Carl Icahn’s Valentine’s Day Massacre of Bill Ackman’s Herbalife Short

You know the Herbalife story by now, right?

Cliff notes:  Well known hedge fund manager (Bill Ackman) announces a monstrous short position in $HLF (no positions here) and presents a 300+ slide presentation on his thesis.   Stock gets annihilated, then bounces hard and continues to rally as others, including another well known hedge fund manager (Dan Loeb), come to the defense of Herbalife.   Drama seems to culminate for the time being with a one-for-the-ages CNBC call-in showdown between the hedge fund short and another even more well known hedge fund manager (Carl Icahn) who is long.

And then there was tonight:  Icahn files his 13D showing a massive synthetic stake in Herbalife, and throws in the little tidbit:

“The Reporting Persons intend to have discussions with management of the Issuer regarding the business and strategic alternatives to enhance shareholder value, such as a recapitalization or a going-private transaction.”

*gulp*.   It’s ON like Donkey Kong.   Anyone who doubted Carl Icahn’s penchant for vendettas severely underestimated him:  the data shows that Icahn accumulated the vast majority of his position AFTER the CNBC showdown with Ackman.   He did it through options combos:  Icahn bought calls and sold puts.   From the filing, he owns a total economic interest in 14,015,151 shares, which is about 13% of Herbalife’s outstanding shares.  But Icahn doesn’t own all stock – he owns:

-combos (equivalent to a long stock position: long calls, short puts, Jan 28th 2015 expiration) on 8,311,738 shares

-combos (equivalent to a long stock position: long calls, short puts, May 10th 2013 expiration) on 3,230,606 shares

which leaves 2,472,807 shares of HLF common stock.

If you read the 13D, you can see the dates of the transactions, and the complicated mess of entities Icahn controls.*   According to my wicked quick spreadsheet math, his cost basis on the common is $34.69, and he bought 1,672,807 of the shares in the days before Christmas, 2012, with the remaining 800k shares being bought on Jan 28th/29th 2013,  AFTER the CNBC showdown with Ackman.   All of the options trades were done after the Ackman CNBC battle – from Jan 28th through Feb 14th (today).

So are you with me so far?  Can you picture Icahn hanging up the phone after that CNBC tete-a-tete and screaming, Rambo-esque: NOTHING IS OVER!

 

Or was it more like Pacino in Scent of a Woman:  I’m just gettin’ warmed up!

Anyway… here’s a 46 day chart of Herbalife, showing the Ackman carnage, rebound, selloff again on FTC fears, and today’s after hours spike:

hlf_46_days

So what happens next?   This is the question I’ve been pondering… What is Icahn’s exit plan for this position?  Ideally, Icahn wants to squeeze Ackman until he cries uncle and is forced to cover his position due to either lack of available borrow, or enormous borrow costs – and Icahn could then sell into that squeeze.   I noted previously that although Ackman was surely smart enough to lock up borrow for some period of time, my instinct was that someone would eventually get hosed on that deal if borrow got tight: either Ackman, or, less likely, his prime brokerage stock loan counterparty.

Note, by the way, that Icahn’s options trading counterparty here is sitting pretty: they are short options combos to Icahn, and surely bought stock to hedge.  Now, if/when borrow rates increase (by the way – at the moment Interactive Brokers is showing decent availability at a cost of 2%, which is up from 1.5% a few hours ago), the brokers on the other side of Icahn’s trade will mint more coin lending out the shares.

Ackman is relying on the regulators to crack down on Herbalife.   Icahn’s game is to get Ackman to puke and cover his position before that happens.  How does Icahn get that done?   I don’t think he wants to commit capital to LBO and/or partial tender for Herbalife.   That would involve him actually believing in Herbalife, and my instinct is that’s just not his game.   He doesn’t want to own Herbalife long term, he wants to stick a billion dollar PnL hit up Bill Ackman’s ass, and twist. Hard.   Plus, if he has a tender outstanding, he can’t be selling stock at the same time, right?

So can Icahn convince the company itself to do a large partial tender that he could sell into?  To buyback a billion dollars of stock at a premium?  Uggh – that’s a tough sell – I don’t think the company wants to lever up here to pay a premium for their own stock.   Someone mentioned record low interest rates to me – yes – but Herbalife doesn’t borrow at 2%, and massive leverage to pay a premium for their own shares isn’t what the doctor ordered right now:  they aren’t just fighting Bill Ackman’s short position, they are fighting his allegations and uncertainty around potential FTC action even if Ackman covers his short.  I just don’t see it.

Icahn could conceivably take delivery of the shares underlying his call options and try to manipulate borrow costs by withholding borrow on his 14% stake.   Would that be enough to drive borrow costs to levels that would force Ackman to throw in the towel?  I don’t know – maybe – if anyone has insights on this, feel free to weigh in in the comments section.

Again, it seems clear that Icahn’s goal is to create a short squeeze:  a squeeze in borrow costs leads to a squeeze in stock price as shorts cover (tangent: there are two kinds of short squeezes that we talk about:  1) when shorts have to cover because shares are unavailable to borrow or too expensive to borrow, and 2) when shorts can no longer take the pain of adverse price movements and throw in the towel, covering.  My instinct is that Ackman is willing to take a good amount of mark-to-market pain, but that continued ongoing elevated borrow costs in the face of regulatory inaction could force him to reduce his position).   I’m not convinced that getting borrow costs jacked up to levels that will crush Ackman is as easy as a lot of people are thinking it is.

Final thought:  maybe Icahn’s actions make Ackman’s investors nervous, and they redeem investments from Pershing Square, causing Ackman to suffer liquidity issues and have to decrease position size, worsening losses, etc, rinse: repeat.   I’m told that Pershing Square investors are subject to a two year rolling lockup: if they don’t redeem in their window, their investment is locked up for two more years.  I have no insights or information as to what % of Pershing’s LPs have a redemption window at any time in the near future.

For now, we’ll sit back and watch this previously epic, now WICKED-EPIC battle of egos unfold.   There’s only one thing that could make this better right now… Two words:  David. Einhorn.

 

EDIT: @mojoris1977 mentioned conversions. I may be misinterpreting him, but I think he’s suggesting that Icahn can now turn around and slap on conversions in size:  buy stock, sell combos (sell call, buy put).   The more Icahn does this (assuming he doesn’t lend his shares out), the harder it becomes to borrow shares: his broker on the other side is shorting stock and buying combos, and building the cost of borrow into the options combo pricing.   So maybe Icahn is willing to pay up to “consume” borrow via conversions, create a tipping point, force a squeeze, and liquidate his long position into it?   Could be…  Then again, if Icahn is willing to eat the cost of that trade (essentially paying for his counterparty’s borrow), maybe Ackman is too.  In order for that to work, I think that there has to be some convexity in accelerating borrow costs that Icahn could tip… dunno.

related:

All of Kid Dynamite’s Prior Herbalife Posts

Icahn’s 13D

Why Bill Ackman is Wrong About Herbalife

Another Million Pixels Killed Discussing Herbalife

Twas the Night Before Herbalife

Battle of the Bloviating D-bags

 

-KD

NO POSITIONS IN $HLF AT THIS TIME

* I really liked this description of Icahn’s inter-related entities:

Barberry is the sole member of Hopper, which is the general partner of High River. Icahn Offshore is the general partner of each of Icahn Master, Icahn Master II and Icahn Master III. Icahn Onshore is the general partner of Icahn Partners. Icahn Capital is the general partner of each of Icahn Offshore and Icahn Onshore. Icahn Enterprises Holdings is the sole member of IPH, which is the general partner of Icahn Capital. Beckton is the sole stockholder of Icahn Enterprises GP, which is the general partner of Icahn Enterprises Holdings. Carl C. Icahn is the sole stockholder of each of Barberry and Beckton. As such, Mr. Icahn is in a position indirectly to determine the investment and voting decisions made by each of the Reporting Persons. In addition, Mr. Icahn is the indirect holder of approximately 93.3% of the outstanding depositary units representing limited partnership interests in Icahn Enterprises L.P. (“Icahn Enterprises”). Icahn Enterprises GP is the general partner of Icahn Enterprises, which is the sole limited partner of Icahn Enterprises Holdings.

Got it?  No? Me neither… need to draw a diagram of some sort… maybe the next paragraph will clear things up?

Each of High River and Barberry is primarily engaged in the business of investing in securities. Hopper is primarily engaged in the business of serving as the general partner of High River.  Each of Icahn Master, Icahn Master II, Icahn Master III and Icahn Partners is primarily engaged in the business of investing in securities. Icahn Offshore is primarily engaged in the business of serving as the general partner of each of Icahn Master, Icahn Master II and Icahn Master III. Icahn Onshore is primarily engaged in the business of serving as the general partner of Icahn Partners. Icahn Capital is primarily engaged in the business of serving as the general partner of each of Icahn Offshore and Icahn Onshore. IPH is primarily engaged in the business of serving as the general partner of Icahn Capital. Icahn Enterprises Holdings is primarily engaged in the business of holding direct or indirect interests in various operating businesses. Icahn Enterprises GP is primarily engaged in the business of serving as the general partner of each of Icahn Enterprises and Icahn Enterprises Holdings. Beckton is primarily engaged in the business of holding the capital stock of Icahn Enterprises GP.

nope…

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