Tobias Carlisle's Deep Value: Book ExcerptVW Staff
Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations is a must-read exploration of deep value investment strategy, describing the evolution of the theories of valuation and shareholder activism from Graham to Icahn and beyond.
This book combines engaging anecdotes with industry research to illustrate the principles and methods of this complex strategy, and explains the reasoning behind seemingly incomprehensible activist maneuvers. Written by an active value investor, Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations provides an insider’s perspective on shareholder activist strategies in a format accessible to both professional investors and laypeople.
Deep Value – CHAPTER 1: The Icahn Manifesto: Corporate Raider to Activist Investor
“Had we but world enough, and time, This coyness, Lady, were no crime. . . —Andrew Marvell, To His Coy Mistress (c. 1650)
bouleversement bool-vair-suh-MAWN, noun: Complete overthrow; a reversal; an overturning; convulsion; turmoil. —Comes from French, from Old French bouleverser, “to overturn,” from boule, “ball” (from Latin bulla) + verser, “to overturn” (from Latin versare, from vertere, “to turn”).
Over the fall of 1975, Carl Icahn and his right-hand man, Alfred Kingsley, hashed out a new investment strategy in the cramped offices of Icahn & Company. Located at 25 Broadway, a few steps away from the future site of the Charging Bull, the iconic 7,000-pound bronze sculpture erected by Arturo Di Modica following the 1987 stock market crash, Icahn & Company was then a small, but successful, discount option brokerage with a specialty in arbitrage. Kingsley, a graduate of the Wharton School with a master’s degree in tax from New York University, had joined Icahn in 1968.
Immediately impressed by his ability to quickly grasp complex transactions, Icahn had asked Kingsley what he knew about arbitrage. “Not a thing,” Kingsley had replied.1 Soon Kingsley was spending most of his days arbitraging the securities of conglomerates like Litton Industries, LTV, and IT&T. Arbitrage is the practice of simultaneously buying and selling an asset that trades in two or more markets at different prices. In the classic version, the arbitrageur buys at the lower price and sells at the higher price, and in doing so realizes a riskless profit representing the ordinarily small difference between the two. Icahn had Kingsley engaged in a variation known as convertible arbitrage, simultaneously trading a stock and its convertible securities, which, for liquidity or market psychology reasons, were sometimes mispriced relative to the stock. Litton, LTV, IT&T, and the other conglomerates had issued an alphabet soup of common stock, preferred stock, options, warrants, bonds, and convertible debt. As an options broker, Icahn used his superior market knowledge to capitalize on inefficiencies between, say, the prices of the common stock and the warrants, or the common stock and the convertible debt. The attraction of convertible arbitrage was that it was market-neutral, which meant that Icahn & Company’s clients were not subject to the risk of a steep decline in the market.
Icahn and Kingsley shortly progressed to arbitraging closed-end mutual funds and the securities in the underlying portfolio. A closed-end mutual fund is closed because it has a fixed number of shares or units on issue. Unlike openend funds, management cannot issue or buy back new shares or units to meet investor demand. For this reason, a closed-end fund can trade at a significant discount or, less commonly, a premium to its net asset value. Icahn and Kingsley bought the units of the closed-end funds trading at the widest discount from their underlying asset value, and then hedged out the market risk by shorting the securities that made up the mutual fund’s portfolio. Like the convertible arbitrage strategy, the closed-end fund arbitrage was indifferent to the direction of the market, generating profits as the gap between the unit price and the underlying value narrowed. It was not, however, classic riskless arbitrage.