wall Street, as in D.C., the enemy of your enemy is not necessarily your friend. In fact, when there's this much blood in the water, "friend" is a relative concept.

The Strategy

Although Icahn's deals sometimes blur the line between shareholder activist, corporate raider and private equity firms like KKR, he tends to stick to the same three pronged strategy (albeit, with subtle and often brilliant variations):

A) He builds a large stake in the target company. (Icahn now has a 15.5% stake in Herbalife.)

B) Lobbies to replace entrenched management with his own people. (Herbalife, check!)

C) Takes the company private

This has generally, but not always, been a net positive for the company and its shareholders. Generally.

But if "Uncle Carl" feels the need to borrow debt against the company's assets in order to give himself a payday, or that liquidation is in his best interests? Then Icahn's involvement can be a liability.

The question HLF stockholders should be asking themselves is not "What will it take to make Ackman go away?", but "What will it take to make Icahn go away?" And, perhaps more importantly, "What will happen to my HLF investment if/when Icahn leaves?"

Beware Hedge Fund Managers Bearing Gifts

Because whether they realize it or not, Herbalife's investors have become heavily - if not completely - dependent on Icahn's patronage.

Such patronage tends to come at a steep price. Icahn stripped TWA down to the bone to pay off the debt he incurred during his hostile bid for the company. In 1991, Icahn sold TWA's all-important London routes to American Airlines (AAMRQ.PK) for $445 million.

According to John Gratz, who flew for TWA from 1955 to 1991:

Selling the London routes was a killer. They were valuable as hell. The other things he did-trying to implement draconian procedures for everything, having people watch people-it's all a hill of beans compared to losing those routes.

Every M&A deal is going to have its detractors, but that's really the whole point. Carl Icahn made $20.4 billion dollars looking out for Carl Icahn. He's not your buddy, and he's not your uncle. Ask TWA.

The Deal

The reality is, that if Icahn were to pull his investment tomorrow, the downward pressure on the stock would be irresistible. Not only would it overwhelm what bullish sentiment remains, but Wall St. would take it as a indictment of the company. Fortunately, for Herbalife's investors, the legendary corporate raider has limited his own ability to sell his stake in the company for at least the next six months due to short-swing profit rules, according to section 16(b) of the Securities Exchange Act of 1934:

Profits from purchase and sale of security within six months

For the purpose of preventing the unfair use of information which may have been obtained by such beneficial owner, director, or officer by reason of his relationship to the issuer, any profit realized by him from any purchase and sale, or any sale and purchase, of any equity security of such issuer (other than an exempted security) or a security-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act) involving any such equity security within any period of less than six months, unless such security or security- based swap agreement was acquired in good faith in connection with a debt previously contracted, shall inure to and be recoverable by the issuer, irrespective of any intention on the part of such beneficial owner, director, or officer in entering into such transaction of holding the security or security-based swap agreement purchased or of not repurchasing the security or security-based swap agreement sold for a period exceeding six months. Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer in the name and in behalf of the issuer if the issuer shall fail or refuse to bring such suit within sixty days after request. (emphasis mine)

In short, if you're a) a beneficial owner, b) up your stake in the company, c) don't hold that stock for 6 months, and d) the value of the stock subsequently declines, you can be sued by the remaining shareholders for the difference between the price you bought at and the price you sold. (Unless you sold at less than you bought, in which case you can exit the trade.) Take a look below at a summary of Icahn's current position.


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Conclusion

With HLF currently trading at below $40, Icahn is stuck. But that doesn't mean he can't make recommendations through his surrogate board members. How much will Icahn pay himself for his services? If your answer is, "He made plenty of money squeezing Ackman!", then you're assuming he's your uncle.

It's Ackman's move. Herbalife is a tough nut to crack, and Ackman's position leaves zero room for error. MLM's are historically a widow-maker trade for short sellers. However, HLF investors may not be out of the woods even if Ackman's position expires at $0. Herbalife's board is still playing a strong hand, as it can increase its dividend or buy back shares to get the stock up. No one knows what the SEC will do. No one knows what Icahn will do.

Maybe he'll make them rich.

Source: Herbalife: Beware The White Knight