Hedge Fund Suit Says Icahn Hurt XO Investors

NEW YORK (Reuters) – Activist investor Carl Icahn is under fire from a hedge fund that accuses the billionaire investor of enriching himself at the expense of minority shareholders in XO Holdings Inc (XOHO.OB), a company he controls.

The suit represents a role reversal for Icahn, who has made a lucrative career of buying stakes in companies he says are not realizing the full value of their businesses.

In this case, R2 Investments LDC, a Fort Worth, Texas-based XO shareholder, complained that Icahn and the XO board of directors repeatedly breached their fiduciary duties in favor of self-dealing.

R2 — pronounced “R-squared” — in June filed a lawsuit in New York state court complaining that Icahn tried to take XO’s $3.5 billion of net operating losses (NOLs) for his own use but at an inadequate price. NOLs are valuable because they can offset income in later periods to reduce taxes.

The lawsuit said XO’s board effectively gave Icahn stock worth $2 billion for $1 billion, and agreed to a preferred stock transaction that diluted minority shareholdings.

Additionally, the suit said Icahn and the board ignored takeover bids for XO that exceeded the telecommunication company’s market price, instead choosing to refinance the company’s debt by issuing $780 million of preferred stock.

Officials at Icahn and Q Investments, parent of R2, did not return calls seeking comment.

Icahn this week told the Wall Street Journal that the preferred stock issue — which he acquired — saved XO from insolvency at a time money was not available from the markets.

“The complaint fails to adequately allege any breach of fiduciary obligation or waste of a corporate asset,” Icahn responded in a motion to dismiss filed last month. “Even if the facts alleged in the complaint are treated as true, (XO’s) independent special committee diligently negotiated and evaluated the transaction with the assistance and advice of an independent financial adviser and independent counsel.”

LONG BATTLE

XO of Herndon, Virginia, was a high-flying telecommunications company that filed for bankruptcy in 2002 after the tech bubble burst. Icahn bought XO debt and held more than 80 percent of the company when it emerged from bankruptcy in 2003.

In 2005, Icahn proposed to acquire XO’s profitable fiber optic unit and its tax-loss benefits. R2 said it filed suit to block the sale and Icahn backed down.

R2, in its complaint, listed a series of Icahn’s actions over the past five years that allegedly hurt the value of XO, including the company’s failure to refinance debt when credit markets were booming.

Icahn and XO also rebuffed three bidders, not identified in the court documents. One suitor made an unsolicited $1 billion offer for the whole company, followed by an expression of interest from another party, R2 said.

Financial advisers told XO the $1 billion bid translated to $2.25 a share, far exceeding the company’s value at the time, according to the lawsuit.

Last June a third bidder offered to pay $900 million to $1 billion just for XO’s wireline unit. Later that month, the XO board voted to put the sales process on hold, according to the complaint.

XO’s advisers, according to the lawsuit, recommended a stock rights offering. Because such a transaction would reduce Icahn’s control, R2 said, he proposed the $780 million preferred stock offering instead.

The preferred stock transaction in July 2008 helped Icahn increase his ownership in the company to more than 80 percent. Minority shareholders were allowed to buy one preferred share for every 20 sold to Icahn.

In the motion to dismiss, Icahn’s lawyers argued R2’s lawsuit was a case of remorse.

“Although (R2) was afforded the opportunity to purchase shares in the offering,” the Icahn motion said, “it elected not to do so, choosing almost a year later to instead file this spurious action, challenging the transaction despite the fact that it resulted in a substantial infusion of cash and capital for XO and eliminated XO’s substantial debt.” (Reporting by Joe Giannone in New York and Ajay Kamalakaran in Bangalore)