CVI - Some Implications Of Icahn Enterprises LP's Ballooning Unit Count

2023-07-24 13:35:28 ET

Summary

• Icahn Enterprises L.P. has seen a significant increase in its outstanding units, with the total unit count rising to over 392 million units in the most recent quarter.
• The increase has implications for IEP's per unit NAV value, which likely decreased materially last quarter due to possible decreases in total NAV, as well as significant unit distributions.
• The company's total NAV and unit NAV are also being negatively impacted by the cash distributions, which could lead to difficulties in refinancing its $5 billion of holding company debt.
• The market value of the units are likely to be negatively impacted by these factors.
• Despite this, there may be some individual worthwhile investments within the IEP conglomerate, including, CVR Partners, a fertilizer manufacturer.

The Ballooning Unit Count

The number of units which Icahn Enterprises L.P. ( IEP ) has outstanding has been increasing at a considerable pace while the NAV per unit has been decreasing. As of the most recently filed quarterly report, for the period ending March 31, 2023, there were almost 357 million units outstanding, more than double the 173.6 million units outstanding five years ago (as of March 31, 2018).

Although the June 30 financial statements have not yet been filed, recent filings by Carl Icahn indicate that the total unit count had increased in the quarter to over 392 million units. This was likely due to Icahn, as well as some other unit holders, taking distributions in additional units rather than cash and some "at-the-market" (ATM) unit offerings during the period. Despite the record high unit count, it DOES appear that IEP bought back some units under the $500 million buyback authorization it announced a couple of months ago.

The unit count increase has implications for IEP's per unit NAV value which has likely decreased again materially in the quarter. Considering the recent changes in Icahn's margin loan terms, he may no longer have a strong incentive to take future distributions in additional units rather than cash, or possibly even to keep the distribution at $2 per unit per quarter which decreases NAV.

Unit Increases In 2022

Based upon information in the 2022 10-K, the following table can be created:

The 10-K contains most of the line items in the "Units" column. The additions due to Icahn and other unit owners reinvesting their distributions was reported on p. 125:

As a result of the above declared distributions, during 2022 we distributed an aggregate 45,520,325 of Icahn Enterprises’ depositary units to those depositary unitholders who elected to receive such distributions in additional depositary units, of which an aggregate of 42,950,364 depositary units were distributed to Mr. Icahn and his affiliates.

The "at-the-market" unit sales were reported on p. 42:

During the year ended December 31, 2022, Icahn Enterprises sold 14,619,272 depositary units pursuant to these agreements, resulting in gross proceeds of $759 million.

There are couple significant items to note. First, if IEP had not done this offering (which was ongoing during the year and in prior years as well), it would not have raised the $759 million in 2022 through these offerings; the total NAV would have decreased by $237 million, to $4.89 billion, rather than increasing by $522 million. Of course, the unit count would have increased by 14.6 million less units also, to just under 339 million, but the NAV per unit would have decreased even more, to $14.40 (4890/339). This is because the offerings were done at an average of $52 per unit, approximately three times the NAV of those new units. It was immediate significant dilution for the new purchasers based upon NAV, but benefitted the preexisting owners.

The total for the first five lines in the units column is a minor 31,000 units short of the reported year-end total. I have assumed that this was likely the result of some employee compensation unit issuances, and put that in the table as a "plug" to make the total reconcile.

The beginning and end-of-year net asset values (NAV's) were from Icahn Enterprises' own estimates as reported in their end-of-year earnings press releases. The NAV's per unit were arrived at simply by dividing the reported NAV by the number of units outstanding.

A few points worth noting:

• In 2022, the unit count increased by 20.5% while the NAV only increased by 10% (and NAV per unit decreased).
• The total NAV would have actually decreased during the year if not for the 14.6 million "at-the-market" units sold during the year at an average of $52.

Unit Increases This Year

The timing of distributions and related unit issuances in the first two quarters of this year has uneven; the distributions announced in the first and second quarters were both actually made in the second quarter. When IEP issued its earnings statement for Q4 on February 22, 2023, it stated that it would make another $2/unit distribution, "on or about" April 19. When it issued its Q1 results on May 9, it declared it would make the $2 distribution "on or about "June 30, 2023". In fact, the second distribution was made on June 30, per a filing by Carl Icahn:

The Reporting Persons may be deemed to beneficially own, in the aggregate, 334,494,577 Depositary Units, representing approximately 85.28% of the Issuer's outstanding Depositary Units (based upon: (i) the 369,197,424 Depositary Units stated to be outstanding as of May 9, 2023 by the Issuer in the Issuer's Form 10-Q filing filed with the Securities and Exchange Commission on May 10, 2023; plus (ii) the 23,016,917 Depositary Units issued to the Reporting Persons by the Issuer on June 30, 2023 in connection with a regular quarterly distribution of Depositary Units by the Issuer).

Utilizing this information and a couple of prior "statement of changes of beneficial ownership" filings of Icahn controlled entities on December 23, 2022 (for December 21) and April 23, 2023 (for April 19), the following table can be created:

Utilizing the fact that Icahn entities controlled 85.28% of the units outstanding at June 30, I could calculate the total number of units outstanding at that date and the number of units owned by other than Carl Icahn. We already know the total that was outstanding at December 31, 2022 and March 31, 2023, and from that I could calculate Icahn's ownership percentage and the number of units owned by others. The figures are in the table below.

I have also provided IEP's total NAV and the NAV per unit. (For Q2, we do not yet have total NAV: my base case assumption is that it didn't change from Q1.)

It should be noted that the unit count owned by "others" increased by 3.4 million units in Q1. As no distributions were made during the quarter, the increase must have been entirely the result of ATM offerings, which is in fact confirmed by the March 31 10-Q, p. 23: " During the three months ended March 31, 2023, we sold 3,395,353 depositary units pursuant to our Open Market Sale Agreement, resulting in gross proceeds of $175 million."

This is consistent with quarterly ATM sales in 2022, when 14.6 million units were sold, or about 3.6 million per quarter.

Some Units Were Likely Bought Back in the Quarter Under IEP's New $500 Million Authorization

If the recently completed quarter were normal, there would likely have been at least 4 million additional shares issued to "others," consisting of 3 to 3.5 million units under the ATM offerings and at least 1 million units as a distribution rather than cash. (Keep in mind there were two distributions in the quarter). In fact, the units owned by others only increased by 766,000.

The quarter was obviously not normal, with the Hindenburg report being issued on May 2 and IEP's unit price subsequently plummeting. The April distribution was paid prior to then, so the typical 500,000+ units reinvested would not have been impacted. ATM sales during the first third of the quarter would not have been impacted either, which likely were already in the range of 1 million units. Although ATM sales and reinvestments from the June 30 distribution were likely much lower, the gross increase in units during the quarter were likely at least 2-3 million.

With a net increase of only 766,000, this means IEP likely bought back a considerable number of shares, at least 1.25 million and possibly more than double that. The lowest price during the quarter was about $18/ unit before rallying to over $30, so the buybacks likely occurred at an average of at least $20-25/unit. The most likely amount spent on the buybacks was in the range of $25 million to $75 million.

The prices paid for the buyback is significant because it impacts per unit NAV. Just as IEP selling ATM units at a substantial premium to NAV increases NAV per unit, buying them at a premium decreases it. If the purchases were in the low 20's, only a modest premium to the NAV of $14/unit or so, the impact is insignificant. However, if it were closer to $30, then IEP was buying back units at twice NAV, which would have had a noticeable negative impact. At current market prices in excess of $30, IEP has a strong disincentive to do further buybacks. Carl Icahn personally also has a strong disincentive, as his new margin loan terms are dependent upon NAV.

My June 30 NAV Estimate of $14.23/Unit May be Optimistic

Earlier in this article, I estimated the June 30 NAV/unit to be $14.23, utilizing my June 30 calculation of unit count and assuming there was no increase in total NAV. This might actually be a bit optimistic.

CVR Energy's market price decreased from $32.12 to $29.96 in the quarter, about 7%. This will decrease the reported NAV value of IEP's investment by about $156 million. IEP also reported in its Q1 report that a major tenant in a commercial building with an NAV of $218 million had defaulted, and that it may be taking a write-down in Q2. A write-down of about 25% would be roughly $50 million. These two items combined could cause a decrease in NAV of about $200 million, or about $.50 per unit.

IEP also made two distributions in Q2. Regarding the first one, footnote (8) of the earnings press release stated " With respect to March 31, 2023, the distribution payable was adjusted to $70 million, which represents the actual distribution paid subsequent to March 31, 2023 . " This means it was already accounted for as a payable at March 31 and its actual payment in April would not have impacted NAV; cash would have gone down by $70 million on that date and the payable would have been satisfied.

The distribution announced in May and paid on June 30 will negatively impact the June 30 reported NAV, however. We know it was $70 million for Q1. I am estimating $100 million for Q2. I suspect a higher-than-normal percentage of unit owners took their distributions in cash last quarter. Although only a small percentage of unit holders take their $2 distributions in cash, this still decreases NAV per unit by $.25 per quarter ($1.00 annualized). Unless IEP's underlying performance improves dramatically, these payments will become unsustainable.

The S&P 500 was up over 7.5% in Q2 which should help IEP's long portfolio. However, it has a substantial short portfolio and likely experienced further losses on it in the quarter. Although the company has indicated it has decreased the short portfolio, it is likely still substantial. With a $5.6 billion short position at March 31 and less than $2 billion of cash, it would be extremely difficult for IEP to completely close out the short position in one quarter.

As a result of the above factors, I expect the actual per unit NAV to be below my $14.23 "base case", likely between $13.25 and $14. If my estimate is accurate, it may be quite a shock to some to see the per unit NAV decreasing by around $2 in one quarter, from the March 31 figure of $15.63.

Is The Distribution Safe?

Both the total NAV and the NAV per unit (as well as book equity value) are being substantially negatively impacted by the cash distributions, even though only a small proportion of unit holders take their distributions in cash. For the distribution to continue for an extended period, the underlying performance of IEP must substantially improve.

IEP has over $5 billion of holding company debt outstanding in five different issues which become due over the next six years, including $1.1 billion due next year. If the total NAV and book value of the company keep decreasing, it may become quite difficult to refinance the issue. There also may be a risk of covenant violations and defaults under the agreements.

Carl Icahn has basically been subsidizing outside unit holders who take their distributions in cash by taking his own distributions in overpriced units. Icahn had an incentive to do this when it supported the market price of the units and therefore his margin borrowing capability. Now his incentive is to support the NAV of the company instead based upon his new agreement, and these cash distributions negatively impact NAV. Icahn may decide to "cut his losses" by decreasing or eliminating the distribution even before he is forced to do so.

My Position

I am NOT short IEP, although I AM short some calls. As a result, I am not betting that IEP will decrease in price, just that it won't increase.

I am long some of the bonds due in 2025. My issue is not with IEP's solvency, just that its market price is 2-3 times its NAV. I am comfortable that the bonds are "money good." As an investment fund, IEP can always sell some of its liquid investment assets to repay its bonds if refinancing them becomes an issue.

I have a significant long position in CVR Partners ( UAN ), in which IEP has an indirect investment via CVR Energy ( CVI ); CVR Energy owns 37% of CVR Partners, while IEP owns 71% of CVR Refining. As a result, IEP has about a 26% indirect interest in CVR Partners.

CVR Partners produces nitrogen based fertilizers ( ..the stuff that makes corn and other crops grow tall, green, and healthy...), mainly Urea Ammonium Nitrate ("UAN" hence its ticker...) at two plants in the Midwest. It has paid out over $30 in distributions in the past year, and may pay out $15-20 per year or more for the foreseeable future. Fertilizer prices can be quite volatile, however. At a current unit price of about $90, there could be yields of 25% or more, all of which are paid out of "distributable cash flow", basically earnings, not a return of capital.

Although UAN may a "hidden gem" in IEP's portfolio, it has a current market cap of less than $1 billion. IEP's interest therefore has a market value of about $250 million. Even if it doubles, this would possibly only add about $.50 to per unit NAV.

Even this is not guaranteed though, as it is only an indirect ownership interest and only aids IEP's NAV to the extent that the ownership increases CVI's market cap. The sizable distributions also go to CVI, not IEP, and IEP only benefits from the cash flow to the extent that CVI pays a larger divided than it otherwise might have.

The Bottom Line

My negative opinion of IEP as an investment is simply one regarding valuation, not solvency. It is trading at a multiple of net asset value, despite having a poor performance record over the past number of years.

There are individual components within IEP's extended tentacles which have much better performance potential than IEP overall, and no premium to market value needs to be paid to have exposure to some of them. One option is CVR Partners stock, which I believe deserves close consideration.

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