Yesterday Carl Icahn filed a 13D disclosing a ~13% synthetic stake in Herbalife. There are three possible reasons that Carl Icahn might want to own half a billion dollars worth of Herbalife stock:

  • as a value investment in a company with strong cash flows and a beaten-up stock price,
  • as a toehold in preparation for launching a tender offer to take the company private, or
  • to fuck with Bill Ackman.

If you watched Icahn and Ackman square off on CNBC, or read the transcript, or witnessed some sort of dramatic recreation of it, I think you’ll join me in assuming it’s sheer fuck-with-ery. “Cry, Jewish boy, cry!,” he probably said as he signed the 13D. But who knows? He’s up $80+ million as of this morning, so two birds with one stone.

A curiosity of this position is that it’s mostly synthetic: Icahn owns about 2.5 million actual shares and about 11.5 million call options. Like so:

As we’ve discussed before, this is Icahn’s standard M.O., and it’s not because his dealers are dummies who will sell him levered upside on a stock that he can move with just a lift of his magnificent eyebrows. Rather, it’s because he’s sold the dealers precisely offsetting put options1: long call + short put = long stock. The dealers buy 100% of the underlying stock, and so are perfectly hedged.2

The two typical reasons for using this structure, as opposed to just buying the shares outright, are, first of all, for leverage – notice that Icahn has only put up $214mm in cash to build a half-billion-dollar position3 – and, second, for HSR antitrust act reasons. If you’re going to buy more than about $68.2 million worth of stock,4 you need to file a notice with the FTC and then wait for antitrust approval. If you’re in the middle of a CNBC battle with your nemesis, you don’t want to wait 30+ days for that approval, so you buy synthetic.

Careful observers will note that Icahn actually bought $86 million of shares, above the HSR thresholds, and that he did actually wait the thirty days between buying the first $54 million and buying the rest of it.5 Which suggests he did his HSR filing, bit his tongue, and waited to ambush Bill Ackman on CNBC until he had a free hand to buy more Herbalife.

Which leaves leverage as the reason for this structure. Icahn is getting something like 2.3:1 leverage on his cash investment. And he’s probably getting very favorable financing; as Kid Dynamite puts it:

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.

Carl Icahn is no dummy and the tight borrow was very predictable, so presumably some of the savings are being passed along to him in the form of favorable financing for the trade. Shares being fungible, you can sort of assume that some of the ~20% of Herbalife shares that Bill Ackman is borrowing and shorting “belong,” in some loose sense, to Carl Icahn (really his dealer counterparty).

There’s a nice symbiosis here: Ackman’s short is helping Icahn finance his long, while Icahn’s method of financing of his long is helping keep Ackman’s borrow costs low on his sort. They’re helping each other out. Sometimes I wonder why in situations like this Ackman and Icahn don’t just go write each other a $500mm swap and leave Herbalife out of it entirely, but I guess you can’t threaten a tender offer if you do that. Also they’d never agree on the contract.

The real question is what Icahn will do next. Here’s what he says:

The Reporting Persons have conducted significant analysis with respect to the Issuer. The Reporting Persons have concluded that the Company has a legitimate business model, with favorable long-term opportunities for growth. 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.

The Reporting Persons acquired the Shares in the belief that the Shares were undervalued. The Reporting Persons may, from time to time and at any time: (i) acquire additional Shares and/or other equity, debt, notes, instruments or other securities (collectively, “Securities”) of the Issuer (or its affiliates) in the open market or otherwise; (ii) dispose of any or all of their Securities in the open market or otherwise; or (iii) engage in any hedging or similar transactions with respect to the Securities.

One possibility is, of course, to use today’s pop to quietly sell down his position and take a very nice profit on a short-term, levered trade: over a 40% return on a $214mm investment in just two months. Another possibility is to convert this toehold to physical shares – putting up hundreds of millions more in cash – and withdrawing those shares from borrow, putting more pressure on Ackman’s short. Or you could launch a tender offer or something? I dunno, seems like a lot of work. The question, really, is what you value more: a quick profit, a long-term investment, or the chance to screw Bill Ackman.

Icahn Capital Schedule 13D [EDGAR]
The same thing, in spreadsheet form [Google Docs]
Icahn Reveals His Stake in Herbalife [DealBook]
Carl Icahn’s Valentine’s Day Massacre of Bill Ackman’s Herbalife Short [Kid Dynamite]
Earlier: Who Is Doing What To Whom On Carl Icahn’s Netflix Trades?

1. From the 13D:

The Reporting Persons have sold, in the over the counter market, European-style put options referencing an aggregate of 8,311,738 Shares, which expire on the earlier of January 28, 2015 or the date on which the corresponding American-style call option described above in this Item 6 is exercised. The Reporting Persons have also sold, in the over the counter market, European-style put options referencing an aggregate of 3,230,606 Shares, which expire on the earlier of May 10, 2013 or the date on which the corresponding American-style call option described above in this Item 6 is exercised.

The agreements provide that they settle in cash. These agreements do not give the Reporting Persons direct or indirect voting, investment or dispositive control over the Shares to which these agreements relate.

As we discussed last time, the price that the dealers paid for those puts was, to a pretty high level of certainty, zero. [Update: actually it was $0.01.]

2. Though that is not a contractual requirement and if I were the dealer I would be sorely, sorely, sorely, sorely, sorely tempted to buy, y’know, 120% of the underlying stock, which, remember, is up like five bucks this morning. I assume that’s crazy illegal though it is sort of a fun puzzle to ponder why. Like: buying 100% of the underlying shares to hedge your option position: clearly not illegal, front-running, or insider trading. (Right? Happens all the time.) Buying 120%: clearly super-shady, but is it illegal? People lean into options positions all the time. Delta-one options positions maybe not.

ALSO! As the dealer here, your profile is kind of “short very out-of-the-money put”: if the stock gaps to zero, as Ackman thinks it will, then Icahn owes you like $300 million that is mostly uncollateralized (see below), and you have to go sue him and that’s very unpleasant, as Ackman knows. So you could theoretically justify being long, like, 99% of the underlying shares instead of 100%. But you’d be an idiot to actually do that, right? Or at least the reasonable move might be to be like long 105% yesterday and sell down to 99% today? I dunno. If you trade synthetics with Carl Icahn, be in touch.

3. Unless he’s also posting collateral on the puts. The puts are pretty out-of-the-money so I’d assume collateral requirements are zero-to-minimal. On the other hand, y’know, it’s Herbalife. Someone thinks it’s going to zero. If I were a dealer here I’m not sure I’d be all that comfortable with the ~$12 cushion (as of yesterday) between the ~$38ish stock price and the $26ish strike price at which Icahn owes me money on the puts. Notice that even as the stock was going up, the dealers stopped selling him $26 January 2015 calls and started selling $23.50 May 2013 calls, effectively requiring Icahn to put up more margin on new synthetic positions (and shortening the maturity) – suggesting that they’re at least a little worried about the exposure too.

4. Now $70.9 million, though I think the lower number was in effect in January when Icahn did his physical buying.

5. Here’s his buying, from the 13D (and my spreadsheet):

Comments (31)

  1. Posted by Not a Quant | February 15, 2013 at 10:33 AM

    As someone who witnessed a dramatic recreation, I'm going to go with option 3.

    -unlike everyone else around here, not a quant

  2. Posted by Kid Before Christmas | February 15, 2013 at 10:47 AM

    Unrelated (sorry), but heads up Matt, Dell "expects to file the proxy statement within five business days after the end of the 45-day “go-shop” period." So maybe have your intern start counting down the days and make Shazzamy camp out in front of the SEC until then to make sure you get a hard copy as soon as its filed.

  3. Posted by guest | February 15, 2013 at 10:57 AM

    Boy, Joe Camel sure has aged.

  4. Posted by Uncontrollable | February 15, 2013 at 11:09 AM

    Ackman is relying on his due diligence, Icahn is relying on his balls. In this game of Liar's Poker, if Ackman folds his hand he loses if Icahn was wrong. If he stays in, Icahn can still win in the short term, by staying in and marginally betting up as he has been doing so far. Considering, Icahn's more recent calls are May 2013 not 2015 LEAPs, he may be in for a short run and will cash out if he hasn't done it already!

  5. Posted by Sparkle | February 15, 2013 at 11:17 AM

    Can we all try just for one day not to be racist?

  6. Posted by asianbankingsensation | February 15, 2013 at 11:30 AM

    What a bitter old man!

    -Team Ackman

  7. Posted by PermaGuestII | February 15, 2013 at 11:42 AM

    Sure.

    Can we also try for one day to make relevant comments?

  8. Posted by Im_a_Dude | February 15, 2013 at 11:56 AM

    what would we do that for?

  9. Posted by Mrs_Slocombe | February 15, 2013 at 12:11 PM

    ….herbal tea bags, Icahn’s balls…..I need a drink.

  10. Posted by David Tepper | February 15, 2013 at 12:14 PM

    I see nothing wrong with Mr. Icahn's strategy.

  11. Posted by Shazango Unchained | February 15, 2013 at 12:29 PM

    Relevant is a racist word created by slave owners.

  12. Posted by John Arnold | February 15, 2013 at 12:44 PM

    That'a boy, Carl.

  13. Posted by guest | February 15, 2013 at 12:59 PM

    The problem for Ackman is that he ran across someone with more gamble than him. Where is E. Texas Gas Trader when we need him to explain this term? Although Ackman's thesis might play out in the long term, it won't matter to his investors if Icahn eliminates the substantial paper profit (HLF already almost doubled off low) in the mean time. If there is a buyout it won't matter if his thesis is correct b/c he won't have the stock to short.

    -Trader who is impressed by the gamble in Ackman and Icahn

  14. Posted by guest | February 15, 2013 at 1:42 PM

    collusion. they're both going to walk away with princely sums

  15. Posted by guest | February 15, 2013 at 2:46 PM

    Didn't realize Jews (if that what you reference) were a race…

  16. Posted by Guest | February 15, 2013 at 4:32 PM

    Berry berry funny, man with the little willy.

  17. Posted by Bejujular | February 15, 2013 at 4:33 PM

    It's simple. Screw the Ack-Man.

    - J. Oker & Co.

  18. Posted by Andrew F. | February 15, 2013 at 5:01 PM

    It's a simple business predicated on promising the poor/aspirational a better life, allowing them leverage to buy products from you and then offset all business risk through declining inventory returns for unsold products…. Sounds like a business Carl would love!

  19. Posted by Impressed | February 15, 2013 at 5:57 PM

    Matt's stepping up his game beyond footnotes. There's a title for each picture when you hover over it.

  20. Posted by guest | February 15, 2013 at 6:12 PM

    You're late to the party.

  21. Posted by Yes Icahn | February 15, 2013 at 6:25 PM

    Let's not forget all the folks that jumped into this trade behind Ackman. Icahn just needs to turn the heat up high enough for them to abandon their positions. Ackman's f-ed. If he moves to abandon his own position the market will clobber him, but if he sticks it out he's going to be all alone.

    "He who sells what isn't his'n must buy it back, or go to pris'n"

  22. Posted by The Anarchist Banker | February 15, 2013 at 6:31 PM

    An even better investment is a sustainable, legitimate, pyramid scheme.

  23. Posted by Donny | February 15, 2013 at 8:48 PM

    Barry McCockkiner

  24. Posted by Guest | February 15, 2013 at 9:27 PM

    Love the spreadsheets, Matt

  25. Posted by Mike Larson | February 16, 2013 at 6:50 AM

    you were not the only witness there.<img src="http://Now.apparelbookstore.info/rest.jpg"/&gt;

  26. Posted by guest | February 16, 2013 at 4:07 PM

    I read the title and think, "man, this is gonna be a great Bess article", but then I look down and feel disappointed.

  27. Posted by wandering jew | February 19, 2013 at 7:48 AM

    Ichann was pissing in his pants when the stock tumbled down.look at how small his average down is.

  28. Posted by fearless frank | February 23, 2013 at 11:45 AM

    Then he began doing some legitimate dd and concluded he was all set, adding another 600k shares up 60%. He's likely already neutralizing the downside risk on NFLX and gearing up to deploy that released capital here. The news of last week, which, irinically and hilariously, the chat boards are rife with shorts thinking it is all good for them, was more likely intended by the company to show they are all over the game of showing they are in command of a new militancy about "boy scouting" distribution practices and masters of product quality/control. The ridiculousness of Ackman suggesting he is "saving" the world on this is that he is likely hedged to $45, but the minions following his self-serving rants and use of national media (unwitting or intentional advancers of Ackman's agenda?) likely have nothing hedged once Carl and his program come stomping on the unhedged shorts. Ackman will just cover in before the tide rises too far.

  29. Posted by fearless frank | February 27, 2013 at 8:04 PM

    check out the share count again. His ave down shares were limited to the Hart Scoot limitation on $ without regulatory approval. LOL Then he came back in with conviction on 600k shares up 60% as discussed in the post below. Carl is committed; Ackman is hosed, especially after tonight's JCP butch which Ackman's bravado ensures is not well hedged either.

    But just think, if Ackman can push this to zero, Carl will be out some coin. GFL with that Ackman…

  30. Posted by james | April 11, 2013 at 9:12 PM

    If he moves to abandon his own position the market will clobber him, but if he sticks it out he's going to be all alone.

  31. Posted by Davis | April 17, 2013 at 1:20 PM

    I think it's a good business as long as people keep finding such diet shakes and drinks effective for weigh loss. I really enjoyed this entertaining meaningful post. Thanks.