IEP's 10-K for 2018 and prior years are available on the IEP website under its "Investor Relations" tab IEP 2018 10-K. As is usual with all public company disclosure, the 10-K begins with "Item 1 Business" followed by "Item 1A Risk Factors".
In IEP's 2018 10-K...
- "Item 1 Business" is a comprehensive description of the company, which in IEP's case is extraordinarily long because the company has so many operating businesses and so many positions in its large investment business.
- "Item 1A Risk Factors" begins at the bottom of Page 9 and continues through Page 24. It is a long and comprehensive list of everything that can possibly go wrong at the company. The list includes every negative factor, event, conflict and anything else anyone involved can think of that might have negative impact on the company in the future. Such extended disclosure is typical of all public company disclosures since disclosure is the first line of defense in any lawsuit against any company.
Two inter-related sections of IEP's Risk Factors disclosure are relevant to this article. The first is (emphasis added), "We are subject to the risk of becoming an investment company" and the second is “We may become taxable as a corporation if we are no longer treated as a partnership for federal income tax purposes". Both are on Page 10 of the 2018 10-K.
The essence of those potential and theoretical problems is that IEP is primarily an operating company and is able to be taxed as a partnership. The potential and theoretical problem is that if the overall company's asset allocation gets over-allocated to investments vs. operating assets, the company will be forced to become regulated under the Investment Company Act, it will be forced to operate in a highly restricted way compared to its entire history and its tax status will change from partnership to corporation, all of which would destroy the company's basic strategy and result in substantially higher taxes.
On September 7, 2018, SA author Sunil Shah wrote a SA article titled, "Herbalife and Valuation: 'It Ain't Over Till It's Over'" Shah Article In it he describes himself as a "long suffering short". The article focuses on two factors that he believed would lead to a severe decline in HLF's stock price.
First, he focused on the the Risk Factors highlighted above and said IEP was then currently in the situation where it's asset allocation was already imbalanced toward investment securities vs. operating companies and it's tax status was at risk unless it did something big and did it quickly. In fact, whatever it did had to be completed by the end of March 2019.
Second, he focused on HLF's valuation and concluded it was grossly excessive.
Putting those things together, Shah's analysis concluded IEP's only solution to its tax problem was to either fully acquire HLF in a going-private transaction (that would address the imbalance by increasing the percentage of IEP assets in operating companies) or engage in a forced distress sale of HLF stock (that would address the imbalance by reducing the percentage of IEP assets in investment securities). His analysis concluded that since HLF was grossly overvalued and Icahn would never do a full going-private transaction of such an expensive company, IEP's ONLY solution to its asset allocation imbalance was to engage in a forced distress sale of HLF stock, which would drive the stock price down dramatically and enrich Shah and other short sellers.
Subsequent to his September 7, 2018 article he's repeated the "forced sale of HLF will cause a dramatic decline in the stock price" and "it will all be required to happen no later than the end of March 2019) memes in huncreds of his Comments on his own and others' SA Articles.
There is only one problem shared by both the the argument's premise and its logic: they are both wrong.
Here are the problems with that argument...
- There is no indication anywhere in IEP's 2018 10-K that the company is currently subject to becoming an investment company, either by March 31, 2019 or any other specific time. In fact, just the opposite, in its just-released 2018 10-K, the company specifically says it is NOT currently in such a position.
- There is no indication anywhere in IEP's 2018 10-K that the company is currently at risk of losing its tax status as a partnership and becoming taxed as a corporation, for any reason at all, either by March 31, 2019 or any other specific time. In fact, just the opposite, the company specifically says it is NOT in such a position.
- If IEP were at current risk of becoming subject to being deemed an investment company (it is not) and having its tax status changed dramatically (it is not), it would clearly be disclosed in the 10-K as of December 2018. Can you think of many things that might be more relevant to shareholders and would be required to be disclosed? But, more directly, the company specifically denies any such situation exists at the current time.
THEORETICALLY, if one assumes the author was correct about the imminence of IEP being required to become and Investment Company and/or losing its tax status as a Partnership and being forced into being taxed as a Corporation – and he’s not correct about either of those things – there are multiple problems with the rest of his assertions and logic. Those are:
- First, it is beyond comprehension that Shah sees the only solution to the theoretical problem involves IEP actions with HLF stock! There are multiple potential solutions to the non-existent problem other than sale of HLF, all of which are ignored in the September 7 Article.
- Under the Investment Company Act, IEP would be given a year to correct the non-existent problem and would not be under current time pressure to do anything at all. The theoretical March 2019 "deadline" is a figment of imagination -- even in a theorectical world!
- According to it’s 10-K, the company has in the past and would in the future engage in a plethora of activities to avoid either being designated as an Investment Company and putting itself in the position of being taxed as a Corporation.
- In it’s history, since Carl Icahn began his several decade long and storied career, neither IEP nor Icahn has ever solved any internal problem by making a forced distress sale of any security.
- HLF is IEP's investment division’s largest holding. But, its other top holdings are also large. If t could solve the non-existent and theoretical problem by working with any of its holdings, in any combination. It is a mystery why Shah chose to focus only on HLF as the engine of a solution to a problem that doesn't exist.
- IEP could solve its theoretical but non-existent problem by making a large acquisition, thereby changing the asset allocation to a larger proportion of operating assets. Among it’s multiple operating business lines there are plenty of opportunities to do that and Icahn DOES have a long history of making just those kind of acquisitions.
- Rather than a full acquisition, IEP could just increase one or more investment positions to greater than 50% -- not 100% as Shah claims is necessary. That would convert the one or more investment positions involved into operating companies and rebalance the overall portfolio.
- There is simply no logic to assume – as does the Shah – that a forced distressed sale of HLF is the only way for Icahn and IEP to solve the theorectical but non-existent problem.
- It is hard to imagine any serious investor would continue to promote as a major short-term stock price trigger a concept and idea that is specifically rejected in a company's current and fresh 10-K.
I keep referring to the "theorectical" and “non-existent” problem. Here’s why the problem Shah speculates on simply does not exist.
In 2018, IEP made a large number of asset sales of divisions of or entire operating companies. By definition that changed the asset allocation of the overall company so that investment operations were a larger percentage of the total than they had been in the immediate past prior to the operating company asset sales. In theory, that could put the company at risk of being required to become a regulated Investment Company under the Federal Investment Company Act and change its tax status. But, despite the theory, it simply didn’t happen that way.
The company deals with this possibility directly and unequivocally in it’s 2018 10-K. As I said above, the company’s annual 10-K disclosures deal with these issues under the Item 1A Risk Factors disclosures. Those disclosures don’t change much year to year. But, there is a significant difference between the 2018 and 2017 10-K disclosure of the company’s risk of becoming an Investment Company. This is an addition to the 2018 disclosure compared to the 2017 disclosure. The bolded sentences are the new disclosure in 2018. All other non-bolded disclosure is identical to what appeared in the 2017 10-K.
“We are subject to the risk of becoming an investment company. Because we are a holding company and a significant portion of our assets may, from time to time, consist of investments in companies in which we own less than a 50% interest, we run the risk of inadvertently becoming an investment company that is required to register under the Investment Company Act. Events beyond our control, including significant appreciation or depreciation in the market value of certain of our publicly traded holdings or adverse developments with respect to our ownership of certain of our subsidiaries, could result in our inadvertently becoming an investment company that is required to register under the Investment Company Act. Our recent sales of Federal-Mogul, Tropicana and ARI did not result in our being considered an investment company. However, additional transactions involving the sale of certain assets could result in our being considered an investment company. Following such events or transactions, an exemption under the Investment Company Act would provide us up to one year to take steps to avoid becoming classified as an investment company. We expect to take steps to avoid becoming classified as an investment company, but no assurance can be made that we will successfully be able to take the steps necessary to avoid becoming classified as an investment company.”
Source: IEP 2018 10-K
How much clearer could the company be? They deal with the issue of the 2018 changes in asset allocation. They say specifically that as of the end of 2018 their recent operating asset sales, “… did not result in our being considered an investment company.” Could it happen in the future that operating asset sales or other things could happen to cause that negative result? Sure. That’s been their common and routine disclosure for years. It's never happened in the past and didn't happen in 2018.
- IEP’s asset allocation is not over-weighted toward investment vs. operating assets and, as a result, neither its organizational structure nor its tax status is at risk.
- Theoretically, even if those things were at risk – which they are not – there is a long list of things solutions the company could employ. My guess is that a forced sale of HLF which would drive down the price would be at the very bottom of that theoretical risk.
- Even if those things were at real, vs. theoretical, risk the company would have one year to solve the theoretical problem from the time it was identified.
- Shah has been claiming with certainty that HLF will be forced to sell HLF at a significant discount, and do it in the next few weeks. Analytically, that is simply wrong.
- HLF, like any stock, can go down sharply for any reason at any time. But, if that happens, a forced distress sale by IEP will not be the reason.