Headline:
Front-Running 13D Disclosures: Something Is Very Wrong Here
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“Activist Investors”, the relatively new classification for corporate agitators, want you to believe that their intellectual tactics/strategies improve both corporate governance and shareholder returns.
That may be true but they also seem to be involved in another, less savory, tactic…that is inflating their claims of company “ownership” with extremely large, and extra-ordinarily short dated/price sensitive, derivatives positions.
The derivatives positions are, typically, not converted to common shares until AFTER the MARKET MOVING, COMPULSORY SEC 13D Disclosure Filings…usually/already deep “in the money”.
Nothing like a “free ride” on the back of the ignorant SEC. Is it legal? Maybe/Maybe Not.
But it certainly does not “smell” right…as this exclusive breed of both newer and established “Activists”, unfortunately, perpetuate the idea that Wall St. is still = a “Den of Thieves”.
That SEC chief Mary Jo White, and her substantial staff of attorneys, have not taken notice of this loop-holed tactic also point to another glaring weakness = the federal government’s “asleep at the wheel” regulators.
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Two recently disclosed positions by “Activist” powerhouses JANA Partners and Carl Icahn will serve to illustrate this phenomenon. Of course, they are not the only firms/personas engaged in these controversial positioning techniques.
Any discussion of dicey, “Activist” trading tactics must also include Pershing Square’s Bill Ackman…he who built a very large stake in the “old” Allergan/AGN knowing, full well, that Valeant/VRX would be bidding to acquire the company. Somehow, in the SEC’s complicated and twisted legal morass, that maneuver was ironically considered both “kosher” and legal.
However this particular “post” will focus on JANA Partners’ place-holding in ConAgra Foods/CAG and Icahn’s footprint in Freeport McMoRan/FCX.
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First off…a little background on JANA/Icahn and their disclosure responsibilities to the SEC.
As of June 30, 2015 [13F Filings] JANA Partners, managed by Barry Rosenstein, managed a portfolio valued at $16.8B with Icahn’s equaling $31.2B. Further, the investment track records, for both, are very good…especially since the market trough in 2009…but even prior to that.
In addition to managing capital both JANA/Icahn must also tend to an array of mandated administrative tasks including public filing disclosures with the SEC. The quarterly Form 13F, in particular, is of keen interest to many industry observers.
This filing specifically reveals a fund’s portfolio composition [as of calendar quarter end]. For all to see… newly acquired positions/liquidated prior positions/existing positions trimmed or added to…punctuated by their dollar value. A true window into the portfolio…but it may be time lagged, to a maximum, by 6 Weeks/45 days…and, typically, not all AUM are subject to the 13F filing. However, in the cases of JANA and Icahn, the majority of the firms’ AUM are reflected in their respective filings.
Moreover…if any investor [including “Activist’s”] acquires 5% of the common equity outstanding [directly or indirectly], of a publicly traded company, it is required [at a minimum] to file an SEC Schedule 13D within ten days of crossing the 5% threshold.
It is also important to note that a firm can request an exemption from disclosure if a position is currently being acquired…as it could interrupt their accumulation pattern and price tolerance[s].
This “Schedule”, once filed with the SEC, immediately becomes publicly accessible. JANA’s 13D was disclosed on June 18, 2015 [5% threshold met on June 8] while Icahn revealed his 13D on August 27, 2015 [5% threshold met on August 17]. Both filings occurred after the close of regular trading hours and adhered to the SEC’s dubious “beneficial ownership” definitions.
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SEC’s DEFINITION OF BENEFICIAL OWNERSHIP:
The SEC, supposedly in the business of enforcing disclosure, seems to be running afoul of its own mandate. They’ve technically refined Webster’s “Ownership” as “Beneficial Ownership”…certainly loosening/stretching the intuitive definition as follows:
Beneficial Ownership =
Direct/Stock Ownership [D/SO]
+
In-Direct/Derivative Ownership [I/DO]
Despite being combined in the SEC’s “Beneficial Ownership” definition these two “ownership” sub-categories are quite different. Specifically, the typical rights accorded to D/SO i.e. voting and dividends are NOT accorded to I/DO.
Derivatives simply offer a trader/investor the RIGHT to future ownership/liquidation with a “hard” set of conditions/choices [buy/sell, strike price & exercise/maturity dates]. Until/If that RIGHT is exercised the trader/investor actually does NOT own/is NOT “short” the underlying asset.
So the 13D’s [filed by Icahn’s and JANA’s legal clans] classifying “Ownership” stakes as 88M/31M shares of FCX/CAG [suggesting approximate capital commitments of $1.1B & $1B] respectively is, in reality, such a great distance from the truth that it is almost comical [see below].
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“OWNERSHIP” POSITIONS:
Icahn/FCX [at time of filing]
88M Shares Beneficially Owned
8.46% of FCX Common Shares Outstanding
52.011M = 5% Ownership Threshold [13D]
3.254M Shares = Directly Owned = Stock
80.402M Shares = In-Directly Owned = Forward Contracts
12M Shares = In-Directly Short = Put Options [implied long position]
4.344M Shares = *Unknown [Direct vs. Indirect?]*
JANA/CAG [at time of filing]
30.863M Shares Beneficially Owned
7.20% of CAG Common Shares Outstanding
21.352M = 5% Ownership Threshold [13D]
6.732M Shares = Directly Owned = Stock
19.032M Shares = Indirectly Owned = Call Options
5.099M Shares = *Unknown [Direct vs. In-Direct?]*
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*13D filings require disclosure of executed positions within the prior 60 days. Any “positioning” prior = no obligation to disclose.
For JANA, since the 13F [dated 3.31.15], did not reveal any prior position in CAG [unless they were exempted…as discussed above] it is likely the “Unknown” share quantities of 5.099M shares were “acquired” between April 1 and April 19.
Icahn’s “Unknown” share quantities are a little more complicated to track. There was no FCX position listed in the 13F dated 6.30.15 [unless they were exempted…as discussed above]. And despite the claim, in the 13D, of 80.402M shares owned through “Forward Contracts” [a very lightly regulated/regarded derivative] it was only possible to track 57.183M of those shares. Anyway I suppose if he says he owns the derivatives…then he probably does.
Similar to the forward contracts it was only possible to track 3.254M of those shares “Directly Owned”…though the document indicates a position of 7.596M shares. Again …I suppose if he says he owns the shares…then he probably does.*
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Consider please, the most important point of this mathematical detail…that Icahn’s initial [direct ownership position] was, possibly, just 3.254M shares [vs. the 88M ownership stake characterized in the 13D filing].
No matter…even if the “Unknown” classification of shares [from above] were entirely included as “Directly Owned” [as the filing “softly” indicates]…it still would equal just 21.38% of the 88M shares claimed as ownership.
As for JANA…their direct ownership position was, possibly, just 6.732M shares [vs. the claimed 30.863M shares characterized in the 13D filing].
And as with Icahn…even if the “Unknown” classification of shares [from above] were entirely included as “Directly Owned”…it would equate to just 38.33% of the 30.863M shares claimed as ownership. .
Another more direct way to assess this = without the large derivatives positions…the “Market Moving” 5% ownership threshold, in either case, would not have been met. Plainly …not even close. [more on this point later].
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A pundit may indicate…“You may not like the SEC’s beneficial ownership definitions but those ARE the current rules. Your “beef” is with the SEC…not Icahn/JANA. They’ve really done nothing wrong”. I suppose that is possible…while also noting that the current SEC “ownership” definition is exceptionally misleading and distorts the “spirit” of true ownership.
BUT THERE IS SO MUCH MORE TO THIS THAN JUST THE ARCANE/LEGAL EXAMINATION OF SECURITIES OWNERSHIP/DISCLOSURE MANDATES…ALBEIT IMPORTANT TO UNDERSTAND. THE REAL STORY, HOWEVER, BEGINS BELOW.
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Cornerstone Question #1 =
IF THE “ACTIVISTS” TRULY WISH TO ULTIMATELY/”DIRECTLY” OWN THE STOCK [AND INFLUENCE STRATEGIC COURSE AT A TARGETED COMPANY] THEN WHY THE LOPSIDED “FRONT END” POSITIONING IN DERIVATIVES?
1. The most obvious answer is that they are simply “trading” the 13D disclosures with the most price sensitive securities on the planet. So…a quick flip? It is possible…but unlikely.
Both JANA & Icahn have substantial records of legitimately pursuing economic/qualitative reforms at their target companies.
2. Perhaps, then, that the stock is just not liquid enough? In the cases of both CAG & FCX that is just a ridiculous thought. And, typically, if the stock is not too liquid then neither are the derivatives underlying the security.
Anyway, during JANA’s accumulation phase, CAG equity traded about 2M shares/$68M volume/value per/day and CAG is no small company = Enterprise Value = $26.2B comprised of approximately $18.9B [427M shares outstanding] of equity and $7.3B of Net Debt.
And, it appears, JANA was acquiring a position since the beginning of April…not filing with the SEC until June 18th [almost three entire months]. Positioning the common equity, during this extended time period, should not have been too challenging.
FCX was even easier to position than CAG [despite the more brief accumulation window from mid-July to mid-August]…as its liquidity was overwhelming [averaging about 30M shares/$330M traded volume/value per/day].
Actually the stock was in a virtual free-fall [down almost 40% during that time period] and, likely, could have easily been bought in the open market…without much detection…many “times over”.
And, for the record, its Enterprise Value = $31.5B comprised of approximately $12.5B [1.128B shares outstanding] of equity and $18.97B of Net Debt.
3. Another consideration is that derivatives positions, initially, require substantially less capital than core equities positions…but ultimately not…when/if exercised.
4. And then…if the expiration/maturity months are staggered it allows for a more gradual capital commitment. I suppose so.
Some of the above may be true but, even aggregated, are not a tremendously powerful argument for such a dislocated position in derivatives vis-a-vis the common equity.
And if the derivatives positions, for whatever reasons, are so attractive then why even buy any stock? [a point that Icahn seems to appreciate a whole lot more than JANA although, it seems, Rosenstein shares the general sentiment]
Now…to examine the specific positioning techniques.
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DERIVATIVE POSITIONING TACTICS:
Icahn:
The positioning in FCX [July 17 – August 21] is just a dizzying array of purchased “forward contracts” and the extremely questionable strategy of selling puts [as the true intent is to directly position long]. As noted above some stock [minimal quantities] was “directly” purchased.
Amazingly, or not, a portion of the derivatives were purchased on margin. From the filing…Part of the purchase price of such Shares was obtained through margin borrowing.
You have to love it. Derivatives Purchased On Margin. Hey…Why Not? And this is America’s future Treasury Secretary [as in Trump]?
Specifically, Icahn’s forward contracts and short put position offer great detail.
First of all, the “forward contracts” were purchased on just about every day he was transacting. Secondly, the three different contract strike prices [mostly far “out of the money”] are articulated. Thirdly, the share counts [underlying the forward contracts] are noted. Finally, it is stated that the contracts are length-ily dated to mature/expire in March 2017.
Plus, the filing indicates a closely dated maturity/expiration for the shorted put position of mid-September 2015.
JANA:
Rosenstein’s call option positions in CAG offer a less complex picture than Icahn [although no specific purchase dates were cited]. It appears the call options were predominantly “in the money” and closely dated to maturity [all within seven weeks after the 13D was disclosed…most much sooner.]
However JANA, unlike Icahn, elected not to utilize margin when building their options [and equity] positions. “Such Shares are held by the investment funds managed by JANA in cash accounts and none of the funds used to purchase the Shares reported herein as beneficially owned by JANA were provided through borrowings of any nature.”
It also ought to be noted that JANA did not sell any put options. So “cleaner” than Icahn but still a very large derivatives position ahead of a significant disclosure.
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Cornerstone Question #2 =
A LARGE DERIVATIVES POSITION AHEAD OF A “MATERIAL” DISCLOSURE?
YES…but the “material” event, ironically, is not a company pronouncement about a transformative strategic initiative. The event, in these cases, is that the well regarded JANA/Icahn have simply announced 13D sized “ownership” stakes in two separate companies…with plans/attempts to increase shareholder value.
And that they utilize the SEC’s compulsory disclosure procedures to host/act as a conduit for their specious, market moving announcements…This is just SO CUNNING & YET…SO BRILLIANT.
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Cornerstone Question #3 =
IF NOT “THE DERIVATIVES FLIP” THEN WHAT IS THE SPECIFIC STRATEGY?
It is not as obvious as it seems but, still, relatively straight forward.
In a surprising twist it appears these quasi “Masters of the Universe” are, rather than bold and daring, just tremendously risk averse….so risk averse that, despite huge capital bases to draw from, they won’t fully commit to “directly” buying a stock they’ve targeted…until, what I’ve termed, the “Angle” comes about.
The “Angle”…the “Real Angle”, it seems, is to get the stock quickly moving in the direction of/exceed their derivative “strikes”. Of course…Right? Like any rational derivatives player they’ll certainly exercise their “right” to acquire the stock…but only when the market price exceeds their strike price[s]…deferring the uptake of any substantial capital “at risk” until there’s essentially “NO RISK”…as in an EXISTING PROFIT. And their spurious 13D disclosures are just the catalyst to help achieve that objective.
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And so the news “hits” the wires…the inevitable price surges occur: 10.43% for CAG on June 19, 2015 and 3.04% [28.66% the day prior as the information seemed to have leaked] for FCX on August 28, 2015.
Naturally the especially price sensitive derivatives contracts are immediately turbo charged…even though they’ll likely be exercised…as many are now massively “in the money”. The “out of the money” contracts automatically re-price much higher too…as that elusive “out of the money” feature suddenly seems almost attainable.
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In the case of JANA this dramatic price crossover feature [market price > strike price], not surprisingly, coincided with the 13D disclosure.
In the case of Icahn, although the 13D disclosure incrementally improved the values of his positions, the majority of the derivatives, were still “out of the money”…but, it seems, only due to their poorly selected [for now] strike price[s]. Still, certainly a good start [with some profitable “marks”]…but more work to be done.
So collectively…somewhat shrewd…but also tremendously slippery. Who wouldn’t want to either: exercise a massively “in the money” derivatives contract or own almost any derivative on a day[s] when the underlying security increases in value by 10.43%/28.46% +.
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They really do have it “covered”. Don’t they? In the VERY UNLIKELY/IMPROBABLE scenario of an immediate price move down, on a 13D disclosure date, their capital at risk is finite. In the LIKELY/USUAL scenario of a sharp price move higher their capital is favorably exposed…in a BIG WAY.
Almost sounds like an asymmetrical capital hedge. But despite the apt classification these positions are not intended to be hedged. They are intended to generate out-sized, positive returns because, as indicated in their 13D filings [including CAG/FCX], the targeted company’s share price is deemed “undervalued”…but, apparently, not “undervalued” enough to buy a lot of stock…just “undervalued” enough to buy a boatload of derivatives.
Because, with a deceptively large ownership position, the true formula they both seemed to adhere to [in these two cases] goes as follows:
1. Build an Equity-“Light”/”Derivative Heavy” Position In A Target Company.
2. File a Schedule 13D & Threaten To Serve As A Company Change Agent…To Move The Stock Price Up.
3. Only Commit “Majority” Capital When Your Derivatives Positions Are “In The Money”.
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And so, in the midst of all this, just where is SEC Chief Ma-Jo? I’m sure she’s probably “nodding off”, right now, at one of those endless afternoon policy meetings but I suggest she “wake up”… “pound” a Red Bull…and start paying attention.
JANA/Icahn seem to be straddling the razor’s edge of a very dangerous “accumulation” game built on both their own creativity and the ignorance[s] of the SEC. Sure…the “soft dollar-ed” compensated lawyers have it “covered”, but occasionally, they are fallible.
Even though Ma-Jo still can’t determine how to “nail” those High Frequency Traders scalping for nano-pennies on just about every conceivable stock transaction [hint: start looking at Citadel] …perhaps she could examine the aggressive trading/positioning disclosures practiced by some “Activist” hedge funds? It may not “smell” right to her either…or, perhaps, it is more than just a foul smell?