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Carl Icahn is Famous for Raising Hell, But Which Balance Sheet Item Obsesses the Investor?

Activist shareholder Carl Icahn is getting good press these days for shaking up corporate managements. It looks like Icahn is striking out against quarterly profit declines. But if you want to make money like Icahn, keep in mind that his real focus is on something else: cash on the balance sheet.

Robust cash generation attracts Icahn into a stock. Once he declares a stake, he prods management when he sees declining cash and dubious cash deployment.

Take for example his investments in oil and gas developer Chesapeake Energy (CHK) and truck and engine maker Navistar International (NAV).

In 2010, when Chesapeake’s stock price was in a rut, Icahn spotted a sharp rebound in cash from operations. He invested and watched the stock rally in early 2011. Then, with cash generation faltering he sold as the share price peaked. Cash has revived, and Icahn is back in the stock.

CHK Cash Operations TTM Chart

CHK Cash Operations TTM data by YCharts

Before Icahn first reported a stake in Navistar a year ago, the company’s cash from operations had blossomed. Speculation at the time suggested he would seek a merger of Navistar with specialty truck maker Paccar (PCAR), whose cash generation was beginning a rebound. Now, Icahn wants to restart the Navistar cash engine.

NAV Cash Operations TTM Chart

NAV Cash Operations TTM data by YCharts

This year, Chesapeake is restructuring its board in the wake of recent complaints by Icahn and other institutional investors over spending and poor results. Icahn recently has boosted his stake in Navistar after the company surprised Wall Street with its second-quarter loss and slump in cash from operations. Navistar restructured management in the wake of the news.

CHK Earnings Per Share Chart

CHK Earnings Per Share data by YCharts

The CEOs –- Aubrey McClendon at Chesapeake and Daniel Ustain at Harvester -– are under scrutiny in the press. McClendon gets attention for a pattern of costly wildcatting for oil and gas wells, and for conflicts of interest with his personal investments. Ustain is unpopular for making weak excuses for the company’s recent slump against competitors Paccar and Oshkosh (OSK).

NAV Revenues TTM Chart

NAV Revenues TTM data by YCharts

Share prices have collapsed accordingly.

CHK Chart

CHK data by YCharts

The companies seem like easy targets for assertive shareholders. An important question for ordinary investors is: what causes a long-term, value-seeking investor like Icahn to act? Newly published academic research suggests that these investment gurus pay a lot of attention to how company managers raise and deploy cash over long periods.

At Navistar, chances are good Icahn's increased holdings (12%, up from 10%) are pressing management for a rebound in cash from operations. Cash from operations is stumbling at Chesapeake Energy too. But Icahn’s bigger concern here seems to be how CEO McClendon is spending company cash. Icahn and institutional investor Southeastern Asset Management want a tighter grip on expenses.

CHK Cash Operations Chart

CHK Cash Operations data by YCharts

Investors often miss problems with long-term cash policies because they get obscured by earnings per share figures that can rise even as cash levels fall. Investors with the hefty research budgets of Carl Icahn can uncover the cash policies over time and potentially exploit the faults of short-term investment thinking. Factors like PR battles and commodity prices may rock the share price temporarily, but they’re not as important in Icahn’s long-term investment strategy.

“It is easy for managers to misuse cash holdings and hard for investors to evaluate the use of cash holdings,” write finance scholars Jarrad Hartford, Ambrus Kecskes and Sattar Mansi, who analyzed the activists’ strategies in the study above. “We predict that firms with longer investor horizons should hold more cash. Moreover, firms with cash holdings in excess of what they need to finance profitable projects should invest less and pay out more the shareholders if they have longer investor horizons.”

Icahn would likely agree. Consider auto supplier Federal-Mogul (FDML), a company in which Icahn owns nearly 80% and is the non-executive board chairman. Last year, as cash from operations was slumping, Icahn announced he was exploring a sale of the company. Cash operations numbers picked up in the latest quarter. Icahn has not pressed for the sale of the company recently.

FDML Cash Operations TTM Chart

FDML Cash Operations TTM data by YCharts

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