Description

Thesis Overview: The IEP floating rate converts due 2013 currently offer a compelling investment as a result of the dislocation in the bond markets that has left certain securities somewhat orphaned in recent months. The converts are difficult to price but did trade at around 59 cents on the dollar last week. Using the minimum 4% coupon for the converts, this equates to a yield-to-maturity of around 20% despite the fact that the non-convertible bonds in the same company which are pari passu to the converts yield approximately 14%. This discrepancy likely exists primarily as a result of the recent blow-up in the convert market generally and the fact that the converts, while being a sizeable $600mm issue, are somewhat illiquid and are one of only a handful of converts not picked up by ordinary bond pricing services. In addition, the straight bonds do also mature slightly sooner from 2012-2013.

In terms of the absolute yield offered by the convert, this is likely high in part due to the complexity of the company, total lack of analyst coverage, usual historical self-dealing and other issues related to having an aggressive, sophisticated control shareholder like Carl Icahn. On the positive side, the company, being aggressive and sophisticated, bought back $44mm in bonds out of $600mm total and likely has continued to repurchase during 2009. In addition, Icahn owns 90% of the equity in IEP which has an equity market cap of in excess of $2bn, and has bought additional stock personally on an almost daily basis of late.

IEP Overview: Icahn Enterprises LP (ticker: IEP) is a master limited partnership that is controlled by Carl Icahn and contains a variety of investments including cash, a direct investment in Icahn's hedge funds, a currently out-of-the-money GP incentive interest in the funds and other direct investment stakes including 75.7% of Federal Mogul (ticker: FDML), PSC Metals and relatively small home fashion and real estate interests.

Asset Coverage: Importantly, IEP had significant assets in excess of its total debt as of 12/31/2008 adjusted for subsequent investment of $250mm in funds:

• Total Holdco Cash                                  $1,119mm
• IEP Net LP Interest in Icahn Funds         $910mm*
• Federal Mogul Stake                              $768mm**
• Subtotal Primary Assets                         $2,797mm
• Total Debt:                                                  $1,869mm

*not subject to ordinary investor lock-up provisions

**at current prices

Other Assets: Assets left out of the above coverage include:

• PSC Metals: Marketer of scrap metal that generated $1.2bn in revenue and $103mm in 2008 though the business fell off a cliff after Q3 losing $20mm EBIT in Q4
• Real Estate: 31 retail, office and industrial properties  with book value of $896mm including $465mm purchased in 2008 that generated income from continuing operations in 2008 of $14mm
• WestPoint International: Designer and distributor of bed and bath products that produced $425mm in sales in 2008

Other Issues:

Recent Performance / Redemptions: Icahn's funds were down 35.6% gross in 2008 and suffered 14% net outflows at year end. We don't have access to Icahn's monthly performance though it was stated on the call (3-5-09) that the funds were in positive territory for 2009 at that point vs. significant negative index performance. As mentioned, IEP put an extra $250mm into the funds on January 1, 2009.

Hedging: The converts can be hedged in part or fully by shorting IEP or the FDML stake. This does not appear to be necessary given that asset coverage mentioned above. In addition, the small float and insider buying at IEP may work against you in shorting the stock. One other interesting trade might be to hedge out the converts with the straight bonds given their equal ranking in terms of seniority.

Icahn Factor: Obviously this investment requires some faith in Icahn's ability to manage capital. Despite the recent poor performance and some ill-timed recent investments (FDML, YHOO, others), Icahn does, as we understand, still have a very good long term track record. In addition, he has a tremendous amount of skin in the game owning 90% of IEP which is worth some $1.8bn at current levels. This stake should provide a level of comfort with regard to some of the self-dealing issues (10K provides history of Icahn entities selling various stakes to one another).

Catalyst

continued company repurchase / maturity in 2013