You don’t amass a net worth of $20 billion by accident. You do so by continually spotting investment opportunities where others fear to tread. And you also need the courage to rattle a few cages when necessary. That’s been the winning formula for Carl Icahn, who is still reaping major investment victories at the age of 79.

To be sure, following in Icahn’s path is not easy. That’s because he tends to focus on investment opportunities that don’t hold much obvious appeal. For example, in recent quarters, Icahn’s firm has amassed a large stake in beleaguered energy driller Chesapeake Energy (NYSE: CHK), even as most investors are shunning oil and gas stocks these days.

And while most investors are avoiding commodity stocks in general these days as they note the deep distress in the industrial metals sector, Icahn recently disclosed an 88 million share stake in Freeport-McMoran (NYSE: FCX), which has seen its share price fall from the 52-week high of $35 to a recent $11.

A Well-Timed Buy
The timing of Icahn’s disclosure of an 8.5% stake in this struggling copper and oil producer was spot on. On August 27, the company threw in the towel on its capital spending plans, announcing that it would slash $700 million (25%) from its 2016 mining budget, and lay off 10% of its workforce. That bold move came right after shares fell below $8 for the first time since 2008. Investors had grown concerned that Freeport’s management was moving too slowly to adjust to the worsening slump in both copper and oil prices.

Later that day, Icahn’s firm announced that it held enough shares of stock to register a 13-D filing (which is required when a stake surpasses 5%).  Investors immediately understood what Icahn was doing. He rarely invests in perfectly healthy companies, and instead likes to target weakened prey. By becoming a major investor, he can push for changes in a company’s structure. First, he pushes to gain a presence on a company’s board, and then helps the board to understand the wisdom of asset sales or other value unlocking moves.

In a filing with the Securities & Exchange Commission (SEC), Icahn noted four topics that he would like to discuss with management: further cuts in capital spending (which may have been accomplished with that August 27 company announcement); relatively high levels of executive compensation; the company’s ungainly mix of copper, oil and gas assets, which have burdened the balance sheet; and high operating costs.

Jeremy Sussman, an analyst with Clarksons Platou Securities, thinks that the third point has particular resonance. “If we look to past shareholder discontent, one could surmise that this has more to do with the oil & gas business as a whole, which could potentially be a game changer,” Sussman wrote in an August 28 note to clients.  Recall that in December, 2012, Freeport-McMoran spent $20 billion on oil and gas assets to diversify away from a focus on copper. That move larded up the balance sheet with massive amounts of debt, and now looks quite foolish in light of the energy price crash.

To be sure, simply selling off assets at this point will be challenging. Low copper and oil prices means that Freeport would not realize full pricing for any of its mining or drilling properties. Moreover, the company’s debt-laden balance sheet requires many key assets to stay on the books in order for the company to live within debt covenants. Yet you can be sure that Icahn will push the company to unload smaller non-core assets to lighten the debt load and reduce balance sheet liquidity concerns.

Freeport’s management has taken note of Icahn’s overtures. On September 4, the company announced that it has retained JP Morgan (NYSE: JPM) to take a fresh look at the company’s options. Look for that process to take several months to complete.

In the meantime, Freeport’s management is looking to calm jittery investors by boosting their own skin in the game. On September 4, Vice Chairman James Flores (who is also CEO of the oil and gas division) acquired $21 million worth of shares at an average price of $9.70 share.  That move follows a pair of other, smaller recent purchases made by insiders.

Frankly, it’s not clear that Icahn’s cage-rattling will work the magic that he expects. Instead, this may become a winning investment purely on the basis of commodity prices. Copper and oil prices are sharply lower this year on concerns that the Chinese economy is rapidly decelerating. Yet we have no actual confirmation that the Chinese economy is in deep trouble, only that the Chinese stock market is. And you should never confuse an economy with a stock market.

If China’s economy proves to be stable in coming quarters, commodities may deliver a sharp relief rally. That fact alone would push this stock up by a considerable amount. Higher realized commodity prices would lead to higher cash flow forecasts for Freeport-McMoran, which would erase any current balance sheet concerns and lead short sellers to cover their positions.
 
Risks To Consider: An utter collapse of the commodity market would lead this and other commodity producers to the brink of insolvency.  

Action To Take: Carl Icahn may only be getting started with this investment. One week prior to his 13-D filing, his firm allegedly notified the SEC of intentions to eventually acquire up to 25% of the company (which must be disclosed on a confidential basis under the guidelines of the Hart-Scott-Rudino Act.) Such a move may prove to be brilliant in hindsight — if oil and copper prices stage even a modest recovery. Considering that these commodities are already at cyclical lows, that’s a fair wager to make. To be sure, commodity prices can fall further, but supply reductions often set the stage for a price rebound. Although Icahn’s investment in Freeport-McMoran brings clear risk, it also brings substantial potential reward when the commodity cycle eventually turns.

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