The comeuppance of Carl Icahn (Fortune 1986)

August 18, 2013: 8:00 AM ET

Editor's note: Every Sunday Fortune publishes a favorite story from its magazine archives. Last week, the investor Carl Icahn announced on Twitter that he's taken a stake in Apple (AAPL) valued at more than $1.5 billion. He is trying to get the company to buy back its own shares. Many of today's activist investors, including Icahn, were the corporate raiders of the 1980s. Their tactics have changed but their objective -- to make money -- has not. In this February 1986 cover story, Carol Loomis examines the difficult position Icahn found himself in after investing in the airline TWA. 

by Carol J. Loomis

Carol Icahn

Carol Icahn

FORTUNE -- CARL ICAHN, corporate raider by trade, is creative, a scrambler, and certainly not to be underestimated. He may yet pull a profit from the $300 million he invested many months ago in TWA. But for the moment he is trapped -- his money locked up when he had expected to get it out, his prospects riding on a marginal company in a viciously competitive industry, his reputation for shrewdness scarred.

The frustrations hardly are Icahn's alone. Last fall TWA stock was around $22 a share, a valuation reflecting Icahn's intention to buy out other shareholders at a price slightly higher than that. But he subsequently walked away from that deal and signed on to another that is not a buyout. Icahn, with 40% of TWA's stock, has simply assumed control of the company. The other shareholders, who include limited partners of Icahn's with about 7% of the stock, can hang on to their shares or sell them or, up to a given amount, swap them for shares of a not-very-valuable TWA preferred. The distaste of shareholders for this affair was indicated by the price of TWA's common in mid-January: around $14 a share.

At that price, the stock for which Icahn paid about $300 million is worth $227 million. He bought the stock on margin, has had margin calls, and is stuck with large carrying costs on the debt.

Though Icahn has control of TWA, he cannot siphon out its cash. Agreements with lenders and unions (two of which have granted him large wage concessions) hamper his ability to pay dividends to himself and other shareholders or to distribute corporate cash to shareholders by repurchasing TWA stock. To prevent Icahn from profiting at the expense of other shareholders, a special watchdog committee of former TWA directors must approve transactions between TWA and other Icahn entities for two years.

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Icahn could get money out of TWA by selling all or part of his stock, and he may eventually do that or sell the whole company. But for now, with the airline industry suffering, who will buy and at what price? The only buyer lurking around recently has been Frank Lorenzo of Texas Air, whom Icahn defeated in a takeover battle for TWA last summer. Lorenzo might pay enough to make Icahn whole. But TWA's two most powerful unions, the pilots and the machinists, loathe Lorenzo, whom they paint as a union-busting ogre. In return for their wage concessions, these unions tied Icahn into contracts that keep him from selling to Lorenzo for three years. In short, Icahn for now seems boxed into this airline.

A lawyer who faced Icahn in the intense nine-month struggle over TWA says he ''visibly aged'' in the period. Indeed, says Icahn, just turning 50, ''it hasn't been easy.'' His time has been chewed up along with his money. To friends he has talked ruefully about the opportunity costs: raids that could have been made, managements that could have been skewered.

Victoria Frankovich

Victoria Frankovich

May the sun always so shine, say scores of managements gleefully. But they should beware of complacency. In early January, as Icahn finally took control of TWA, he announced it would borrow $750 million. The airline has lately been losing money at a rate of $1 million a day and it can certainly use a cushion. But without question, Icahn is keenly aware that TWA could use the borrowed funds as a war chest for raids. Air raids.

Icahn's raid on TWA started off last May, looking like just one more of Carl's forays. The assault naturally appalled TWA's management, which combed the land for other bidders and lined up Lorenzo. Horrified, the unions offered concessions to Icahn and persuaded him to fight Lorenzo rather than bail out at a profit of $40 million or more. By August 20 he had a victory. On that day, hearing by phone that the TWA board had rebuffed a Lorenzo bid that topped his own, Icahn donned the jacket and cap of a TWA pilot and marched around his office proclaiming, ''We got ourselves an airline.''

By late September TWA's chief executive, C. E. Meyer Jr., had resigned and the company's board had delivered Icahn a signed contract authorizing him to proceed with a leveraged buyout. Most of the directors then ''retired,'' secure in the knowledge that clauses shoehorned into the contract guaranteed them and their families first-class TWA passes for life (see box).

Three directors stayed on to see the deal to its completion (and to offset Icahn and two associates joining the board). Two who stayed were, in effect, representatives of TWA constituencies: W. L. Hadley Griffin, former chairman of Brown Group, a shoe company based in St. Louis, a TWA hub, and Morton I. Sosland, head of a publishing company in Kansas City, another important TWA station. Neither will talk today about their experiences over the months that followed.

The third director who remained was TWA's president, Richard D. Pearson, 50. He is a likable, tough-talking engineer whose office features a large picture of John Wayne. Pearson says he has ''a powerful memory'' of meeting Icahn for the first time. The place was Icahn's New York office, the time a few days after the contract was signed. Said Icahn: ''I don't know anything about you and I'm not going to make you any commitments.'' Responded Pearson: ''I don't know much about you either and I don't know whether I'm going to stay.'' He has, as operating head of the airline. Icahn looked for a chief executive for a while but says he is not looking now.

MORE: A 4-point guide to fighting Bill Ackman

WHEN THE September contract was signed, Icahn still needed to arrange the financing for the buyout. To ease the way, he needed to round out the wage concessions that underpinned his whole deal. Icahn's expectation since summer had been $300 million in wage and benefit cuts, which would reduce TWA's labor costs around 20% and its total costs, before taxes, about 8%. In return, Icahn has given the pilots and machinists a profit-sharing plan and the promise of an employee stock ownership plan (ESOP), and he may extend similar benefits to other employees.

Profit sharing, however, is for the moment an irrelevancy because of TWA's losses, which were $99 million in the four quarters that ended last September and apparently ran close to $150 million in the calendar year. More than half that loss occurred in the fourth quarter, a period in which TWA's traffic fell more than is typical for the season, fare cuts proliferated in the airline industry, and terrorist attacks in European airports cast a pall over TWA's important transatlantic business.

Wage concessions are difficult to quantify, since their magnitude depends on many operating variables. But Icahn came out of the summer thinking he had around $150 million in concessions pinned down: about $100 million from the pilots, who agreed to roughly 30% reductions, and $50 million from the machinists, who took a cut of 15% or so. The pilots accepted the bigger hit because they fear Lorenzo the most and also earn the most. Before the cuts, their pay ran as high as $140,000 and averaged $90,000. The machinists averaged about $38,000.

Icahn expected the remaining $150 million in labor savings to come partly from TWA's non-union employees and management. He turned over the job of getting those cuts to Pearson, who trimmed the work force and reduced the compensation of those remaining by about 14%. Pearson thinks those actions may have produced annual savings of $125 million.

The missing piece in this puzzle is TWA's flight attendants, who have so far done little to welcome Icahn on board. The head of the flight attendants' union, Victoria Frankovich, 38, was a part of the union crew that bargained with Icahn last summer. But she was not willing to accept greater pay cuts than the machinists. Icahn wanted more. In fact, he was obliged by his agreement with the pilots to seek pay cuts of 20% to 22% from the flight attendants. The pilots resented the 15% the machinists had wangled and did not want the flight attendants to get off so easily.

Harry Hoglander and Eugene Keilin

Harry Hoglander and Eugene Keilin

Frankovich, who customarily spends the week in New York and weekends in California (where her husband practices law), is a forceful, not-to-be- intimidated sort. She not only balked at Icahn's demands but chose not to show up on the key August weekend during which the other union leaders and Icahn struggled to an agreement through 28 straight hours of negotiations. Frankovich happened to have planned a large party at her California home that weekend for people with whom she had gone to grade school.

After a fruitless session with Icahn on Friday, she left for California, infuriating both Icahn and the pilots. Says Harry Hoglander, 52, head of the TWA pilots' union (and the man whose uniform Icahn borrowed on V-Day), ''My God, my members would kill me if I did something like that!'' Frankovich says she left both because negotiations were stalled and because she was fed up with Icahn's tactical games, in which he habitually called her on Friday afternoons just as she was set to head west. Frankovich's lawyer, William Jolley of Kansas City, also suspects that Icahn is somewhat sexist. Jolley says Icahn argues that the flight attendants are not breadwinners in the same sense the mechanics are and can therefore afford to take deeper cuts.

ICAHN VEHEMENTLY DENIES that allegation: ''I never said they weren't breadwinners; that's completely untrue. What I do say is that we can't compete with airlines that are paying half what we are for flight attendants. Our average cost is $35,000 to $40,000. People Express and Continental are paying around $18,000. I tell you categorically that TWA would have gone into Chapter 11 if I hadn't come along and gotten wage concessions. They're losing $150 million this year even with a Pan Am strike helping them.''

The flight attendants' contract has long since expired, and this hassle could easily develop into a strike. TWA is training new attendants, who Pearson hopes would go to work in the event of a strike, and has been advertising for additional recruits. But the big question about a strike is whether TWA's other unions would cross a picket line. The pilots have a written position on that. They agreed in their contract with Icahn that they would not honor the picket lines of other unions. Hoglander's face tightens as he discusses that commitment. Though he has no great affection for the flight attendants, he is a dedicated unionist with no stomach for such a promise. But he suspects that the issue was a ''deal breaker'' -- so important to Icahn that he would have refused to go ahead without it.

The machinists, who signed with Icahn later than the pilots, refused to make a similar commitment and they will not say what their members will do in a strike. Knowing TWA's fragility, however, and the damage a strike might do, the machinists hope to mediate between Icahn and the flight attendants. John Peterpaul, 50, head of the machinists, says he won't be playing favorites: ''I just want to exert all the pressure I can on both sides.''

The leaders of both the pilots' and machinists' unions know Icahn well by now. They have laughed with Carl, battled with him over millions and over pennies, screamed at him in public restaurants, grown wearily accustomed to his habit of phoning at any hour, any day -- with special attention to 7 A.M., midnight, weekends, and holidays. Seasoned negotiators themselves, they seem warily respectful of his abilities, regarding him as the consummate bargainer, ever looking for ways to seize an advantage.

Brian Freeman, 40, an investment banker out of a firm bearing his name and adviser to the machinists, makes a matter-of-fact, near-admiring assessment: ''Carl is inherently a chiseler. He will always be trying to chisel you around the edges. Few other people out there are as tenacious, flexible, and greedy.'' But Freeman joins with other union representatives in saying that when Icahn has made a commitment to them, he has kept it. Says machinist Peterpaul: ''I've found him very honorable.''

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A bond also exists between Icahn and the unions because they share contempt for TWA's erstwhile management. The machinists say that a couple of years ago, they offered wage concessions to then C.E.O. Ed Meyer in exchange for some sort of equity participation, such as profit sharing or an ESOP. Meyer wasn't interested. To Wall Street analysts he spoke of ''taking the unions on.''

Icahn maintains that good airline management is rare, and that TWA's leadership has been distressingly common. The pilots' Hoglander, a natural comic, loves to imitate Icahn describing TWA's former directors. ''Harry,'' says Harry posing as Carl, ''you know how I feel about boards of directors. Those guys are nothing but self-interested ignoramuses who come to town and just collect their checks and leave. This board of directors of TWA -- I'm telling you -- is the worst. The worst board of directors I've ever seen. Ever. I've had my people over there. They're looking at the books. For three weeks they're looking at the books. These guys should get hung for how they mismanaged this airline.''

The bargaining group from the machinists' union. (From left) Timothy Connolly, John Peterpaul, and Brian Freeman

The bargaining group from the machinists' union. (From left) Timothy Connolly, John Peterpaul, and Brian Freeman

How Icahn himself proposed to manage the airline became a topic of broad interest last fall when he set out to line up $770 million in financing for his leveraged buyout. Of that, $250 million was to be unsecured debt sufficiently low in quality to be called junk bonds. Wall Street's junk-bond leader, Drexel Burnham Lambert, had commitments to Frank Lorenzo that kept it from running Icahn's deal. So Icahn went to PaineWebber, whose corporate finance department included an experienced airline team.

Faithful to the creed of the leveraged-buyout honor society, Icahn wished to get all his money out of TWA and still own most of the company. Some $310 million of the money to be borrowed was slated to pay off the Icahn Group, which had paid $356 million for its stake in the airline.

The money wasn't all that Icahn had in mind to take out. TWA has a reservation system called Pars, a competitor of American's Sabre and United's Apollo, both very profitable. The PaineWebber plan presented to lenders showed that Pars was being assigned a fair market value of $75 million and -- on top of the $310 million in cash -- would be given to the Icahn Group as a dividend. The Icahn Group planned to lease Pars back to TWA for ten years for an amount covering its direct costs and overhead plus an annual profit of $25 million. Not bad on an asset described as having a fair market value of $75 million, especially since Icahn anticipated getting Pars business from other airlines as well. Inching through the fine print on Icahn's deal, prospective buyers of the junk bonds began to burn at his intention to strip so much from the company, leaving so little security for the debt he was trying to sell. One scornful prospect asked, ''Why should I risk anything in this loser if Icahn won't?''

Furthermore, Icahn failed to inspire much confidence in TWA's future. One portfolio manager who heard him speak in October at a ''road show'' at the Waldorf Astoria in New York thought he seemed extremely naive about the airline industry. Asked about the likelihood of fare wars, Icahn said he believed the industry wouldn't get into them because they would be ''suicidal.'' His listener shuddered at this ''worst possible answer'' applied to an industry whose suicidal tendencies are ever on display.

On November 1, after weeks of a full-court press on bond buyers, PaineWebber told Icahn it could not raise the full $770 million, only $670 million. The last $100 million, PaineWebber said, would materialize only if Icahn agreed to leave Pars in the company. Icahn, who clearly had an obsession about Pars, thought PaineWebber had one as well. ''They kept saying, 'Pars, Pars, Pars.' And I said, 'Hey, that's not the deal.' ''

DREXEL was by this time free of its Lorenzo commitments and soliciting Icahn's business. So Icahn dumped PaineWebber. Drexel promptly restructured the deal and raised the ante to $1.27 billion, of which $500 million was to be ''blind money'' available to Icahn for non-TWA, undefined purposes. But Drexel told Icahn that his financing was shopworn, and it too said he must leave Pars in the deal to pacify lenders. Icahn might even be required, Drexel said, to modify his plans to take $310 million out of TWA.

This possibility became a certainty in the weeks that followed. TWA revised the forecast of its losses for the year from $70 million to $110 million and Drexel began to question whether TWA management knew what it was doing. TWA's stock started to fall, a sure sign that arbitragers were sniffing the collapse of the deal.

TWA president Richard Pearson (left) with Salomon Bros.' Michael Zimmerman and lawyer James Freund

TWA president Richard Pearson (left) with Salomon Bros.' Michael Zimmerman and lawyer James Freund

Icahn was indeed becoming exceedingly doubtful that he really wanted to pay $19.50 in cash and $4.50 in TWA preferred stock for each non-Icahn share of TWA, as he had committed to do. His agreement with the company gave him two outs. One allowed him to exit the deal if the airline suffered ''material adverse change,'' the other if he could not arrange financing. Believing himself to have a case on both fronts, Icahn went back to TWA saying he wanted to renegotiate the deal.

Finding someone to negotiate with wasn't simple. Pearson, his underling, whom Icahn could conceivably fire at any moment, did not seem an obvious candidate. Pearson himself says he faced an impossible, two-hat problem. In one role he had to keep TWA going and deal with operating problems Icahn was concerned about. In the other role he was forced to argue with Icahn over the interests of the non-Icahn shareholders. ''I said to a friend,'' Pearson recalls, perhaps censoring his line as he repeats it,'' 'Did you ever try to walk astraddle a fence that's too high to straddle?' ''

Two other negotiating candidates, TWA directors Griffin and Sosland, were off in Missouri, possibly beginning to wonder whether they should have put in for combat pay. Both entered the negotiations, but mostly by phone. In the end Icahn mainly negotiated with TWA's outside lawyer, James Freund of Skadden Arps Slate Meagher & Flom, and the company's investment banker, Michael Zimmerman of Salomon Brothers.

By early December Icahn had decided he should proceed with the buyout, but on terms that would give TWA shareholders less cash and more preferred. Freund reluctantly agreed that a revision of the terms might be in order and scheduled a board meeting for Sunday night, December 8, at which the matter would be discussed.

Anticipating revised terms and wanting to build the confidence of its junk- bond salesmen in TWA's management, Drexel set up a big 9 A.M. meeting that Sunday at its Beverly Hills office, where all junk-bond activity is centered. TWA executives were on stage. Things went well. Later, at that night's board meeting in New York, Icahn and TWA edged up on a new deal: a buyout providing shareholders with $13 in cash per share and $11 in preferred stock. All that remained was for Salomon Brothers to render an opinion that the deal was fair to shareholders.

That question quickly became academic. On Monday, TWA got its first reading on November results and they were colossally bad, signaling that the year's loss was going to be close to $150 million. Freund drew the job of telling Icahn. Able to chuckle a little about it today, Icahn says Freund stumbled with the figures, finally getting his message across. Shocked, Icahn also thought the timing was like some bad joke. ''Why,'' he asked, ''didn't they figure this out last Friday?'' Getting the word in Beverly Hills, Drexel's salesmen stopped hawking the TWA deal.

The action shifted promptly into TWA's hands. If Icahn terminated the September buyout agreement, which he was inevitably going to do, TWA had the right for a short period to find someone who would buy Icahn's shares at $22 each, taking the rest of TWA's shares as well. Salomon's Zimmerman went searching for a buyer. Resorts International, a previous bidder, was not interested. Several airlines were, in part because they lust after TWA's transatlantic routes. But they saw problems: an adverse operating climate; Icahn's insistence, based on a contractual right, that he get cash immediately for his shares; the necessity, despite his demand, to get Department of Transportation approval for the merger, which might take months. With one exception, no airline was ready in those circumstances to offer $22 a share.

The exception was Texas Air. Still interested, Lorenzo said he would commit to buy and would also put up half the cash forthwith, taking his chances that Transportation Department approval would follow.

Drexel Burnham's Leon Black

Drexel Burnham's Leon Black

SOME PEOPLE who know Icahn well believe he would have liked to sell at that point. He quite possibly could legally have done so. His contracts with the unions, with all their wage concessions, had not yet gone into effect. But Icahn says he was less interested in the legalities of this matter than the ethics. He considered himself, he says, to have a moral commitment to the unions not to sell to Lorenzo. He told the unions he would oppose a deal with Texas Air. All parties knew, however, that TWA's non-Icahn directors might insist on taking Lorenzo's offer.

After all, the directors had a busted deal with Icahn and an offer on the table that looked as if it might deliver a respectable outcome for TWA shareholders. But what, then, from the unions? Freund asked several union leaders to meet with him, Pearson, and other TWA representatives on December 18. Vicki Frankovich said she was willing to deal with anyone who would do well by her members -- even Lorenzo. Tim Connolly, 54, a crusty negotiator who had represented the machinists in their dealings with Icahn, said his union would not tolerate a sale to Lorenzo. He said he could imagine machinists, in their fury, damaging airline property if the company persisted on this course. Some of the TWA people recoiled. Later, the non-Icahn directors agreed not to pursue Lorenzo's bid.

Icahn now faced a hard choice. He did not want to proceed with a leveraged buyout because it would leave TWA -- meaning himself -- cash short at a particularly difficult time. On the other hand, if he were simply to assume control of TWA and buy no one out, he could not get any of his own money out of the company -- certainly a dismal thought. Drexel was standing by saying it could raise $750 million whichever way Icahn decided to go. But it was also saying that it did not see any plan that would permit Icahn to get more than $100 million out of TWA.

The meanness of that amount compared with the $356 million his group had sunk in TWA probably encouraged Icahn to pass up the leveraged buyout. The general downturn at TWA had an impact too. But Icahn was also influenced by the airport bombings in Rome and Vienna on December 20, which killed several people at TWA ticket counters. On that night, Icahn called Freund and said he had decided simply to borrow the $750 million, keeping it in the company. There it would proclaim to travel agents, competitors, and Vicki Frankovich that TWA is a strong airline. ''Everybody in this industry,'' says Icahn, ''picks on the weak guys. This money turns us from being an attackee to an attacker.'' The $750 million also clearly satisfies an Icahn inclination to seize almost any opportunity to acquire cash.

Icahn's decision could have left TWA's minority shareholders getting nothing. But Freund bargained hard to come away with something for them. Ultimately, Freund and Icahn agreed that directors Griffin and Sosland would resign from TWA's board and be reconstituted into the special watchdog committee to monitor Icahn's actions, that certain protections would be granted the minority shareholders, and that they would have an option to exchange part of their common shares for preferred stock.

One protection blocks Icahn from selling any of his TWA stock through September 1987 unless all shareholders can sell on the same or comparable terms. Another protection says the watchdog committee must pass on any future buyout Icahn proposes, and that minority shareholders will be given a vote on the deal. Freund worried more about what would happen if Icahn didn't do a buyout and instead bought shares on the cheap in the open market, thereby ( destroying liquidity for minority shareholders who did not sell. So a protection was negotiated that limits Icahn's ability to buy shares this year. In 1987, however, he can snap up as many as he wants.

It took an artfully crafted 11-page TWA press release to explain these provisions and the rationales for no buyout by Icahn and no sale to Lorenzo. One sentence near the beginning of the release said Pars would remain in the company, a detail possibly mystifying readers who did not know just how much commotion the reservation system had caused. Icahn, incidentally, is not sure today that Pars is really worth as much as he had thought. But he says he has no intention of selling it.

Some people who have grown to know Icahn well during this marathon believe he wants to sell the airline as soon as possible -- to flip it, as the trade says. Icahn himself claims he is not a seller. He says he might be a buyer, riding the trend toward consolidation that he thinks is inevitable in the industry. Eugene Keilin of Lazard Freres, adviser to the pilots, says the one thing Icahn won't do is just sit there: ''It's not in his interest or his nature to do that.''

American Airlines and Northwest Airlines have been mentioned as possible acquirers of TWA; both covet its transatlantic routes. But both were also among the airlines taking a look at TWA in December and deciding not to bid $22 a share. Northwest is buying Republic instead. Eastern has looked longingly at TWA. Its north-south route system would fit well with TWA's east- west system. But Eastern is in poor shape to acquire an airplane, let alone an airline.

Buying another airline instead of selling would allow Icahn to expand TWA's fleet. The other paths to expansion -- the purchase or lease of planes -- are not options that he finds attractive. Says Icahn: ''The cheapest place to buy planes is on the floor of the New York Stock Exchange.'' In any event, the TWA fleet will definitely not be declining. Icahn's contract with the pilots prevents that.

AS THE NEW chairman of TWA, Icahn has quarterbacked some management actions. He personally forced TWA's advertising agency, Ogilvy & Mather, to reduce its commissions. He has been active in continued bargaining with the pilots. He is trying to substitute changes in work rules for some of the pay cuts the pilots took last summer. The pilots argued then for having a lot of their give-ups come from work rule changes, but Icahn resisted on the ground that he didn't know enough about the subject to make intelligent decisions. Now he thinks he does. Pearson says Icahn has been a quick study: ''Considering what we've been through, he's now got the experience of someone in the business 20 years.''

It is hard to say how much Icahn is caught up in the idea of airlines being a romantic business. That line, ''We got ourselves an airline,'' seems revealing, and his office now sports several models of TWA planes. He also started to read -- but didn't like -- a book about Howard Hughes's tenure as chairman of TWA.

Icahn says he is less enraptured by the airline business than he is intrigued by its workings. The business reminds him of a chess game, in which one must carefully pick and choose stratagems, manipulating routes, prices, and schedules. He doesn't want to suggest that he's getting into route planning. Neither does he wish to suggest that anything about the road ahead for TWA will be easy. A good title for this article, he says, would be ''The Challenge of Carl Icahn.''

A singular fact suggests the challenge. In its 52-year history, with all profits and losses taken into account, the airline has made no money. Zero. It is a tough business to be locked into.

Research associate Alan Farnham

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