IEP - Icahn Enterprises L.P.: Trading At A Substantial Premium To A Decreasing Net Asset Value

2023-05-08 10:40:14 ET

Summary

• Icahn Enterprises' performance over the past few years has been uninspiring at best.
• Its high distributions have only been possible due to Icahn generally taking his distribution in more units as well as a few large ATM offerings bringing in funds.
• Dilution has been huge and the current low price makes that situation even worse; dilution will likely be over 5% this quarter alone.
• There will be a time to "pay the piper" but it may not be imminent due to IEP's continuing ability to pay distributions, even though they are not from earnings.

I'm Short Icahn Enterprises but Long CVR Partners

I have a significant long position in CVR Partners ( UAN ), an MLP in which Icahn Enterprises ( IEP ) has a significant indirect ownership interest. Although I will mainly discuss the reasons for my skepticism concerning IEP's market value and the Icahn family's management of it, I find UAN a hidden gem within this mediocre conglomerate, which I will discuss a bit in a later section.

As a UAN investor, various other investors have periodically made positive comments about IEP in Seeking Alpha articles, which had caused me to occasionally take a look at it at, but I could never get comfortable with the company despite the high reported distribution. The recent Hindenburg report has helped me focus on IEP's specific issues. I will discuss their report a bit near the end of this article.

Historical Dilution and Collapsing NAV Per Unit

The table below provides a few key figures from UAN's press releases and financial statements for the past eight years.

IEP's "Indicative NAV" (Net Asset Value) is the company's estimate of its mark-to-market value. As can be seen, the amount generally increased from 2015 and then has steadily decreased. The unit count has exploded over the period, with the total going up over 20% in each of the two most recent years alone. This has been mainly due to Icahn generally taking his high distributions in additional units rather than cash as well as substantial ATM ("at-the-market") unit sales.

The decrease in NAV has also been impacted by the substantial distributions IEP has been making each year, even with Icahn and some other holders taking distributions in units rather than cash. As a result of all these factors, the NAV per unit has plummeted from $42.47 to $15.96 since 2015.

Projected Unit Dilution and NAV Decreases through June 30, 2023

Although IEP declared a regular $2.00 dividend on February 22, it wasn't paid until April 19, when the stock price was about $52. As a result, there will be no dilution reflected in the results to be released on Wednesday (assuming there were no ATM sales in the quarter). However, if 90% of unit holders at that time took their distribution in stock, the share count likely increased by about 12.2 million in April.

Icahn Enterprises has already pre-announced a $2 distribution next week. Assuming 90% of the distributions are reinvested, another 13 to 22 million shares will likely be issued late this month. A lower unit price is quite damaging with respect to both unit increases and NAV dilution as the following table demonstrates:

The table shows the actual units outstanding at December 31, 2022 and my estimates under various scenarios of the number of total units likely to be outstanding at June 30. The three columns calculate the number of shares which would need to be issued late this month at unit prices of $30, $40 or $50. At $30/unit, IEP would need to issue 67% more units than at $50 unit.

When results are released in August, many investors will likely be a bit surprised to see the unit count increase in a single quarter by possibly 25 million to as many as 35 million units.

I am also likely being bit generous with the NAV for June 30. For starters, despite most distributions being made in additional shares, there are still likely over $140 million in cash distributions being made this quarter, which reduces NAV. It's possible this will be made up by earnings, however.

There are also some assumptions IEP has made which appear to be somewhat optimistic and there has been a demonstrable decrease in values in some of its assets recently. I will discuss this issue below.

Value Destruction....Largely Due to Poor Portfolio Performance

As this table indicates, IEP has had a cumulative GAAP loss of over $2.2 billion in the past eight years. (The results for the most recent four years were much worse.)

Of course, IEP always emphasizes the off-balance sheet value it has by providing NAV estimates. At December 31, the figure it reported was $5.6 billion, while book equity was $3.9 billion. This suggests off-balance sheet value of $1.7 billion. However, at December 31, 2015, the off-balance sheet value was over $2.3 billion ($8.385 bn.-$6.092 bn.) so it has decreased by $600 million.

This $600 million value decrease needs to be added to the GAAP loss of $2.216 billion, so the economic loss over the past eight years has actually totaled over $2.8 billion!

Yes...IEP's Investment Portfolio performance is the main culprit:

Here are the annual results for IEP's investment portfolio for each of the past eight years. The figures include mark-to market valuations of the portfolio, not just realized gains and losses:

One of the most surprising aspects of IEP's results is just how poor its investment portfolio performance has been. It has experienced losses in three of the past five years with the cumulative loss being almost $5.3 billion. The company hedges much of its investment portfolio with short positions (oh..the irony) with its notional short position at December 31 being 47% of its long position.

In its 2021 year-end letter, Icahn press release stated the following: "The full-year 2021 results were negatively impacted by losses of $1.3 billion on IEP's Investment segment short positions (used to hedge our long positions)."

The end-result was a modest $193 million gain in a year when the S&P 500 was up by about 27%. I am quite baffled as to why someone who claims to be able to recognize hidden value would hedge so much of his portfolio. The investment segment reported a further $168 million loss in 2022.

Questionable Valuations of Private Company Investments

in the same 2021 year-end letter, the company also said that " Other losses included ... $205 million of Automotive transformation losses and inventory write-downs. " The company then wrote: " In 2021, we revised how we estimate the fair value of our Automotive segment's owned real estate and its Services business which better reflects the fair value of the assets, which also contributed to the positive change."

Despite having "Automotive transformation losses," IEP actually wrote up the value of the segment by over $1 billion!

One of the automotive segment's subsidiaries is the Pep Boys , and the logic for the write-up is that they have decided to close many of the owned locations and sell the real estate, thereby adding the estimated market value of the real estate to be sold.

IEP's NAV detail at December 31, 2022 showed the auto segment at about $1.7 billion, an $800 million decrease from the prior year, although still $200 million more than the figure at year-end 2020. There is no specific detail as to the reason given for the decrease but it appears not to have been the result of owned real estate being liquidated, as owned P,P,&E in the automotive segment has actually increased in the past year. (10-K: p. 97).

The Hindenburg report references another subsidiary within this segment, IEH Auto Parts Holding LLC, which Hindenburg claims is its main subsidiary. It filed for bankruptcy in January.

As a result, I believe a write-down in this segment is imminent soon due to this bankruptcy (if it did not actually happen in the just finished quarter). The current real estate market also suggests the value of the Pep Boys' properties not yet sold may have decreased in value recently. This would decrease the NAV reported by Icahn Enterprises.

CVR Partners

As I mentioned earlier, I am long CVR Partners, which I believe is the golden nugget within this conglomerate. It is trading at about a 3 p/e and a 30%+ distribution yield. The yield is based upon real income and cash flow, not by selling additional units to investors or by liquidating assets. It is also likely insulated from any negative events at IEP.

Although CVR Partners mainly produces nitrogen related fertilizers, a cyclical industry, it has declared over $30 in distributions over the past year (including an upcoming distribution of $10.43) and will likely continue making material distributions, even if a bit less, for the near future. Despite that, it is currently only trading at a bit over $100/ unit, possibly partly due to an Icahn discount.

If anyone would like further details on CVR Partners, I would strongly recommend reading this article, " CVR Partners Third Quarter Preview " by "Publius." Although it is now a bit dated, this article and a couple his prior ones provide full background. He and others have also been providing daily updates on various aspects of the company's business, market intelligence etc. in the comments, and I am under the impression Publius may be penning a new article soon. He has a deep understanding of the company as well as the industry.

In Icahn's complex structure, CVR Partners is about 37% owned by CVR Refining ( CVI ), an oil refiner, and CVR Refining in turn is about 71% owned by Icahn Enterprises.

CVR Partners currently has a market cap of a bit over $1 billion. Its immediate parent, CVR Energy, a refiner, owns 37% of it, meaning its value to CVR Energy is about $400 million. In turn, IEP's 71% interest would represent about $280 million. I strongly believe the intrinsic value of UAN is at least double its current market cap., so that could eventually add $280 million to IEP's value (only about $.75/unit, however.)

There is currently a complex transaction being contemplated by CVR Energy/Icahn Enterprises, where CVR Energy's 37% partnership interest might be spun out into a separate corporation where all CVR Energy investors, including IEP, receive pro-rata shares. Icahn and others would then be able to sell their shares in this entity of they so desired.

This does not affect UAN directly. The 37% owner would simply be this new corporation rather than CVR Energy; it would be "business as usual" for UAN. In fact, it might even increase liquidity for UAN, as investors who do not want to invest directly in an MLP could invest indirectly by purchasing shares in a corporation which owns some of its partnership units.

CVR Energy's market performance has not been good recently. Although the unit price was quite consistent in Q1 in the $31 to $33 range, the price is now down to $24. In its December 31, 2022 NAV estimate, IEP indicated a market value of over $2.2 billion, a figure which was about the same at March 31. However, if CVR's market price doesn't recover by June 30, the result could be a downward NAV adjustment for IEP of about $500 million.

My June 30 NAV Projection of $5.6 Billion for IEP Could Be Optimistic

The "base case" NAV I utilized for IEP through June 30 was $5.6 billion, the December 31 actual figure. This may be a bit optimistic, however. If CVR Energy's market value is $500 million lower at June 30 than it was at December 31, (or March 31), this alone could reduce NAV and NAV per unit by 10%. As previously discussed, there are also questions about the NAV of some of Icahn's private investments, including the automotive segment which could require a further write-down.

It is possible that there could be some unanticipated positive surprises, but otherwise, IEP's NAV could be below $5 billion at June 30 and the NAV per share could be below $13 then.

Are There Further Downside Catalysts?

As long as IEP continues to make $2 per quarter in distributions, there will obviously be considerable support for the unit price, even though the distributions are essentially a return of capital rather than income. It is obvious from reading some of the Seeking Alpha comments that many investors only focus on the distribution.

Some posters have pointed out that IEP has plenty of cash (over $2.3 billion although $1.7 billion of this was raised in equity offerings the past three years). As an investment company, IEP can of course also liquidate investments to pay distributions, which is true, although it would need to pay down its substantial debt in the process.

In fact, liquidating assets seems to be part of the plan. As I previously discussed, the company is liquidating the owned real estate within "The Pep Boys" and there appear to be moves afoot to facilitate the company's ability to spin out the CVR Partners portion of its CVR Energy investment in a tax efficient manner. It is also interesting to note that in 2015 IEP listed four "market valued" subsidiaries and six "other" subsidiaries in its NAV calculations, while in its most recent report, it only listed two "market valued" subsidiaries and five "other subsidiaries."

As a result, the $2 per quarter in distributions can theoretically continue for several years as long as Icahn continues to take his distributions in units rather than cash. What if he doesn't, though? What if he takes some of it in cash? In the first quarter of 2020 he actually did so, which is why total cash distributions were an unusually high $526 million that year.

This would cause NAV to further decrease. Maybe Icahn could eventually decide IEP can no longer afford the full distribution; in fact, he could decide to eliminate it entirely. He would be entirely justified in doing so with cash dwindling and NAV decreasing into the single digits. The unit price would likely drop to NAV or below, giving Icahn a perfect opportunity to buy the remainder of the company for almost nothing, maybe even with the cash distributions he had previously received. Btw, being an MLP, limited partners don't get to vote.

My Approach vs. Hindenburg Research

I agree with Hindenburg Research's short thesis regarding Icahn Enterprises in that we both begin our analysis from the same starting point, an NAV at December 31 that was $15.96. The figure itself should not be controversial; it is the figure reported by Icahn Enterprises itself after marking its asset values to its estimate of market values. We both agree that the NAV, particularly per unit, has likely decreased since then and that the premium of market value to NAV is a reason for concern.

Interestingly, we don't even know whether Carl Icahn himself disagrees with us. I am not aware of him explicitly indicating that IEP should trade at a multiple of NAV; his recent public pronouncement has only said that the company will continue with its $2/unit distribution for now and is liquid. It will be interesting to hear if he broaches the valuation issue on Wednesday.

Both Hindenburg and I focused on most of the same issues. The difference between Hindenburg and I are more a matter of tone than of substance. The Hindenburg report is a bit "Darth Vaderish" and finds only alarming negatives where I try take a bit more balanced approach and find some positives, or at least give the company in some cases a bit of "the benefit of the doubt."

Specific aspects of the Hindenburg report which I think had an overly negative tone, possibly detracting from the company's detailed research, included the following:

• I wasn't impressed with the usage of the word "ponzi," an emotionally laden one, even though Hindenburg did not at all accuse Icahn Enterprises of being a Ponzi scheme. Specifically, the report simply said: "Icahn has been using money taken in from new investors to pay out dividends to old investors. Such ponzi-like economic structures are sustainable only to the extent that new money is willing to risk being the last one "holding the bag". " It is worthwhile to point out to investors that do not read the financial statements in detail that, in fact, distributions are not being paid out of income but rather largely from money coming in from new investors (one element of a Ponzi scheme) via ATM offerings. The other main element of a Ponzi scheme is to lie about the source of payments to existing investors, and inaccurately claim it is from profits. Icahn Enterprises does nothing of the sort and appears to accurately represent where its cash comes from (and goes to) therefore disqualifying it as a Ponzi. (readers should be aware that Icahn issued a response to the allegations presented in the Hindenburg report).
• Hindenburg wrote "IEP owns 90% of a publicly traded meat packaging business that it valued at $243 million at year-end. The company had a market value of only $89 million at the time. In other words, IEP marked the value of its public company equity holdings 204% above the prevailing public market price" while it did not provide IEP's justification for this. IEP actually footnoted its justification as follows: " Amounts based on market comparables due to lack of material trading volume, valued at 9.0x Adjusted EBITDA for the twelve months ended December 31, 2022 and December 31, 2021." I think there are valid reasons to question the justification, but the justification itself should have at least been provided. In fact, the company's financials are a bit of a mess with minimal GAAP income, but substantial "comprehensive income" mostly related to its pension plan adjustments. I don't know the details, but based upon Icahn's reputation for raiding pension plans, I would personally be interested in more details.
• There is not one positive mention in the Hindenburg report. At a minimum, I think CVR Partners deserves one.
• Hindenburg has not provided any justification for either selling or shorting IEP now or even at a specific time in the future; there is no discussion of a catalyst. If the company continues to make $2 per unit per quarter distributions, this arrangement could go on for quite a while. However, I have provided one scenario where this game of "chicken" or "musical chairs" might terminate sooner.
• Hindenburg's report may have been particularly poor timing. They possibly should have at least waited a quarter, as there were no distributions actually paid in Q1 but there will be double-payments and double-dilution in Q2 which may be a "wake-up call" for some investors then.

One point where I do have to agree with Hindenburg regards the company's accusation of "suspicious valuation" based upon subsequent events. From the report: " Suspicious Marks In Less Liquid Assets ... Icahn's Auto Parts Division Was Valued At $381 Million In December 2022... In January, one month after IEP's $381 million mark, IEH Auto Parts Holding LLC and its subsidiaries including Auto Plus, filed for bankruptcy . A search through the bankruptcy administrator showed $238 million in creditor claims, suggesting significant indebtedness. Given this, we suspect IEP's $381 million mark will be written down significantly further." Although the bankruptcy occurred after year-end, it DID happen prior to the annual report filing. I agree there should be a markdown on the $381 million investment, and since this was known prior to the report filing, should have already been done in the annual report/earnings press release as a "subsequent event."

Summary

Over the past number of years, Carl Icahn has not demonstrated any particular investment acumen nor any particular skill at running various operating businesses. IEP's unit price seems to have been mainly supported by outsized distributions along with substantial value destruction. Maybe there's a rabbit or two Carl and son can pull out of their hats, but I personally don't see any substantive ones.

As a result, I see no reason to pay over twice the company's own estimate of Icahn Enterprise's rapidly decreasing Net Asset Value. Investing in its partially owned indirect subsidiary, CVR Partners, would likely be a wiser choice.

This should not be considered investment advice. I am simply providing a factual analysis to assist other investors in making their own decisions regarding IEP (and UAN). My only specific investment advice is to go long popcorn on Wednesday.

For further details see: