Tuesday, August 05, 2008

A Mistaken View of Carl Icahn

Friday's Wall Street Journal carried an editorial of uncommon stupidity and bad logic. Written by a woman named Lynn Stout, a law professor at UCLA, and entitled "Why Carl Icahn Is Bad for Investors," the piece contains numerous errors of logic and perspective.

If there is any merit in the headline's contention, Ms. Stout's editorial isn't the reason you would know it.

Ms. Stout begins by bald-facedly declaring, referring to Mr. Icahn and his "fellow activist hedge fund managers,"

"they will be robbing average investors of better returns."

Ms. Stout alleges that shareholders of companies targeted by the likes of Icahn suffer because the activist investors drive up the stock's price quickly. Then, she contends, these activist investors quickly dump their shares, driving the company's price down, and harming, it is presumed, long-term shareholders.

She cites Icahn as preying on Time-Warner, Motorola, Blockbuster and Yahoo.

But here is the first of Stout's errors. As the nearby Yahoo-sourced 2-year price chart for Motorola, Yahoo, Time-Warner and Blockbuster, and the S&P500 Index, clearly shows, all of these firms have been in significant decline and unable to deliver even the passive market average total return to their investors for several years. If you examined the 5-year chart for the same entities, the story is roughly the same.

Why anyone would have been 'holding for the long term' in these issues is beyond me. Maybe Ms. Stout just likes to do charity work. For the feeble-minded and inept investors.

Hilariously, Stout accuses Icahn and his kind,

"They push for strategies that raise the stock price of the few companies they own but may lower the stocks of other companies, or that raise prices in the short term while harming companies' long-term prospects."

Suddenly, Ms. Stout has shifted her perspective, claiming that, when you own stock A, you have a moral imperative and duty to protect and bring no harm to stock B. Does this not make Ms. Stout a socialist? Hardly logic and sentiment which belongs in a discussion of activist investing, is it? Capitalism, in case you've forgotten, Ms. Stout, requires and depends upon self-interest.

Further in her editorial, Stout repeats this mistake by claiming that, because Icahn and others like him often demand the sale of the company to another firm, usually at a premium, the shareholders of the acquirer experience declines in their returns ex post.

Again, apparently selling an asset to another firm, which unwisely overpays for it, is wrong. And immoral. At least, according to Ms. Stout. Next, I guess she'd be calling for some kind of governmental intervention to protect the management and boards of all acquirers from their own mistakes.

If I'm not mistaken, most acquisitions, not just those of companies pushed to sell themselves by Carl Icahn and other hedge fund investors, fail to return appropriate or expected superior returns to shareholders of the acquiring companies.

For example see my prior post today on the subject of one company buying another's failed businesses.

As to her contention that long-term prospects are harmed by short-term stock price increases, Stout badly misunderstands the nature of "shareholder democracy."

Any shareholder can sell when Icahn sells. There's no rule or law barring other shareholders from piggy-backing on Icahn's unlocking of more value in mismanaged, has-been companies with entrenched, self-enriching, slumbering management.

Ms. Stout alleges that the shortage of well-performing public companies is due to the likes of Icahn buying the best-performing companies and taking them private

Now, that's odd, because you would think that private equity and hedge funds would have to be buying those companies at expensive prices. But Ms. Stout spent most of her editorial alleging that those activist investors by temporarily-distressed firms which, in reality, have excellent prospects.

It can't be both. Which is it, Ms. Stout?

Finally, Stout alleges that by sometimes draining targets of their excess cash, Icahn and company are damaging the companies' prospects for future profitable growth, which, she contends, is

"a serious problem for long-term average investors tyring to save for retirement."

But why is an 'average investor's' desire for retirement in any way linked to their holding period for equities? In today's fast-moving, dynamic world of American business, the old concepts of 40 years ago, to 'buy and hold' for decades, is laughable irrelevant.

Not to mention, of course, that the reason Icahn and his cohorts do this is because, as the chart above illustrates, their targets are busily wasting that cash, as if it were free. By returning it to shareholders, Icahn forces a company to account for the true cost of cash it must raise for growth-oriented initiatives. Using 'free' cash on the balance sheet cheats investors when the company is, in fact, destroying value year after year. By forcing the management to pay the market rate for its use of new cash, Icahn and his ilk actually benefit shareholders. Otherwise, management might simply assign a zero value for capital costs on internally-funded projects.

This is one situation in which past experience is a strong argument for future expectations. A management that has destroyed market value for shareholders really cannot be trusted with excess cash on its balance sheet.

Further, why would anyone necessarily have their retirement harmed because Carl Icahn temporarily drove up the stock price and returns of a mismanaged company, allowing all shareholders who wished to sell at a larger profit? Then invest the profits in better companies.

Apparently, Ms. Stout and her own investing concepts are laughably irrelevant, and wrong, as my comments have demonstrated.

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