Carl Icahn is known as an activist investor, a strategy he has pursued since 1980. He is also one of the most successful investors in the U.S. His estimated net worth of $25 billion ranks him as the second-richest investor in the U.S., behind Warren Buffett's $74 billion and just ahead of George Soros' $24 billion. Astute investors can learn and profit from studying the stocks the greatest investors in the world are buying.
Every quarter, large investors must disclose what stocks they own in the U.S. via 13F filings with the Securities and Exchange Commission. The SEC also requires investors who own more than 5% of the stock in a public company to disclose within two days any buying or selling of those shares on a form called a Schedule 13D.
On Dec. 17, Icahn filed two 13Ds for purchases of shares of Hertz (HTZ +0.00%) and Navistar (NAV +0.00%). Read on for more detail.
Icahn
First, a brief introduction to Icahn's investment strategy, in his own words:
We seek to find undervalued companies in the Graham & Dodd tradition, a methodology for valuing stocks that primarily looks for deeply depressed prices. ... We often become actively involved in the companies we target. That activity may involve a broad range of approaches, from influencing the management of a target to take steps to improve shareholder value, to acquiring a controlling interest or outright ownership of the target company in order to implement changes that we believe are required to improve its business, and then operating and expanding that business. This activism has brought about very strong returns over the years.
Icahn's positions in Hertz and Navistar both reflect this strategy.
Icahn first built his stake in Hertz by buying call options through the third quarter of 2014. After he converted those into shares, the stock was beaten down when the car rental company announced it would have to restate financials dating back to 2011.
The errors in the financial statements caused Icahn and others to lose confidence in CEO and chairman Mark Frissora, who subsequently resigned in early September. Hertz then agreed to appoint three Icahn nominees to the board of directors and to raise its poison pill to a 20% ownership threshold. Icahn has steadily increased his stake in Hertz since then.
The 13D filing on Dec. 17 indicated that Icahn had added another 2.63 million shares at an average price of $21.36. The purchase brings his total holding to 51,922,405 for an 11.34% stake. While the financials refiling is weighing on shares of Hertz, there's still much to like about the company, which you can now buy into at a lower price than Icahn originally did.
First, the financial restatement should not materially impact Hertz's business over the long run. The errors covered the capitalization and timing of depreciation for certain non-fleet assets, allowances for doubtful accounts in Brazil, allowances for uncollectible amounts with respect to renter obligations for damaged vehicles, and restoration obligations at the end of facility leases and certain other items. Hertz first said it had found $43 million in errors, and then it upped that to $87 million over three years -- roughly $30 million per year during that period. Even if that were to double again, Hertz expects to make $1.3 billion in EBITDA this year, which is more than enough to cover the error costs and fix them going forward. Looking back, net income is expected to drop 18%, 14%, and 6% for 2011, 2012, and 2013, respectively. While that's sizable, it's certainly not life-threatening to the company.
While the depreciation error is worrisome in that it is an accounting issue where there shouldn't have been one, the other three issues are all areas in which there is a lot of leeway, particularly in developing countries like Brazil, where the rule of law is not as straightforward as in the U.S., particularly with regard to the collection of payments. It should be noted that the depreciation issue only affects a small portion of Hertz's $14 billion fleet of cars, which, as of the end of 2013 (the last time Hertz filed a full annual report), had a collective $2.7 billion in depreciation, making the $87 million just a drop in the bucket.
Second, if low oil prices hold through the summer, Hertz's busy season, the company will surely benefit as people choose to drive rather than taking expensive and overcrowded flights.
Third, Hertz plans to spin off its equipment rental division at some point in 2015 once the restatement is completed. Hertz intends to load the spinoff with $2.5 billion in debt, which would allow the company to deleverage or pursue stock buybacks to return value to shareholders. Looking forward, Hertz is the second-largest player in an industry that has greatly consolidated over the past 10 years. As the economy improves and people take more vacations, rental companies are primed to benefit from the increased travel.
Navistar
Navistar makes trucks, MRAP military trucks, buses, recreational vehicles, and diesel engines.
Icahn first built a position in Navistar in the second half of 2011 as the company lost market share after a bad bet on an engine design for lower emissions.
The problem was actually worse than everyone realized, and it cost the company hundreds of millions of dollars over the next few years in penalties and warranty payments. With his investment chopped in half in 2012, Icahn then pursued one of his other strategies:
We believe that one of the best ways for many cash-rich companies to achieve increased earnings is to use their large amounts of excess cash, together with advantageous borrowing opportunities, to purchase other companies in their industries and take advantage of the meaningful synergies that could result. In our opinion, the CEOs and Boards of Directors of undervalued companies that would be acquisition targets are the major road blocks to this logical use of assets to increase value, because we believe those CEOs and boards are not willing to give up their power and perquisites, even if they have done a poor job in administering the companies they have been running. In addition, acquirers are often unwilling to undertake the arduous task of launching a hostile campaign. This is precisely the situation in which a strong activist catalyst is necessary.
A year after starting the position, Icahn made an offer for Navistar rival Oshkosh (OSK 3.05%), suggesting that merging the two companies would make sense. Oshkosh didn't bite.
Since then, Navistar has slowly regained ground and taken market share in the truck segment. It was expected to post a profit this past quarter. However, Navistar's stock plummeted in December when the company issued weaker-than-expected earnings numbers. Navistar's loss of $0.88 per share was better than the year-ago loss of $1.91 per share, but analysts were expecting a profit of $0.15 per share.
Icahn used the opportunity to pick up 1.9 million shares for $29.90 per share, raising his stake by 13% to 16.3 million shares. Icahn now owns about 20% of the company.
As Navistar works off the warranty expenses, results should improve. Further, the company is seeing rapid growth in its order backlog, which says good things about the quality of Navistar's products and future demand for them. These two reasons are why analysts see the company returning to profitability in 2015 and delivering 9% annual growth over the next five years.
While Icahn is a large holder of Navistar, keep in mind that his position makes up only 1.6% of his portfolio. His saga with the company is a good reminder that position sizing and diversification really matter so that you are not crushed by a single investment error.
Learning from the greats
While some people blindly follow the moves of other investors, it's good to remember that the greatest investors in the world also make mistakes. That said, it's always worth taking the time to study their positions and learn from them.
