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Deal Journal – WSJ.com : How Icahn Influences Yahoo Without Buying the Stock

How Icahn Influences Yahoo Without Buying the Stock
Posted by Heidi N. Moore

Carl Icahn is preparing to wage a proxy fight against Yahoo, using 59 million shares as his club. But Icahn doesn’t really own all those shares. He only bought 9.9 million.

How can Carl Icahn hold the rest without actually owning them? It’s because of an old strategy that Icahn and other corporate raiders used in the 1980s of using matching put-and-call options. Here’s how it works.

Icahn bought American call options on 49 million shares of Yahoo and sold European-style put options on another 49 million. The call options give him the right to buy Yahoo stock at a certain undisclosed price, while selling the put options allows Icahn to make money right away and allows other investors to protect themselves against a fall in Yahoo’s price.

Why would Icahn buy options instead of outright stock? Mainly because it is cheaper — and, when in done in a certain way, less visible to the market so that he doesn’t have to file with the FTC and signal his intentions. Call options for Yahoo have been selling for only a few dollars. 59 million shares of Yahoo at Monday’s open of $25.15 would have been worth $1.48 billion — a lot of money for Icahn to put to work on a proxy fight that may or may not work. However, the 9.9 million shares he bought would have been a relative bargain, valued at only $248.9 million at Monday’s price. And options can be used for a variety of purposes — either to take a position in the stock or to hedge against a fall in the stock — which makes it hard for the market to figure out why they’re being used. That, in turn, helped Icahn maintain the element of surprise – and earn money when Yahoo’s stock jumped as investors finally realized Icahn was buying the stock.

Icahn arranges with investment banks to make “flex trades,” so that the banks design the terms of the put and call options to Icahn’s needs. Icahn likes to use European-style put options because they can only be sold at a certain date. For instance, on Yahoo, Icahn sold European-style put options on 49 million shares, with a strike price of $19.50 per share and an expiration date of Nov. 5, 2010.

That means he’s betting that the shares will be worth well above $19.50, so the options will expire worthless and he gets to pocket the premium. Icahn also arranged that those options are settled in cash, which means that if Icahn’s bet goes wrong he will pay the market value of the stock instead of getting stuck with the devalued shares. He also has no control over the shares, which fends off concerns from the Federal Trade Commission.