It was a bombshell announcement when Carl C. Icahn disclosed late on Wednesday that he had taken a 9.98 percent stake in Netflix. The question now is what happens next.
Mr. Icahn is a master of activist investing. Since 1994, he has conducted 106 campaigns at 88 companies, according to the data provider Factset SharkRepellent. His modus operandi is to make an investment, then agitate for change or a quick sale. If that does not work, he will nominate a slate of directors to the board to do the same.
And when Mr. Icahn loses, he does not go away, instead returning to run successive election campaigns as he has done with investments in Lionsgate and Oshkosh. Of late, Mr. Icahn has put a twist on this game plan by actually stepping up and buying his target companies, as in the case of CVR Resources.
The Netflix investment may follow this pattern.
As an initial matter, Netflix does have defenses against Mr. Icahn. It has a staggered board, which means t hat only three of its directors will be up for election at the next annual meeting; it would take two full years to acquire a majority of the board. Netflix has typically held its meeting in June, and nominations for opposing directors will not even be accepted until Feb. 5, 2013.
So, Netflix can fend off a complete takeover of its board. But this is probably not a big deal for Mr. Icahn, since he usually only nominates a minority of directors to avoid taking full control and the legal issues it raises. Instead, he puts a minority of directors on the board to agitate for change and to put public pressure on the majority to sell or restructure the company. It often works.
But given that Netflix is not even expecting these nominations until February and that the meeting will not occur until June or July, Mr. Icahn may be hoping he can cash out his investment before a proxy contest is necessary.
Mr. Icahn mentioned in his filing that “Netflix may hold signif icant strategic value for a variety of significantly larger companies that are engaging in more direct competition with one another due to the evolution of the Internet, mobile, and traditional industry.â€
This is talk of a sale - probably Mr. Icahn's first choice and what he will push for over the next few months.
Once a shareholder exceeds the 5 percent ownership threshold, the position must be disclosed within 10 business days to the Securities and Exchange Commission. During that time period, Mr. Icahn acquired shares to just below the 10 percent threshold.
Netflix does not have a takeover defense plan, or poison pill, so he could have acquired even more shares. He probably did not because of the short swing profit rules under Section 16 of the Exchange Act. The rules, which are intended to prevent insider trading, stipulate that once a shareholder exceeds the 10 percent level the shareholder must disgorge profits made from the sale and purchase of sec urities in any six-month period. By staying under this threshold, Mr. Icahn keeps the flexibility to sell this stake quickly without penalty.
By the way, expect Netflix to quickly adopt a poison pill - but not to keep Mr. Icahn from buying more shares. Rather, any takeover defense plan adopted by Netflix would probably contain expansive provisions intended to prevent Mr. Icahn from coordinating actions with other shareholders or otherwise risk being seen as acting together and activating the poison pill.
Thus far, all of this is standard operating procedure for Mr. Icahn.
Where it may be different, though, is with the people who run Netflix and its quite volatile stock price.
Reed Hastings, the chief executive of Netflix, has previously stated he believes a C.E.O. should run the company without board interference. That is at odds with the view of those who believe companies should be run, or at least heavily supervised, by boards.
Not only does Mr. Hastings have a strong view of the chief executive's role, he is Silicon Valley royalty. Of late, however, his crown has been tarnished by the large misstep he made in trying to split Netflix's mail and Internet businesses. Mr. Hastings has also just departed the Microsoft board.
Even before Mr. Icahn arrived on the scene, Mr. Hastings was probably feeling besieged. It will be interesting to see how he reacts to Mr. Icahn's investment, but the prospect of a headstrong chief executive resisting Mr. Icahn's entreaties is nothing new.
What may be different is that Netflix really is a growth stock. Mr. Icahn often invests in biotechnology or in companies with long track records that have had operational or business problems. Netflix is a company with a lot of potential, and its stock price has reflected that in its volatility. It is not really a troubled company, though it may need better management.
Because Netflix is a growth story, its board is likely to say the company's share price is unduly low to justify a sale. The shares were trading at about $70 before Mr. Icahn's announcement, less than a quarter of the $300-a-share high in 2011.
But the company's shareholdings are about to turn over as arbitrageurs race in to acquire Netflix stock in anticipation of a sale. Hedge funds already had a big stake in Netflix; one fund, Blue Ridge Capital, held a 4.5 percent position as of June 30, according to public filings. Mr. Icahn is counting on these funds to come to his aid. And insiders, including Mr. Hastings, hold just 6.76 percent of the company, according to Factset SharkRepellent.
What we could be seeing is a replay of the Air Products bid for Airgas, where a board just says no to what it believes to be an undervalued sale, even if a bidder does emerge and even if its shareholders want a sale to happen. And, as in the Netflix situation, there is a chief executive and founder who firmly believes in the company an d probably wants anything but a sale.
Mr. Icahn realizes this and is likely hoping for a quick sale to sidestep such a battle. He may still start a proxy contest, and I would not be surprised if that happened. But he could also adopt a softer tactic like a withhold-the-vote campaign. Netflix does not have a policy requiring directors to resign if they do not receive a majority of shareholder votes, but such a campaign would still put pressure on the board. Again, this would be standard practice for Mr. Icahn.
Ultimately, the question will come down to whether a number can be assigned to Netflix's value at this moment, particularly since it has such rich opportunities and only very recent glory days.
Given the uncertainty, and the board's ability to just say no for years, Mr. Icahn may well run his usual campaign, but it may not go as quickly as he hopes.
