Sold ARII for 93.75% Total Return

On Oct 22, ARII (American Railcar Industries) stock was sold at $69.814/share. We purchased the shares in Oct 2013 for $39.99/share. Including the dividends, we achieved a total return of 93.75% on this investment.

ARII was majority owned by Carl Icahn through his investment arm. The original investment thesis relied on the increasing demand for the tanker cars in the US as the shale oil production kept increasing and in the absence of the Keystone pipeline, rail continued to be the transporatation method of choice for shale oil.

The Reason the Stock was Undervalued

The company had undertaken a change in their business model from a manufacturing -> sale operation to manufacturing -> lease operation. As a result, the revenues showed a year over year decline and the stock sold off. Investors failed to realize that the leasing model actually increased the profit margins and locked in revenues for years to come. This of course was a critical piece as the subsequent years showed. With OPEC manouevering to put the US shale companies out of business, the iron clad lease agreements kept the revenue flowing at ARII.

Carl Icahn increased his stake over the years. The company instituted a massive $250 million share repurchase program and Icahn’s stake was exempt. The eventual result, had this program being taken to completion, would have been to increase Icahn’s stake in the company to over 75%.

Icahn’s Exit

It was not necessary as the company was sold to a subsidiary of ITE Management LP, a hedge fund run by a former ARII CEO, at a 51% premium to the market price last week.

This marks a departure from Icahn’s original intent of consolidating the railcar manufacturing in the United States. His earlier attempts to merge ARII with Greenbrier were not successful. Nevertheless, as the economy has boomed in the recent years, the demand for cargo cars has jumped, and this was the right time to sell.

VSG Members’ Profits

ARII was what is called a controlled entity. Icahn had a disproportionate share of the voting stock, and at some point these kind of companies tend to be run for the benefit of the majority shareholder, not necessarily for the minority shareholders. There was risk, but the rewards were tremendous. We could have exited at a better price a few years ago and the oil glut and subsequent slowdown in shale production meanth that we had to wait a few years longer for the profit realization than we intended to. However, the value was certainly there, and regular dividend payments (4% yield on the purchase price) helped compensate us for waiting.

The acquisition will close by the end of this year. We see no point in continuing to hold the stock as the stock should not exceed the sale price of $70/share by any significant amount.

We believe that 93.75% total return over a period of 5 years is adequate. About 14% IRR is not spectacular, but certainly better than the long term market returns.

This investment will be added to the next edition of the case studies.