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.
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):