What happened
Shares of Icahn Enterprises (IEP 0.41%) slumped as much as 44% this week, according to data from S&P Global Market Intelligence. The investment vehicle run by Carl Icahn saw further losses after more light was shone on its potentially unsustainable dividend practices and inflated net asset value (NAV) when famous investor Bill Ackman tweeted about its corporate structure. Shares of Icahn Enterprises are now down 60% year to date.
So what
Icahn Enterprises is a publicly traded investment vehicle run by Carl Icahn and his investment team. He holds 85% of the shares outstanding, making it a very illiquid security as he is not a regular buyer or seller of the stock. The stock trades (or, before this week, did trade) at a considerable premium to its NAV, which is extremely unusual for an investment fund. Why would investors buy a dollar's worth of securities for a stated value of three dollars?
It only makes sense given the very low float (i.e., the shares publicly traded) and the high dividend yield Icahn Enterprises pays out to outside shareholders, currently close to 40% after the stock's recent drop. How does the company pay this dividend? Not with operating cash flow, but by returning money to outside shareholders funded by other share sales to investors. Another strange (some might allege unsustainable) tactic used by Icahn's management is taking margin loans pledged to the common stock that trades at a huge premium to NAV and using the cash to buy more assets, which will further drive up the fund's NAV. This works as long as the share price stays high, as the share value is being used as collateral in these loans to buy more assets.
A lot of this was brought to light in early May by Hindenburg Research, which started the selling of Icahn Enterprises stock. Then, this week well-known investor Bill Ackman posted a long-form tweet highlighting these unusual financial engineering tactics used by Icahn Enterprises management. With over 1.6 million views, this tweet further spread the word to the market that Icahn Enterprises is not as structurally sound as some people thought. Since the stock is highly illiquid, only small changes in sentiment can drive major movements in the share price, which is why shares fell by as much as 40% this week.
Now what
You might look at Icahn Enterprises' extremely high dividend yield and think the stock is an easy buy. But that couldn't be further from the truth. High dividend yields are dangerous if they are not funded by profits, which is exactly the case here.
This company could be in major trouble if these margin loans unravel. It would be smart to avoid Icahn Enterprises stock unless you understand all of the moving parts of this business.
