What’s the “Public Hedge Fund” With a Tax-Sheltered 5% Dividend?

by Travis Johnson, Stock Gumshoe | October 28, 2013 12:57 pm

Sniffing around the Oxford Club's latest tease

There are a lot of different ways of appealing to investors … but two of the most appealing are by letting them know that you can get them in on a secret, hidden investment that’s connected to a superstar hedge fund; and telling them that you can earn a high income yield and/or get a tax break on your income.

And today, the Oxford Club[1] is hinting around at a way to get both. So it’s no surprise that the questions came rolling in en masse to Gumshoe Headquarters just moments after this email ad started running this morning.

So what are the Oxford Club folks teasing as the latest pick for readers of their Communique[2] newsletter? Here’s how they introduced it in one version of the email pitch I received:

“If you haven’t heard yet, Chief Investment Strategist Alex Green just discovered a ‘public hedge fund’ that offers a juicy 5% tax-sheltered dividend.

“Better yet, since 2000, this investment has handed investors an unbelievable 1,222% return… That’s 24 times the return of the S&P 500.

So you can see why folks want to know what this is, yes? Heck, maybe even some of you have already guessed — but wait a moment, don’t spoil it for the rest of the class, let’s hear a few more clues from the ad first:

“… the CEO of a unique “publicly traded hedge fund” bought $478 million worth of his own company’s stock at market.

“And he believes the share price is set to take off in the months ahead.

“For good reason… the performance has been nothing short of astonishing….

“Instead of placing money with high-fee funds and getting sub-par returns, this investment is a stellar alternative.

“You’ll find Alex’s full write-up on this investment in this month’s issue of The Oxford Communiqué.”

I was thinking we’d have a long, drawn-out pitch about this one … but nope, that’s about it as far as clues are concerned. The rest of the pitch is all just general stuff about the long-term performance of the Oxford Club’s portfolios, which have indeed been pretty good (Hulbert, who tracks the actual portfolios of a couple hundred newsletters, says that the Oxford Club currently trails the market average for the last one and three-year periods, but has done better than the broad market over 5, 10 or 15-year periods according to Hulbert’s methodology).

And they do throw in a few hints about other “special reports” they’ve teased, in case you were wondering about those — we covered the RNA Interference story here[3] and the “fuel the nuclear renaissance” pitch here[4] if you missed those. But that’s it for our “publicly traded hedge fund” …

So it’s a good thing we’ve got the Mighty, Mighty Thinkolator on our side. Who is the Oxford Club pitching here?

Thinkolator sez it is almost certainly: Icahn Enterprises, L.P. (IEP)

Which is one of those oddball Master Limited Partnerships[5] that we don’t talk about all that often — almost all MLPs are in the energy sector, owning pipelines or storage facilities or even producing wells, but there are a few that fall outside the norm, Icahn’s is probably one of the most prominent of those, though that’s debatable now that the big hedge funds[6] like Och-Ziff (OZM), Fortress (FIG), KKR (KKR) and Blackstone (BX) have publicly traded units, but in the past we’ve also covered publicly traded partnerships that own cemeteries (StoneMor Partners, STON) or amusement parks (Cedar Fair, FUN), or nitrogen fertilizer[7] plants (Terra Nitrogen, TNH), and there are a few other “different” partnerships out there as well.

But one thing the publicly traded partnerships generally have in common is that they offer tax deferral of at least some of the cash they distribute to shareholders/unitholders, because often that distribution is not really income but is a return of capital, taxable only when you sell to realize capital gains. And yes, Icahn’s IEP does currently pay out on a $5/year pace for a yield of roughly 5% on the current $102 share price.

And this partnership has clobbered the S&P 500 over the long term, though a huge amount of that outperformance came just in the past year or two when Icahn’s profile rose even higher in the mind of investors and the partnership started trading for now more than 2X book value after trading at very close to book value for about five years.

Icahn is both an activist investor and a control investor, and over the years he has gradually funneled more and more of his assets into IEP — he is now one of the top 20 or so wealthiest people on Earth, and roughly half of his wealth consists of his 90%+ ownership of Icahn Enterprises. I’m not sure exactly why he has used this publicly traded vehicle, though it does give him a “currency” to use in takeovers (he can do stock-for-stock takeovers instead of having to use cash or debt) and presumably it confers tax benefits to him and his family as well as to minority unitholders.

These days IEP consists largely of controlling interests in CVR Energy (CVI)[8] and auto parts[9] company Federal Mogul (FDML), companies that he built activist positions in and substantially restructured, but IEP also controls a gambling[10] company (Tropicana, TPCA), a railcar company that we talked about last week (American Railcar, ARII)[11], and a variety of other smaller private and public firms and non-control investments (like his stake in Netflix that he famously exited at a very opportune time this year). You can get a pretty good idea of their structure, major holdings, and philosophy here in their latest investor presentation[12] — it’s a few months old, but probably still largely accurate.

IEP has obviously been an extremely successful investment for longterm owners, but I don’t have any idea whether or not that outperformance will continue — particularly because the 150% gain this year has come thanks to investor attention that came from big high-profile Icahn “wins” like Netflix, Herbalife and Apple which did not boost the portfolio nearly as much as the actual IEP share price has climbed, so the huge gain this year has been from IEP getting a big premium to net asset value after for many years trading at or near net asset value … and much of that has come in just the last quarter.

As of the end of June, they reported a Net Asset Value of $64 per share. We’ll see how that has changed when they report their next quarter (the September 30 numbers) on November 4, but at the time that means it was trading at about a 10% premium to asset value (the shares were in the low $70s as of June 30) … I know that Icahn has done well this year in many of his investments, but I very much doubt that the net asset value has climbed 50% in three months to get it to the $90-100 range that would seem more appealing for a $100+ share price (his largest holding, CVI, has fallen in value since June 30, though not dramatically, and his second largest, FDML, has doubled, though half of that move came after the September quarter end, so guessing at the NAV would just be guessing — investors are guessing it will be a big gain by driving the shares up 50% since last quarter). These units may well deserve to trade at a substantial premium to asset value, given Icahn’s abilities as an activist investor, but Carl Icahn[13] is also 77 years old and may not work forever, despite the resurgence his public persona has seen over the past year or so, and he may have bad years investing in the future as well.

IEP has done better than the S&P even if you don’t count the huge gain the shares have made over the past year as Icahn shot out the lights with some activist positions and investments and as it concurrently began to trade at a real premium — but it has been much bumpier than the S&P, too. The beta for these shares is about 1.5, but that might understate the historical vacillations, the shares have gone from $40 to $90 to $55 and back to $105 in just the past year, and before that they had a huge run in climbing from about $10 to $120 in the mid-2000s, culminating with Icahn merging much of his hedge fund into the IEP, but then collapsed far more dramatically than the average stock during the financial crisis, falling from $120 back down to about $20. The company is quite a bit different today than it was in 2008, to be sure, but don’t expect the stock to move steadily.

And like most publicly traded partnerships, particularly the non-traditional ones like Blackstone, IEP is likely to be whipsawed if we get another debate in Congress about “carried interest” that turns into debating the tax breaks built into publicly traded partnerships.

But yes, IEP has done tremendously well, it is run by one of the best activist investors of all time and a remarkably successful hedge fund manager and it still accounts for at least half of his wealth, and it does pay a decent tax-advantaged yield.

Whether or not you want to own this one probably depends most on how comfortable you are paying a premium above asset value for that yield and for control of a few major IEP holdings, and for exposure to whatever Carl Icahn does in the future. With about 91% of the shares, Carl Icahn can do pretty much whatever he wants with IEP — over the last year that’s been great, and for most of the past decade it has worked very well, but whatever’s to come, well, I dunno. The premium over net asset value makes me nervous, personally, but I wouldn’t want to bet against Carl Icahn.

P.S. Carl Icahn did add to his personal holdings with some insider buying[14] of IEP shares, but it wasn’t all that recent — his personal purchase of an addition $478 million worth of shares was back in January 2012, when the stock was around $36. If I could go back in time and buy it at $36 22 months ago, I definitely would. For now, I think I’ll hold off and see what the next quarterly report looks like.

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