RealMoney Silver - Piggybacking Activist Investors: Carl Icahn

Piggybacking Activist Investors: Carl Icahn
By Bill Trent
RealMoney.com Contributor
1/18/2008 11:28 AM EST

Oracle's (ORCL) agreement to meet BEA Systems (BEAS) halfway on the price to acquire the company was hailed by InfoWeek as making Oracle a middleware powerhouse.

An investor who likes the latest deal even more than I do is Carl Icahn. I agree with James Altucher that piggybacking the best activist investors can pay off. Carl Icahn's portfolio at Stockpickr lists a few other ideas. First, let's look at the ORCL/BEAS deal, then we'll take a look at Motorola (MOT) .

Consolidation Raises the Stakes

Oracle has been leading the way in software-industry consolidation, and this deal is another step in the process. When SAP (SAP) announced in October that it would be buying Business Objects (BOBJ) , I hoped it was following Oracle's lead. It is better business for SAP to integrate its software with that of Business Objects than to force its customers to do the integration.

In the past, there were just too many different application-software vendors. The excess made competition stiffer than it needed to be and made it difficult for customers to integrate the different products. Oracle figured out that customers would be willing to accept the reduced competition in favor of reduced complexity.

Furthermore, software companies generate so much cash that these deals quickly pay for themselves. For example, Oracle's free cash flow (the difference between the cash generated from operations and cash paid for new equipment) before acquisitions was $6.6 billion over the last 12 months. BEA has averaged another $200 million in free cash flow in each of the last three years. The combined companies will generate enough cash in the next 15 months to completely pay for the acquisition, leaving Oracle's balance sheet as strong as it is today.

In my October column, I said a higher yield and growing free cash flow (at Oracle) compared with a lower, flat one (at SAP) is not much of a choice in my book. Since then, Oracle's stock has continued to outperform, being down just 3.4% compared with a 12.6% decline in the S&P 500. SAP is down 9.8%.

Oracle's 6% free-cash-flow yield, at twice the Treasury rate and growing, more than meets my qualifications for a buy candidate (though I don't currently own it).

Icahn's Interest in Motorola

There is another company in which Icahn has an interest, and it brings me back to the first article I wrote for RealMoney, in which I said a cash flow upturn could carry Motorola upstream. Motorola represents 25% of Icahn's holdings.

In September, I said, "If Motorola can get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there, I estimate the stock would be worth nearly $23, more than 25% above the current price. Management could do that pretty much just by trimming R&D expenses to the 2004 level (which was all they needed to produce the previous hit product anyway)."

The obvious risk, of course, was that cash flow could move in the wrong direction. And it did. Free cash flow over the trailing 12 months ended in September was just $325 million, compared with the 2004 level of $2.5 billion. With the cash flow, the stock has also headed down -- 19.1% since I wrote that article, compared with a 6.5% drop in the S&P over the same period.

At the new (lower) enterprise value, the free cash flow yield is just 1.2%. But turnarounds don't happen in a day, and the CEO change only happened in late November. I don't expect next week's earnings report to be anything special, but I also expect a return to pre-RAZR cash flow levels.

And if that doesn't happen, I expect Icahn will have lots to say about it.