Netflix's adoption of a shareholder rights plan, commonly known as a poison pill, to fend off the activist investor Carl C. Icahn is no surprise. Still, Netflix, the video-streaming and DVD rental company, couldn't resist putting some unusual terms into the pill just to keep things exciting and place a shareholder-friendly spin on the event.
The workings of a poison pill are intricate but essentially boil down to this: When a shareholder acquires a percentage of shares above a certain threshold, the pill is activated. Setting off the pill means that the poison is taken, and the net result is that every shareholder but the one who sets it off receives discounted stock. Consequently, the stake of the trigger-puller gets hugely diluted.
Because activating a pill is economically stupid â€" why would you cause your stake to be reduced without compensation? - there has only been one intentional trigger of a poison pill in recent memory. The case involved the co mpany Selectica, and it didn't go so well for the shareholder. The Delaware courts found the pill to be valid, and the shareholder was left with a stake worth much less than before it intentionally activated the pill.
The threshold set by the company is thus important because it effectively places a hard cap on the number of shares an investor can buy.
Netflix took an unusual tack in setting its threshold. For institutional shareholders who take a passive stake, the limit is 20 percent. For all other shareholders, the limit is 10 percent, just a bit above Mr. Icahn's current holdings of 9.98 percent.
Regular pill watchers of the world will immediately see what is unusual here. Typically, the threshold for a poison pill is 15 percent for all shareholders, though a 10 percent bar is increasingly common. The twist here is that Netflix treats passive shareholders differently.
The 10 percent cap is a symptom of increased aggressiveness by companies ag ainst activist hedge funds. Under Delaware law, to justify a pill, a company needs to show that there is a threat and that the response is proportional in relation to the threat. Lawyers call this a Unocal review, after the case that adopted part of the standard.
In Netflix's case the threshold of 10 percent versus 15 percent or even 20 percent makes no difference in terms of working to prevent a takeover, unless the board agrees. And this consequence jibes with the traditional notion behind a pill, to prevent an unwanted takeover that undervalues the company. But setting the standard at the lower level also prevents Mr. Icahn or another shareholder from accumulating more shares to vote to influence the board to sell the company or take other strategic actions.
Netflix is likely to justify this limitation of shareholders by the fact that Mr. Icahn has specifically mentioned his goal is a sale. In this light, the 20 percent threshold can be viewed as a public r elations move, adding a shareholder-friendly gloss to the pill adoption. Netflix can argue that it is still looking out for its shareholders because it is really taking aim only at those pesky activists. The Fidelity Investments and other mutual funds of the world can still buy more shares, they just can't actively campaign against the company.
The hedge funds are likely to counter that the threat though is misidentified because it really is all about keeping the Netflix board in power and preventing any activist from effectively running a campaign to unseat them. In this regard, their rights as shareholders are being unduly limited.
Netflix's move would undoubtedly be upheld by the Delaware courts as a matter of practicality if nothing else. The Delaware judges have not been keen to side with hedge fund activists.
Moreover, the justification that Netflix would give â€" that it is really just trying to prevent a forced sale on the cheap - has particular salience because Mr. Icahn has said he'd like the company to explore a sale.
Still, while Netflix's maneuver may be justified in this case, it is part of a more aggressive tone taken by companies against shareholder activists. Expect the trend to continue. Left hanging is the question of whether it is a net benefit for boards to protect themselves in this manner.
The other notable thing about Netflix's poison pill is how it tries to limit Mr. Icahn's contacts with other shareholders. Poison pills typically have expansive definitions, treating shareholders as a group and adding their shares together to determine if the pill is activated. The goal is to limit them from ganging up on the company. And other companies have taken aggressive positions in defining a group in order to limit conversations between hedge funds and shareholders generally.
For example, Barnes & Noble's original pill, adopted to fend off Ronald W. Burkle, defined a group to include shareholders with “any agreement, arrangement or understanding (written or oral) to cooperate in obtaining, changing or influencing the control of the company.†The provision effectively chilled almost all shareholder communication, and its validity was challenged in court by Mr. Burkle. Barnes & Noble dropped it before the court could rule. Other companies have been even more aggressive. According to a memo by the law firm Latham & Watkins, other companies have adopted group language like “acting with conscious parallelism,†“acting in concert†or “cooperating†in order to prevent activist hedge funds from working together.
But in Netflix's case, the company did not go this route. Instead, Netflix, just added the usual language that “any agreement, arrangement or understanding†among parties would lump them together.
While a poison pill may raise shareholder rights concerns, the Netflix pill can be viewed as a nonevent because it doesn't change much. It appears that the company is going out of its way to be noncontroversial in its adoption and to put on a shareholder-friendly face. In addition, Mr. Icahn's stake is just below 10 percent, although he could have acquired more, so he will not be affected and is not likely to care.
The main event remains whether anyone will take Mr. Icahn's bait to try to buy Netflix.
