Motley Fool Money - Short-Seller vs Prize Fighter

Episode Date: May 17, 2023

What happens when a short-seller collides with an activist investor? (00:21) Bill Barker discusses: - Target's 1st-quarter results beating expectations - CEO Brian Cornell's comments about organized (and violent) retail theft - Retail sales rising in April (11:15) Dylan Lewis and Bill Mann discuss Hindenburg Research's report on Icahn Enterprises, raising questions about the conglomerate's accounting practices and its dividend. Companies discussed: TGT, HD, IEP Host: Chris Hill Guests: Bill Barker, Dylan Lewis, Bill Mann Producer: Ricky Mulvey Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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Motley Fool Money starts now. I'm Chris Hill, joining me in studio today, Motley Fool's senior analyst Bill Barker. Thanks for being here. Thanks for having me. Let's talk Target, shall we? First quarter results were better than expected. I'll leave it to you to tell me how high those expectations may have been. The thing I said the other day on the show that I was going to be watching with Target specifically was their inventory level.

Inventory dropped 16% over a year, so it's moving in the right direction. They still have some work to do there. But it seems like this report and the comments from management were at least welcome on Wall Street because shares are up about 3% as we're having this conversation. Yeah, I mean, there's not a whole lot that's been changing here. You may recall that exactly 12 months ago, they threw out a report that took the stock down 25% in a day. I remember. I'm a shareholder. We all remember. So what was the rest of that day like for you? Kind of like all of 2022. Yeah. So they've been hanging around the same price. I mean, the same price today

that it was at the end of that day. And they reset expectations at that point, and they haven't really changed them today. They reiterated their guidance for the rest of the year. Things are more flat than anything else, both on the stock price and on sales, when they're basically flat year over year on the sales, and you know that inflation over that period of time has been ballpark 6, 7%. You do the math. They're not really selling more stuff as much as they're selling a little bit less at higher prices, and nothing is really evolving at the moment here. Yeah, I think if you go back a year or so, and even really just until the end of 2022, Target was a business that you could look at and say they have a lot of work to do.

I look at this report, the inventory being just one example of, all right, they're making progress. They're doing the things they need to do, but they're not where they want to be as a business. And one of the things, I wanted to get your thoughts on this, one of the things CEO Brian Cornell talked very specifically about. And I'm curious to see if this is going to be something that we hear more of from other retailers. He talked about organized crime. He specifically said that in the case of Target, their profitability is going to drop by about half a billion dollars compared to a year ago. And I'm quoting here from the conference call. He said, the unfortunate fact is violent incidences are increasing at our stores and across the entire retail.

industry. Shrink is one of those things every retailer deals with, and it is more often than not almost a footnote to any one quarterly result. This is the first time in a while, I can recall a major retailer CEO giving this much sunshine to this topic. And I'm curious if you think we are going to hear, you know, we're going to hear from Walmart later this week. do you think this is something that we're going to get more commentary on? Because they're all dealing with it. But Cornell is really calling this out as a problem for them. Yeah, half a billion dollars is a problem.

And it's sort of a public negotiation, which is, he's saying, look, other people have left. Other companies have left some of these urban locations because whether they've said it exactly or not, They have said, you know, the employees were concerned for employee safety, so they're leaving certain urban locations. And what he's saying is we would like not to leave them. We haven't left them yet.

But we need some help. We need some more, essentially, we need some more police help. They're not going to draw a gun or something in the store if somebody breaks in and steals things. So what can they do? They can hire a few more security guards, but there's really not a good solution within the store to a crime that's going if the police actions aren't supporting them. So companies have the choice to leave places they don't want to be either for profitability,

for safety reasons. And he's, I think, calling out to like, what can you do? We want to be here, but we can't do it on our own. I want to go to the broader retailer environment in a moment. But first, just specifically with Target, you talked about the stock drop over the past year. When you look at this business and where the share price is right now, how attractive is this as a business? I think long term, it's attractive. I mean, not necessarily ballparking today's exact price and saying what's going to happen over the next year.

But long-term shareholders of Target have been well-served, and so there's every reason to think that's going to be a good investment over the long term. Now, you could have said that a year, year and a half ago when the stock was almost double what it is right now, and you would have been proven fairly wrong. So you don't want to just put your stock in, oh, this has worked out well over the long term, and any price is justifiable. Now, you're seeing the stock at a P.E. of about 27, which I would call high in general. Earnings are supposed to pick up next year and the year after, and you're looking at something

more on like 16 times two-year-out earnings. So there's still a lot of confidence, a lot of, I would say, optimism priced into the stock, just not the same level of optimism, as was the case with many other stocks toward the end of 2021. We also got the monthly retail sales data for April, and it was up. Not a lot, but overall retail sales up almost half a percent that reverses a trend of several months of retail sales declining. I like this for a couple of reasons. One, it's just nice to see it moving back up again. But the other reason is, I said coming into the earning season. And it's always nice to be proven right, because it doesn't happen that often

for me. But I said coming into this earning season, this is going to be one of those seasons where every company is going to be judged on its own merits. This is not like a year ago where it didn't matter how good your numbers were or how rosy your guidance was. Stuff was selling off. This wasn't like the second half of 2020, where it didn't matter how brand new your SPAC was to the public markets or how shaky your business was, pretty much every stock was being bid up. This earning season, it really seems like every company is being judged on its own. And this retail data, it gives ammunition to the retailers that are delivering, and it doesn't really give cover to any retailer management team who is tempted to excuse not so great results

by saying, well, look, consumers just aren't spending. It's like, no, consumers are spending. They just might not be spending at your place. Yeah, well, they're spending on some things and not others, which is always the case. Quarter over quarter, year over year numbers, consumer staples are up about 13%. That's a lot of inflation, and people are continuing to buy staples. Discretionary, up 3% year over year. This is across the S&P 500, and that's inflation adjusted. That's a negative number.

So, people have to spend on food. They're spending about as much as ever, maybe a little more. Americans, a little bit more food all the time. Although, as we talked about recently, price of bacon has come down. Yeah, not enough. I mean, for those of us that prefer to have too much bacon. So that's where things are right now. People are spending more on experiences.

Everybody knows this. They're getting out. able to get out a year ago, you still were dealing with the Omicron, sort of the outer edge of the surge on Omicron, but you still couldn't travel easily back and forth internationally without getting a negative test. So that is all going well. You look at the cruise lines are up like 60 percent year-to-date. That's off being hit pretty hard. So the more discretionary experience, that's up, discretionary home. You talked about Home Depot, I think, down, and Staples, well, people need their staples. And then part of Staples is the health and beauty.

I think Target pointed that out. People are going out more, so there's, you know, more call for looking good when you do so. Although it seems like, you know, Home Depot's latest results aside, It seems like you're personally doing everything you can to boost the home improvement landscape. Yeah, I don't know why you've got to raise that, you know. I didn't bring up how good you look and how much you must be spending on beauty products this week. Look at you. You look younger than ever. It's an audio podcast.

But, you know, I appreciate that. And I know that, like anyone who undergoes a home renovation, it's not necessarily going to schedule. but the Home Depot shareholders like me, we appreciate what you're doing. And the Target people enjoy the lotions that you've been buying or really whatever it is that's making you look so young today. Well, if they were a sponsor of the show, I'd give them a shout-up, but I'm not going to do that. Are we going to talk about anything else here? Was there anything you wanted to hit before I kick you out?

I don't know. I mean, it seems like an appropriate thing to do to kick me out. Bill Barker. Always good talking to you. Thanks. Up next, Dylan Lewis and Bill Mann break down the recent report that Hindenburg Research published about Icon Enterprisers, including questions surrounding the company's accounting practices, its dividend, and why shares of Icon Enterprises fell by 30% over the past month?

Iconn Encprises, the holding company owned and led by Carl Icon, has been scrutinized recently by short sellers at Hindenburg Research. They published a report in early May questioning. elements of how the company operated, specifically calling out valuations for its private and illiquid holdings and expressing concerns over the company's premium to its assets and the sustainability of its dividend yield. To talk through that and explain what's going on for investors, I'm joined by the Motley Fools, Bill Mann. Bill, thanks for joining me. Hey, Dylan, how are you?

I'm good, and I think I'm probably having a little bit of a less chaotic month of May than the folks at Icon Enterprises. We had a short report come out from Hennberger Research, like I mentioned, and following that short report, the U.S. Attorney's Office for the New York Southern District contacted the company seeking information related to asset values, governance, and more. All to say, this short report came out a couple weeks ago, and it seems like there is a lot worth paying attention to here. Wanted to dive into it, but I know that ICON Enterprise is one of those companies that we don't talk about a whole lot on the show, and it's actually kind of a lesser followed public company. So I want to just kind of

set the table here, what does this company do and how do they make money? So, it is an expression of Carl Icon's portfolio of companies that they've owned. You can think of it as being an asset manager. It is somewhat strange to me that the company is even public. And I think that the reason that it is public is because it is meant to give Carl Icon and his family some access to liquidity. It also allows that the reason that it is public, them to take margin loans against their holdings. And they have taken huge amounts up to 60% of his personal holdings in ICON holdings have been pledged for margin loans. So it's a weird company. They own the Icon family owns 88% of it. So it is a controlled entity. So I'm not sure why

they went public. But once you go public as a company, you have a different set of obligations. than you do as a private investor. And crucially, one of the things we should probably get out in front of here is this is a limited partnership business. And so we may be talking about units. You can think of those as shares, just to add a little complexity to the conversation. But if you hear us talking about units, it's just because this is a slightly unique structure. But there were a lot of different categories that the Hindenberg report called out, Bill.

We had the way that they were booking some of their private and less liquid holdings. were elements of just the sheer premium that the company traded to relative to its net asset value, discussion of the dividend and its sustainability. Where do you want to jump into here? What's most interesting to you? I think that the most important thing to jump into is how they are valuing their illiquid assets. There are processes by which this happens, right? And they are well-known. But if you're talking about something that's illiquid, there is a huge, you know, there is a huge amount of judgment that you can put into how it is valued. But if you've got a whole series

of holdings that are generating some form of cash flows, you have to be able to go back and show, I mean, you have to go back and be able to show how you went about valuing them. And so what Hindenberg is saying is that the icon enterprises valuations are somewhat inscrutable, and they are very, very high. And you're talking about a company that is closely held by the family. So they don't really have to answer to shareholders. You know, they can't be voted out. They have 88% of the votes plus. But at the end of the day, because there are minority shareholders and because there is, because there is a dividend that, you know, not obligated to pay the dividend, but it is very much front and center why they are suggesting

that people should invest in ICON enterprises. So, the valuation of those illiquid assets is very much germane as to whether this company is worth anywhere near what it suggested is. You mentioned the dividend, and I want to dig into the dividend policy a little bit, because I'm sure for people that are a little less familiar with this company, maybe doing that first search and kind of taking a look at the stock, the company's yield probably pops out to a lot of people. Current yield is around 24%. Shares have fallen about 30% since the short report came out, but this is always a company that had a relatively high dividend relative to the price of its units. And it comes up in the short report because there's questions about how long the company

can continue to pay out this high yield. And because, Bill, the... the dividend itself is structured in kind of a unique way because not all shareholders are receiving that same dividend. You are getting at a lot of the reason why we haven't talked about this business very much as a, you know, as a company that we would be interested here on The Motley Fool. It is a structure that is essentially to the benefit of Carl Icon and his family, and kind of outwardly so. So, the dividend yield itself is not something that is, I don't know, to put this the right way, it's not necessarily the fault of the company, right? When you've got a 24% dividend yield, what the market is saying is that they do not believe

that it is sustainable. They believe, for example, in these types of structures that some of the dividend comes in the form of a repayment of capital, as opposed to. to as opposed to income. So a 24 percent dividend yield, that's not set by the company. What that is being set by is the market saying, we don't believe that this to be sustainable. Because I don't know if you know this, Dylan, but the market is pretty good at determining what companies are worth over the long run. Yeah, the market has an incentive.

You've heard this, right? And to do it at scale. Yeah. And what jumped out to me is just the, the, the, you unusual nature of the way that those dividends are paid out and how that may or may not affect the sustainability of the dividend. Typically, when people hear dividend, they assume we're talking in cash, and that is true for a lot of the investors that own units of ICON enterprises. However, the largest shareholder, as you mentioned, the ICONs own about 85 percent, receive the dividend in units instead of in cash. And that seems to kind of match. ask whether or not this is a cash dividend that's actually sustainable.

Yeah, and it is such an interesting thing because essentially the way that they are doing it allows for the company to re-concentrate additional shares in the Icon family to, you know, to Carl Icon. And lots of companies have differential dividend pay. out. So it's not something that you would look at and say, this is illegal or immoral or fattening. It's fine. But whenever you see that, you do want to ask yourself, who benefits? Why did they structure it this way? And ultimately, what are the additional risks, not just to the dividend, but to the principle of the company that you own? And so just a second ago, I mentioned that it was a return of capital as opposed to fully a dividend. And basically what that means is that when a

company does not generate enough income to satisfy a dividend. Essentially, what they're doing is paying out of money that they would conceivably otherwise be reinvesting into other businesses. And to that end, Bill, the company has not been profitable, I believe, for the last four years. And so there hasn't been income to share with investors, which kind of gets that exactly what you were talking about there. Yeah, you've got to be a little bit careful when you're talking about, when you're talking about LPs like this, because not necessarily profitability, because they don't have huge income streams from the business itself. A lot of those income streams are passive because through the holdings in some of the companies that they own, so like, for example,

Sandridge Energy the other day announced that they were paying a much larger dividend and a return of capital, and they were doing a buyback. So, that's a company that IEP IKIN Enterprise's owns, so they will get cash from that. People are looking at that going, well, that's kind of interesting timing. But that's where the income comes from. So, you have to be a little bit careful when you talk about a company, a asset manager's profitability. That's not necessarily the most important way to look at it.

But still, that cash for a dividend does have to come from somewhere. We talked about how Carl Icon and his family are receiving the dividend in shares or units. Shares outstanding for this business have effectively doubled over the last five years. And that's a roundabout way, Bill, of saying that there's been some pretty heavy dilution with this business as a consequence of just how it's operated. Yeah, and that's one of the claims of Hindenberg. And I do want to make sure that we do say this so that people are. who are listening are clear. We have not corroborated what Hindenberg is saying. So when I say Hindenberg is saying this, I don't know that it's true. I do know that their win-loss record is

pretty, pretty strong. So I would take it as being a credible suggestion. But one of the things that they're saying, because the icons have levered up so much and they've taken so much money out in the form of margin loans against their own holdings, that they presume that the icons are using the money that they have received from shares to prop up the company by buying additional shares, which is an incredible way to look at it. That would be, if it is true, and Hindenberg uses this word, it would be Ponzi-like. It would be a way to prop up a company. And it's fine if you can fill that hole, I guess. Well, I mean, ultimately, it's not fine. But if you can fill that hole, you may be able to get away with it. But if you can't, at some point, the amount of

capital that you have at your disposal is not going to be enough in order to keep the game going. And as far as Hindenberg is suggesting, when that happens, ICON enterprises is going to collapse. It remains to be seen exactly what this all leads to, but I think two weeks out from this initial short report and seeing that there's some interest from folks at the U.S. Attorney's Office in New York, it seems like there's at least something worth paying attention to here. Shares are still down 30 percent from when this report came out. So I think the market is continuing to weigh the merits of what's being discussed here. To me, I think, Bill, if nothing else, this just seems like it shined a spotlight on things

that seem kind of strange for a business or worth paying attention to for a business. And it's okay, I think, for investors if the amount that they pay attention to this kind of stops there, where it's like you take the lessons from this thing and just kind of leave it exactly there. So one thing that's important to note is that Carl Icon has called himself a warrior for corporate transparency. So one of the things that I always think about, when companies go public, if they are a little bit weird. I always just ask myself, why is this happening? Why is this company going public?

Carl Icon did not need for Icon enterprises to go public for him to have been a sensationally successful investor over time. Something was weird about this. I know that's great analysis, right? Hey, it's weird. But something was really strange about this from the outset, why it is that they decided to go public. They don't need or presumably didn't need the capital for additional investing. I think that this was done simply for the benefit and the liquidity needs of the Icon family as Carl Icon comes to the end of his career. And to me, that's not a situation in which I think the average investor should be excited to be on the other side. Bill Mann, you're the man I call.

when things are weird to help talk through it. Thank you for explaining this one and running through it with me. Thanks, Dylan. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy ourselves stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.