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Finding Value the Icahn Way

By Michael Carr   |   Thursday, 29 May 2008 10:13 AM

Carl Icahn is widely recognized as being among the most active of activist investors. He generally buys a minority stake in undervalued companies and pushes for change to unlock shareholder value.

After studying philosophy at Princeton, Icahn headed for Wall Street with $4,000 he made playing poker. From this humble beginning, he became one of the most feared investors of the 1980s. Today, his personal wealth is estimated to be approximately $17 billion.

Icahn’s investment philosophy is to find underperforming companies with valuable assets. Witness, for instance, his headline-making moves to force Yahoo! into the arms of Microsoft.

What separates Icahn from other value investors is his focus on what he considers to be management’s inadequate focus on shareholder value. He buys in, then creates pressure on management to unlock that value.

After early successes with Texaco and USX, Icahn has of late gained minor concessions from management at Motorola and Time Warner.

“The consensus thinking is generally wrong,” Icahn has said, in explaining his investment style. “If you go with a trend, the momentum always falls apart on you.”

“So I buy companies that are not glamorous and usually out of favor. It is even better if the whole industry is out of favor.” Lately he has turned his attention toward technology companies, in particular healthcare and software.

Trying to say one step ahead of Icahn, this week’s superstar screen looks for stocks which have value the market might not recognize — yet. We searched for companies with signs of good management that are undervalued.

The screen includes:

• Market capitalization of at least $2 billion to ensure significant profits. Like Warren Buffett, Icahn is too large a player to buy small caps.

• Debt-to-capital ratio less than 20 percent, ensuring that management can borrow money if necessary for share buybacks, a popular Icahn demand.

• Less than 60 percent ownership by institutions, making enough supply of stock to acquire a significant stake.

• Return on equity above the industry average, indicating sound management.

• Stock price within 50 percent of its 52-week low, which shows the market is punishing the stock.

Not surprisingly, there are a few tech and healthcare stocks on the list, areas where Icahn has been buying recently. Also not surprisingly, out-of-favor financials appear on the list.

Altogether eight stocks appear on the list of potential Icahn targets:

Cincinnati Financial (CINF)

This insurer has no prime or subprime exposure but holds mostly financial stocks in its equity portfolio, which means it has indirect exposure. Over the long-term, CINF has grown its book value at the same rate as Berkshire Hathaway. With a recent price of 35.51, the 4.4 percent dividend yield exceeds that of almost all other property casualty insurers.

Erie Indemnity (ERIE)

An insurance company with above-average margins and below-average valuation, the stock has been a laggard for years. Recently priced near 51 and yielding 3.4 percent, ERIE is paying patient investors until the market discovers this company.

Franklin Resources (BEN)

BEN owns the Franklin, Templeton, and Mutual Series families of mutual funds. Steady growth in revenues and profits have failed to capture a premium in the stock market, most likely because of the large ownership stake of the founding family. Undervalued brand names have long been attractive to Icahn. Recent price: 98.48.

Garmin (GRMN)

The GPS giant was a classic bubble stock which went up faster than justified by solid fundamentals. Now, the market has overcorrected and the stock is undervalued. Trades near 47.50, just 12 times earnings.

Genentech (DNA)

Concerns about competition for its blockbuster cancer drug Avastin are likely overblown. DNA has 14 potential drugs in testing that can help offset any decrease in sales. At a recent 68.53, the stock is still more than 25 percent below its 2005 highs.

Mercury General (MCY)

MCY is rated “Outperform” by Credit Suisse based on takeover expectations. Their analysts say, “This expectation reflects both the fact that over 50 percent of the stock is held by two individuals in their 80s as well as that Mercury has some 9.7 percent of the personal auto insurance market in California supported by perhaps the state’s strongest agency plant. This asset is coveted by many.” At 50.54 a share, MCY is at least 16 percent below their target price.

NetApp (NTAP)

Financial companies make up the majority of this company’s customers. The data-storage giant should recover with the financial industry but could also do well diversifying into other sectors. Recent price: 23.92.

SEI Investments (SEIC)

An S&P A-plus quality ranked stock, SEIC has one of the highest returns on equity in its industry but one of the lowest P/E ratios. This investment advisory firm traded at 23.45 recently.

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MichaelCarr
Carl Icahn is widely recognized as being among the most active of activist investors. He generally buys a minority stake in undervalued companies and pushes for change to unlock shareholder value.After studying philosophy at Princeton, Icahn headed for Wall Street with...
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