Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended June 30, 2007, for American Real Estate Partners, L.P. (AREP), a master limited partnership controlled by Carl C. Icahn. The company operates as a diversified holding company with two primary continuing segments: Real Estate (rental, development, and resort activities) and Home Fashion (manufacturing and distribution via West Point International, Inc.). The filing reflects a significant strategic transition, as the company divested its Oil & Gas and Atlantic City gaming operations in late 2006 and entered into an agreement in April 2007 to sell its remaining gaming operations (ACEP), classifying them as discontinued operations.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2007 | Six Months Ended June 30, 2006 |
|---|---|---|
| Total Revenues | $429.7 million | $549.4 million |
| Net Earnings | $71.1 million | $128.8 million |
| Net Earnings Attributable to LPs | $69.6 million | $126.3 million |
| EPS (Basic & Diluted) | $1.13 | $2.06 |
| Operating Loss (Continuing Ops) | $(98.3 million) | $(83.6 million) |
| Income from Discontinued Ops | $61.8 million | $116.3 million |
| Cash and Cash Equivalents | $3.13 billion | $351.8 million (Year End 2006) |
| Total Long-Term Debt | $2.02 billion | $0.93 billion |
Material Changes vs. Prior Period
- Revenue Decline: Consolidated revenues decreased by 21.8% ($119.8 million) compared to the prior year. This was driven by a 21.7% drop in Home Fashion sales due to a weaker retail environment and strategic reductions in less profitable programs, and a 22.5% drop in Real Estate revenues due to a slowdown in residential property development.
- Operating Loss Expansion: The operating loss from continuing operations widened to $98.3 million from $83.6 million. The Home Fashion segment recorded an operating loss of $92.0 million, exacerbated by $15.4 million in fixed asset impairments and $9.3 million in restructuring charges.
- Investment Income Surge: Interest income increased by 218.9% to $72.3 million, and net realized/unrealized gains on investments contributed significantly to offsetting operating losses. This was fueled by a massive increase in the Holding Company's cash position following the sale of Oil & Gas and gaming assets and new debt issuances.
- Debt Issuance: Long-term debt increased by over $1 billion due to the issuance of $500 million in 7.125% senior notes (January 2007) and $600 million in variable rate senior convertible notes (April 2007).
- Discontinued Operations: Income from discontinued operations dropped significantly to $61.8 million from $116.3 million, as the Oil & Gas and Atlantic City gaming assets were sold in late 2006, leaving only the remaining gaming operations (ACEP) and some real estate assets in this category.
Guidance, Outlook, and Risks
- Home Fashion Restructuring: Management expects restructuring charges and operating losses to continue throughout fiscal 2007. Additional restructuring costs of $10.0 million to $17.5 million are anticipated over the next twelve months to close U.S. plants and shift sourcing overseas.
- Real Estate Outlook: Sales in the property development segment are expected to continue in a down-trend for the remainder of fiscal 2007 and into 2008 due to the residential real estate slowdown.
- ACEP Sale: The company anticipates realizing a gain of approximately $570 million (after tax) from the pending sale of its remaining gaming operations (ACEP) for $1.3 billion. Closing is expected by the end of fiscal 2007, subject to regulatory approval.
- Subsequent Event - Icahn Funds Acquisition: On August 8, 2007, AREP acquired the general partnership interests in the private investment funds controlled by Carl Icahn (Icahn Partners). This transaction, valued at approximately $810 million in AREP units plus contingent earn-outs, transforms the company into a holding company for both operating businesses and a major asset management platform.
- Legal Risks: Significant litigation regarding the ownership of West Point International (WPI) remains pending. A Delaware court action challenges the issuance of WPI preferred stock and could reduce AREP's ownership stake below 50%, potentially requiring deconsolidation of WPI from the financial statements.
Investor Verification Checklist
- WPI Litigation Status: Verify the outcome of the Delaware proceedings challenging WPI ownership, as losing control could materially alter the consolidated financials.
- ACEP Transaction Closing: Confirm the closing of the $1.3 billion sale of ACEP and the realization of the anticipated $570 million gain.
- Home Fashion Turnaround: Monitor the execution of the restructuring plan, specifically the closure of U.S. plants and the ramp-up of overseas facilities, to assess if operating losses can be reduced.
- Debt Covenants: Review compliance with debt covenants, particularly the cash flow to fixed charges ratio, given the increased debt load and operating losses in continuing segments.
- ImClone Valuation: Note the volatility in the ImClone investment, which is now marked-to-market under SFAS 159, causing significant swings in "Other income (expense)" ($39.2 million unrealized gain for the six months ended June 30, 2007).