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Chapter 6.1: Carl Icahn: Master of the Universe

Chapter 6.1: Carl Icahn: Master of the Universe

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(NASDAQ: IEP), or own stock in the companies he targets. The secret to his success? Even his

critics will tell you Carl Icahn doesn’t just look for opportunities in business—he makes them.

But most outsiders still think of him as a Wall Street caricature, a ruthless vulture capitalist who

pillages companies for personal gain. When you Google the term corporate raider, Icahn’s name

autofills in the search bar.

But Carl Icahn is challenging that creaky old stereotype. Icahn thinks of himself as a “shareholder

activist.” What does that mean? “We go in and shine a light on public companies that are not giving

shareholders the value they deserve,” he told me. His obsession, he says, is to stop the abuse of

stockholders by improving corporate governance and accountability—which makes American

companies stronger and therefore the American economy stronger.

The New York Times describes him this way: “By rattling corporate boards, mounting takeover

efforts and loudly jostling for change at companies, he has built a multibillion-dollar fortune,

inspiring fear among chief executives and admiration among his fellow investors in the process.”

Icahn buys up shares of top-heavy or underperforming companies and then puts them on notice that

it’s time to step up their game—or face a proxy fight for control of the board.

He sees himself in a battle with those who use the coffers of public companies to enrich themselves

at the expense of the shareholders. “Tony, people have no idea how they’re getting screwed,” he said,

adding that average investors aren’t aware of the abuses that go on behind the closed doors of

boardrooms. But part of the problem is that shareholders don’t believe they have the power to change

things because they don’t think like owners. Icahn, however, knows the power of leverage—and he’s

not afraid to use it.



$24 BILLION FOR COCA-COLA MANAGEMENT

INCENTIVES?

An example of the kind of action that public company boards take that outrage Icahn can be found in

his recent criticism of Coca-Cola. Coke was planning to dilute the company’s stock value by issuing

$24 billion in new, discounted shares. The reason? To finance huge compensation packages for top

management. This would weaken the retirement investments of ordinary investors, including teachers

and firefighters, because so many people have Coke stock in their retirement portfolios.

Icahn wrote an editorial in Barron’s blasting the company for the scheme, and calling out Warren

Buffett—Coca-Cola’s single largest shareholder and a board member—for not voting against the

move. “Too many board members think of the board as a fraternity or club where you must not ruffle

feathers,” Icahn wrote. “This attitude serves to entrench mediocre management.”

Buffett responded that he had abstained from the vote but was opposed to the plan, and that he had

been quietly talking to management about reducing its excessive pay proposal—but he didn’t want to

“go to war” with Coke over the issue.

In contrast, Carl Icahn is always ready for war. He’s been in the trenches many times before,

making runs on companies as diverse as US Steel, Clorox, eBay, Dell, and Yahoo. But this time was

different: instead of Icahn, a younger fund manager named David Winters was buying stock and

leading the charge against Coke’s management. To the dismay of overpaid CEOs everywhere, a new

generation of “activist investors” is taking up the fight Icahn started decades ago.



Naturally, Carl Icahn has ticked off a lot of corporate dynamos, enemies with big clout in the

media. So you’ll often hear his critics saying that he’s only in it for the money, or that he “pumps and

dumps” stocks, sacrificing long-term corporate goals for short-term profits. But Icahn points out that

this is ridiculous, in that he often holds his positions for much longer than people realize—sometimes

10, 15, even 30 years. And when he does take control of a company, its value continues to rise for

years, even after he’s left. This claim has been borne out by a study conducted by Harvard Law

School professor Lucian Bebchuk, who analyzed 2,000 activist campaigns from 1994 to 2007. It

concluded that “operating performance improves following activist interventions.” The study also

found that not only were there no detrimental long-term effects, but instead, five years later these

firms continued to outperform.

Carl Icahn isn’t after the head of every CEO in America. He’s often acknowledged that there are

some extraordinary leadership teams out there, and executives who maximize company resources and

make the economy more resilient. But he’s always looking for ways to make the management—even

of the most popular and well-run corporations—more responsive to shareholders.

Take that Apple tweet, for example. He told me he wasn’t trying to drive up the price and sell his

stock. (In fact, on the day of our interview, he bought a large amount of Apple stock.) And he wasn’t

trying to interfere with the company’s management—which he thinks is solid. The tweet was just part

of a campaign to pressure Apple to return $150 billion of its cash reserves to its shareholders as

dividends. The company eventually expanded its capital return program to over $130 billion in April

2014, including an increase in its share repurchase authorization to $90 billion from the previously

announced $60 billion level. At the same time, Apple announced an increase to its quarterly dividend

and a seven-for-one stock split. Today it is 50% higher than the day he did the tweet.

Icahn is a CEO himself, owning 88% of a public company, Icahn Enterprises. The company’s stock

has done amazingly well, even during the so-called lost decade. If you’d invested in Icahn

Enterprises from January 1, 2000, to July 31, 2014, you would have made a total return of

1,622%, compared with 73% on the S&P 500 index!

Carl Icahn wasn’t born into this life. He says he grew up “in the streets” of Far Rockaway, New

York. His mother was a teacher; his father, a former law student and a frustrated opera singer who

worked as a cantor at a local synagogue. Carl played poker to pay for his expenses at Princeton,

where he majored in philosophy. After a brief attempt at medical school and a stint in the army (and

more poker), he realized that his greatest talent was for making money. Corporate America has never

been the same.

Icahn is now 78 years old and thinking about his legacy. He’s been busy writing op-ed pieces and

giving select interviews about the rights of investors and shareholders. But, frankly, he’s sick of being

misunderstood and quoted out of context. Which is why, not knowing who I was or my true intent, he

asked that my video crew not film our interview and stated, “I’ll give you a few minutes.”

To my great relief, Icahn warmed up after those first awkward moments, and two and a half hours

later I was lingering with him in the hallway and being introduced to Gail, his extraordinary wife of

15 years. Carl is very different from his public persona. He’s funny and curious, even grandfatherly.

His friends say he’s mellowed a bit. But he still talks with a Queens accent, and he still has the sharp

edge of a New York street brawler. Icahn says he’s not the kind of guy who gives up. Especially

when he’s found something worth fighting for.

You come from a family of modest means, and you went to public schools in a rough part of

TR: Queens. Did you have a goal when you started out, that you were going to become one of the best



investors of all time?

I’m a very competitive guy. Passionate or obsessive, whatever you want to call it. And it’s my

nature that whatever I do, I try to be the best. When I was applying to colleges, my teachers told

me, “Don’t even bother with the Ivy League. They don’t take kids from this area.” I took the

CI: boards anyway and got into all of them. I chose Princeton. My father had offered to pay for

everything, then he backed out and would only pay tuition, which—if you believe it—was $750

a year back then. I said, “So where do I sleep? How do I eat?” My parents said, “You’re so

smart, you’ll figure it out.”

TR: So what did you do?

I got a job as a beach boy at a club in the Rockaways. I was a good beach boy! The cabana

owners used to say, “Hey kid, join our poker game and lose your tips for the week.” At first I

CI: didn’t even know how to play, and they cleaned me out. So I read three books on poker in two

weeks, and after that I was ten times better than any of them. To me it was a big game, big

stakes. Every summer I won about $2,000, which was like $50,000 back in the ’50s.

TR: How did you get started in business?

After college I joined the army, where I kept playing poker. I came out with maybe $20,000

saved up and I started investing it on Wall Street in 1961. I was living good, had this gorgeous

CI:

model girlfriend and I bought a white Galaxie convertible. Then the market crashed in 1962, and

I lost everything. I don’t know what went first, the girlfriend or the car!

TR: I read that you got back in the market, selling options, then going into arbitrage.

I borrowed money to buy a seat on the New York Stock Exchange. I was a hotshot guy. My

experience taught me that trading the market is dangerous, and it was far better to use my

CI: mathematical ability to become an expert in certain areas. Banks would loan me 90% of the

money I needed for arbitrage, because back then, in riskless arbitrage, if you were good, you

literally couldn’t lose. And I was starting to make big money, $1.5 to $2 million a year.

I’d love to talk to you about asymmetric returns. Were you also looking for those when you

TR:

began taking over undervalued companies?

I started looking at these companies and really analyzing them. I tell you, it’s sort of like

arbitrage, but nobody appreciates that. When you buy a company, what you’re really buying are

its assets. So you’ve got to look at those assets and ask yourself, “Why aren’t they doing as well

as they should be?” Fully 90% of the time, the reason is management. So we would find

CI: companies that weren’t well run, and I had enough money that I could come in and say: “I’m

taking you over unless you change, or unless the board does X, Y, or Z.” A lot of times the board

said, “Okay.” But sometimes the management would fight us and perhaps go to court. Very few

people had the tenacity I had—or were willing to risk the money. If you looked at it, it appeared

that we were risking a lot of money, but we weren’t.

TR: But you didn’t see it as risky because you knew the asset’s real value?

You look for risk/reward in the world, right? Everything is risk and reward. But you’ve got to

CI: understand what the risk is, and also understand what the reward is. Most people saw much

more risk than I did. But math doesn’t lie, and they simply didn’t understand it.

TR: Why not?

CI: Because there were too many variables and too many analysts that could sway your opinion.

TR: They’re making it harder for you to beat them these days.



Not really. The system is so flawed that you can’t get mediocre managers out. Here’s an

example: let’s say I inherit a nice vineyard on beautiful land. Six months later I want to sell it,

because it’s not making any money. But I’ve got a problem: the guy who manages the vineyard is

CI: never there. He’s playing golf all day. But he won’t give up his job running the vineyard. And he

won’t let anybody look at the vineyard because he doesn’t want to see it sold. You might say to

me, “What are you, crazy? Get the police, kick him out!” But that’s the trouble with public

companies: you can’t do it without a very difficult fight.

TR: The rules make it hard to kick the CEO off your property.

That’s the trouble: the shareholders of corporations have great difficulty being heard, but at IEP

we fight and often win. Once in power, sometimes we find the CEO is not so bad. But the bottom

line is: the way public companies are governed is really bad for this country. There are so many

CI: rules that keep you from being an activist. There are many barriers to getting control, but when

we do, all shareholders, as the record shows, generally do very well. Additionally, what we do

is also very good for the economy, because it makes these companies more productive, and this

is not just short term. Sometimes we don’t sell for 15 to 20 years!

TR: What’s the solution?

Get rid of the poison pills [that issue more stock at a discount if any one shareholder buys too

much] and get rid of the staggered board elections so the shareholders can decide how they want

the company run. We should make these companies be accountable and have true elections. Even

in politics, as bad as it is, you can get rid of the president if you wanted to. He’s only there for

CI:

four years at a time. But at our companies, it is very hard to get rid of a CEO even if he or she is

doing a terrible job. Often CEOs get that top job because they’re like the guy in college who was

the head of the fraternity. He wasn’t the smartest guy, but he was the best social guy and a very

likeable guy, and so he moved up through the ranks.



Sometimes you don’t need a proxy fight to change the direction of a company. You bought a lot

of stock in Netflix recently, almost 10%, and you made $2 billion in two years.

That was my son, Brett, and his partner who did it. I don’t know much about technology, but he

CI: showed me in 20 minutes why it was a great deal. And I just said, “Buy everything you can!” It

TR:



wasn’t really an activist play.

What did you see? What did he show you in those 20 minutes that made you know that the stock

TR:

was that undervalued?

Simple: most of the great experts were worried about the wrong thing. At that moment, Netflix

had $2 billion in fees coming in every year. But those fees aren’t on their balance sheet. And so,

all these experts were saying, “How are they going to get money to pay for content?” Well,

CI:

they’ve got the $2 billion coming in! And generally subscribers are loyal for longer than you

would imagine! It would take much longer than most people thought to put the huge cash flow in

jeopardy, no matter what happened.

TR: But you never tried to take over Netflix?

They thought they were going to have a proxy fight. But I said, “Reed [Hastings, Netflix

cofounder and CEO], I’m not going to have a proxy fight with you. You just got a hundred-point

CI: move!” Then I asked them if they knew the Icahn rule. They said, “What’s that, Carl?” I said,

“Anybody who makes me eight hundred million in three months, I don’t punch them in the

mouth.”

TR: [Laughs.] You cashed out a portion of the stock toward the end of 2013.

CI: When the stock got to $350, I decided to take some off the table. But I didn’t sell it all.

TR: What is the biggest misconception about you?

I think people don’t understand, or maybe I don’t understand, my own motivations. While it may

sound corny, I really do think that at this point in my life, I am trying to do something to keep our

CI: country great. I want my legacy to be that I changed the way business is done. It bothers me that

so many of our great companies are so badly managed. I want to change the rules so that the

CEO and boards are truly accountable to their shareholders.

You and your wife have signed the Giving Pledge. What other types of philanthropy are you

TR:

most passionate about?

I give a lot, but I like doing my own thing. I just put $30 million into charter schools because in

charter schools the principal and teachers are accountable. As a result, a charter school run

correctly gives our children a much better education than they generally get in public schools.

CI:

We are a great country, but, sadly, the way we run our companies and our educational system,

for the most part, is dysfunctional. I hope to use my wealth to aid me in being a force in changing

this. Sadly, if we don’t, we are on the road to becoming a second-rate country or even worse.



CHAPTER 6.2



DAVID SWENSEN: A $23.9 BILLION LABOR OF LOVE



Chief Investment Officer, Yale University, and Author of Unconventional Success: A

Fundamental Approach to Personal Investment



David Swensen is probably the best-known investor you’ve never heard of. He’s been described as

the Warren Buffett of institutional investing. Over the course of his celebrated tenure as Yale’s chief

investment officer, he’s turned $1 billion in assets into more than $23.9 billion, boasting 13.9%

annual returns along the way—a record unmatched by many of the high-flying hedge funds that have

tried to lure him away over the last 27 years.

As soon as you meet Swensen, you realize that he’s not in it for the money—he’s in it for the love

of the game and a sense of service to a great university. And he’s got the paycheck to prove it: his

worth in the private sector would be exponentially higher than what he earns at Yale.

At his core, Swensen is an inventor and a disruptor. His Yale model, also known as the endowment

model, was developed with his colleague and former student Dean Takahashi, and is an application

of modern portfolio theory. The idea is to divide a portfolio into five or six roughly equal parts and

invest each in a different asset class. The Yale model is a long-term strategy that favors broad

diversification and a bias toward equities, with less emphasis on lower-return asset classes such as



bonds or commodities. Swensen’s position on liquidity has also been called revolutionary—he

avoids rather than chases liquidity, arguing that it leads to lower returns on assets that could

otherwise be invested more efficiently.

Before his days as the rock star of institutional investing, Swensen worked on Wall Street for bond

powerhouse Salomon Brothers. Many credit him with structuring the world’s first currency swap, a

trade between IBM and the World Bank, which in effect led to the creation of the interest rate and

ultimately credit-default swap markets, representing over $1 trillion in assets today. But don’t hold

that against him!

I had the privilege of sitting down with Swensen at his Yale office, and before I ventured up the

hallowed halls of that storied institution, I did what any good student would do: I spent the night

before cramming. Not wanting to be anything less than prepared, I absorbed 400 pages of

Unconventional Success, Swensen’s manifesto on personal investing and diversification, before the

meeting. What follows is an edited and abridged version of our nearly four-hour interview.

You work on behalf of one of the largest institutions in this country, yet you have a deep interest

in and commitment to the individual investor. Talk to me about that.

I’m basically an optimistic person, but when it comes to the world that individual investors face,

DS:

it’s a mess.

TR: Why is that?

The fundamental reason that individuals don’t have the types of choices they should have is

because of the profit orientation in the mutual fund industry. Don’t get me wrong, I’m a

DS: capitalist, and I believe in profits. But there’s a fundamental conflict between the profit motive

and fiduciary responsibility—because the greater the profits for the service provider, the lower

the returns for the investor.

When we’re talking about fiduciary responsibility, not all investors even know what that means.

TR:

What we’re really talking about is: you have to put investors’ interests ahead of your own.

The problem is that the managers of the mutual funds make more money when they gather huge

piles of assets and charge high fees. The high fees are in direct conflict with the goal of

producing high returns. And so what happens over and over again is the profits win and the

DS: investor seeking returns loses. There are only two organizations where that conflict doesn’t

exist, and they’re Vanguard and TIAA-CREF. Both operate on a not-for-profit basis—they’re

looking out for the investors’ interests, and they’re strong fiduciaries. And fiduciary

responsibility always wins.

Because mutual funds spectacularly underperform the market. I’ve read that from 1984 to 1998,

only about 4% of funds [with over $100 million in assets under management (AUM)] beat the

TR:

Vanguard 500. And that 4% isn’t the same every year—a more simple way of saying that is that

96% of all mutual funds fail to beat the market.

Those statistics are only the tip of the iceberg. The reality is even worse. When you look at past

DS:

performance, you can only look at the funds in existence today.

TR: Survivors.

Exactly. Those statistics suffer from survivorship bias. Over the last ten years, hundreds of

mutual funds have gone out of business because they performed poorly. Of course, they don’t

DS: take the funds with great returns and merge them into funds with lousy returns. They take the

TR:



funds with lousy returns and merge them into funds with great returns.

TR: So the 96% isn’t accurate?

DS: It’s worse.

TR: Wow.

There’s another reason the investor’s reality is worse than the numbers you cite, and that’s

because of our own behavioral mistakes we make as individual investors. Individuals tend to

DS: buy funds that have good performance. And they chase returns. And then when funds perform

poorly, they sell. And so they end up buying high and selling low. And that’s a bad way to make

money.

TR: What’s the reality of chasing returns?

A lot of it has to do with marketing. Nobody wants to say, “I own a bunch of one- and two-star

DS:

funds.” They want to own four-star funds. And five-star funds. And brag about it at the office.

TR: Of course.

But the four- and five-star funds are the ones that have performed well, not the ones that will

perform well. If you systematically buy the ones that have performed well and sell the ones that

DS: have performed poorly, you’re going to end up underperforming. So add to your statistics that

more than 90% of funds fail to match the market, and then add in the way people behave—they

further depress their returns below the market.

TR: So chasing returns is a guaranteed way to have a lower return or lose money?

Those factors that randomly cause something to perform well are just as likely to reverse

DS: themselves and cause what had performed well to perform poorly—it’s called reversion to the

mean.

TR: Okay, so what can investors do to help their cause?

There are only three tools, or levers, that investors have to [increase] returns. The first is asset

allocation: What assets are you going to hold in your portfolio? And in which proportions are

DS:

you going to hold them? The second is market timing. Are you going to try to bet on whether one

asset class is going to perform better in the short run relative to the other asset classes you hold?

TR: Are you going to be in bonds, or stocks, or real estate?

Yes, those short-term market-timing bets. And the third tool is security selection. How are you

DS: going to structure your bond portfolio or stock portfolio? And that’s it. Those are the only three

tools we have. The overwhelmingly most important [as you figured out] is asset allocation.

TR: I read that in your book, and it blew me away.

One of the things I love teaching my students at Yale is that asset allocation actually explains

more than 100% of returns in investing! How can that be true? The reason is, when you

DS: engage in market timing, it costs you money; it’s not something you can play for free. Every time

you buy or sell, you pay a broker. So there’s a leakage in fees and commissions paid—which

reduces overall returns. And the same is true for security selection.

TR: So this takes us back to index funds and a passive approach to investing.

Right. The active managers charge higher fees with promises of beating the market, but we’ve

DS: seen it’s a false promise more often than not. You can take a passive approach and own the

whole market. And you can buy the entire market for a very, very low fee.

TR: How low?



Less than 20 basis points. And you can get it through a mutual fund offered by Vanguard. So if

DS: you can implement your investment with low-cost, passively managed indexed funds, you’re

going to be a winner.

TR: You’re not paying fees, and you’re not trying to beat the market.

Plus, you get another benefit: your tax bill is going to be lower. This is huge. One of the most

DS: serious problems in the mutual fund industry, which is full of serious problems, is that almost all

mutual fund managers behave as if taxes don’t matter. But taxes matter. Taxes matter a lot.

TR: Is there any bigger bill we face in our lives?

No. And this speaks to the importance of taking advantage of every tax-advantaged

DS: investment opportunity that you can. You should maximize your contributions if you’ve got a

401(k), or a 403(b) if you work for a nonprofit. You should take every opportunity to invest in a

tax-deferred way.

TR: How do we set up the most efficient asset allocation?

Anybody who’s taken freshman economics has probably heard “There ain’t no such thing as a

DS: free lunch.” But Harry Markowitz, whom people call the father of modern portfolio theory, says

that “diversification is a free lunch.”

TR: Why is that?

Because for any given level of return, if you diversify, you can generate that return with a lower

DS: risk; or for any given level of risk, if you diversify, you can generate a higher return. So it’s a

free lunch. Diversification makes your portfolio better.

TR: What’s the minimum diversification you need?

There are two levels of diversification. One is related to security selection. If you decide to buy

an index fund, you are diversified to the maximum extent possible because you own the whole

market. That’s one of the beauties of the index fund, and it’s one of the wonderful things Jack

Bogle did for investors in America. He gave them the opportunity in a low-cost way to buy the

DS: whole market. But from an asset-allocation perspective, when we talk about diversification,

we’re talking about investing in multiple asset classes. There are six that I think are really

important and they are US stocks, US Treasury bonds, US Treasury inflation-protected securities

[TIPS], foreign developed equities, foreign emerging-market equities, and real estate investment

trusts [REITs].

TR: Why do you pick those six versus others? And what’s your portfolio allocation?

Equities are the core for portfolios that have a long time horizon. Equities are obviously riskier

than bonds. If the world works the way it’s supposed to work, equities will produce superior

returns. It’s not true day in and day out, or week in and week out, or even year in and year out,

DS:

but over reasonably long periods of time, equities should generate higher returns. I have a strawman portfolio in my book, and 70% of the assets in there are equities [or equity-like], and 30%

are fixed income.

Let’s start with the equity side of the portfolio: the 70%. One of your rules for diversification is

TR:

to never have anything weighted more than 30%, is that correct?

DS: Yes.

TR: And so you put the first 30% where?

US stocks. One of the things I think that’s really important is we should never underestimate



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