My Favorite Investor

There are contrarian investors, and then there's Carl Icahn – the king of contarian investing.

To understand how Icahn operates, look no further than his recent purchase in Las Vegas. In November 2009, Icahn offered $156.5 million for the 63-story bankrupt Fontainebleau, a hotel and casino situated on 27 acres at the north end of the Las Vegas Strip. The Fountainebleau is 70% complete, at a cost of $2 billion to the original builders. In short, Icahn is buying a distressed property in a recession-ridden burg for $0.10 on the dollar (not including the additional investment required to finish the project).

This isn't the first time Icahn has exploited a perceived Las Vegas bargain. In 2007, he booked a billion-dollar gain after he sold a hodgepodge of gaming properties, led by the Stratosphere, for $1.3 billion. Many of these properties were purchased on a default or out of foreclosure over the previous decade.

One investor imposing his will
Icahn has long applied this the-uglier-the-better strategy toward buying distressed and disfavored stocks. Older investors remember Icahn from the rambunctious zeitgeist of the 1980s, when greenmail -- acquiring a threatening equity position, and then selling the equity to the existing owners at a premium -- was in vogue. In 1988, the New York Times reported that Icahn extracted more than $100 million in greenmail from 10 of his 18 target investments.

That's an ungentlemanly way to make money, to be sure. Fortunately, it's seldom practiced today. Changes in corporate ownership structure, in overall investment markets, and in Federal tax treatment of greenmail gains (a 50% tax) has relegated greenmail to historical footnote.

But that hasn't stopped Icahn from making money (and to be fair, most of his estimated $10.5 billion fortune wasn't extracted through greenmail.). Icahn long ago transmogrified into the archetypal activist contrarian -- one who takes minority stakes in lagging public companies, then pushes for change. Icahn has garnered headlines for browbeating underperforming managers at Time Warner, Yahoo!, Motorola (NYSE:MOT), and Genzyme (NASDAQ:GENZ).

Meanwhile, in the passenger seat...
Granted, most of us lack the financial wherewithal to impose our will on management; we're simply along for the ride. But that doesn't mean Icahn's underlying strategy and philosophy isn't sound or replicable.

To the contrary, I think that for most investors, the Icahn approach of buying distressed companies at very good prices even surpasses the Warren Buffett approach of buying good companies at fair prices. Investors too often consider companies "good businesses" just because they're performing well at the moment. "Good," alas, is frequently overestimated and ephemeral. (See most technology investments, circa 1999.)

Another mark in the Icahn approach's favor is the way it tempers optimism by highlighting what can and has gone wrong. This forces an investor to think about how things were screwed up, and what it will take to make them right again -- if they can be made right at all.

That can be a big "if." The path to a company's salvation isn't always reflected in its financial statements; finding it requires critical thinking and a long-term focus. To increase your odds of eventual success, avoid certain industries: Specialty and regional retailers, airlines, software companies, and sit-down restaurants have a high proportion of lost causes. It's also a good idea to avoid companies that find themselves in trouble within two years of their IPOs.

That still leaves a plethora of established companies from which to choose. If the following list doesn't represent stocks that would interest Carl Icahn himself, it should at least pique the curiosity of deep-contrarian, passive investors -- or the rest of us:

Of course, no one bats 1,000%. Icahn has had a few notable failures, none more egregious than Blockbuster and WCI Communities. I've had a few of my own, including Citadel Broadcasting, a third-rate string of radio stations whose fortunes I bet would turn on the purchase of ABC's radio network and its prized asset: nonagenarian broadcaster Paul Harvey. Unfortunately, when Mr. Harvey went to his final reward, he took Citadel with him. Not my greatest success in the critical-thinking department, I'll admit.

On balance, though, betting on the changing fortunes of established firms, instead of betting on their continued good fortune, has proven more remunerative than not. At least, it has for Carl Icahn -- and for me.