One More Sign Netflix Is Poison

Netflix (Nasdaq: NFLX  ) has given many indications it's becoming obsolete, and its recent strategy to adopt a poison pill to thwart activist investors like Carl Icahn is not a step in the right direction. In fact, it adds the insult of poor corporate governance to ongoing injury to shareholders in recent memory.

A shareholder rights oxymoron
You know how sometimes people call an extremely tall person Shorty? Well, that's kind of like the way the term "shareholder rights plan" plays out in comparison to how it actually functions. Of course, from corporate managements' point of view, the friendly sounding term "shareholder rights plan" is simply good old-fashioned misleading marketing.

Take longtime Fool Bill Mann's word for it: Check out what he said in 2004 when Staples (Nasdaq: SPLS  ) moved to reinstitute an expiring shareholder rights plan: "Here's the deal with poison pills -- they should more accurately be known as 'management rights plans,' since what they do is actually limit shareholders' ability to choose whether to go along with a hostile takeover on its merits."

A shareholder rights plan or poison pill is triggered when an investor buys a certain threshold of stock (usually 10%). The plan allows a whole slew of extra stock to be issued, which current shareholders (excluding the potential acquirer, of course) can buy at a bargain price. This dilutes shareholders' holdings -- particularly the pesky investors who might try a takeover -- and makes a potential acquisition difficult and more expensive.

Bill Mann described a poison pill in place as a potential red flag for investors. Many of the companies that tend to institute them have been poorly managed, which actually set them up for activist intervention and even the auction block in the first place.

In other words, a "hostile takeover" may not be something investors like you and I should necessarily consider so terribly hostile. It's likely "hostile" to current management, and when that management's failing miserably, you can see why this presents a problem. Good corporate governance principles give shareholders more power to affect change in managements and boards, they don't protect those individuals' positions above shareholder interests.

Activists and revisionists
Netflix's move reacts to activist investor Carl Icahn's Netflix stake (which is just below the all-important, poison-pill-triggering 10% threshold), and his stated desire that Netflix find a buyer, with Amazon.com (Nasdaq: AMZN  ) , Microsoft (Nasdaq: MSFT  ) , and Google (Nasdaq: GOOG  ) being imaginable candidates.

Here's Icahn's official response to Netflix's "shareholder rights plan":

This morning the Issuer announced its adoption of a poison pill. The Reporting Persons believe any poison pill without a shareholder vote is an example of poor corporate governance, and find the pill Netflix just adopted is particularly troubling due to its remarkably low and discriminatory 10% threshold ... As one of the company's largest shareholders we are concerned about the poor corporate governance at Netflix that these and other actions reflect.

Granted, Icahn's acquisitive ideas may be off the mark, at least in terms of the above possibilities. Also granted, Icahn's shareholder activism has a spotty track record of actually spurring on positive change; take Blockbuster as just one example.

Bad medicine
Regardless of all the debates and conjecture about activists, which tech giants might pony up to possibly buy Netflix, and myriad other questions, Icahn is absolutely correct to emphasize the troubling corporate governance ramifications of Netflix's move.

Win or lose at Netflix, investors now have reason to familiarize themselves with the tricky "shareholder rights plan" practice, and possibly even treat companies that utilize such desperate measures like poison. At the very least, the policy certainly doesn't indicate companies that are at the top of their respective games.

Meanwhile, even though there's good reason to throw more light on M&A activity in the investing world to begin with, shareholders should have every right to weigh these deals themselves. Let's refuse to swallow the idea that poison pills are in our best interest, investors.

The precipitous drop in Netflix shares since the summer of 2011 has caused many shareholders to lose hope. While the company's first-mover status is often viewed as a competitive advantage, the opportunities in streaming media have brought some new, deep-pocketed rivals looking for their piece of a growing pie. Can Netflix fend off this burgeoning competition, and will its international growth aspirations really pay off? These are must-know issues for investors, which is why we've released a brand-new premium report on Netflix. Inside, you'll learn about the key opportunities and risks facing the company, as well as reasons to buy or sell the stock. We're also offering a full year of updates as key news hits, so make sure to click here and claim a copy today.

Check back at Fool.com for more of Alyce Lomax's columns on environmental, social, and governance issues.


Read/Post Comments (2) | Recommend This Article (13)

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  • Report this Comment On November 10, 2012, at 8:36 AM, Darwood11 wrote:

    Good article on the issues of "poison pill" strategies and what they may mean for shareholders.

    I'm glad you acknowledged Icahn's spotty record. Overall, his Icahn Enterprises has done very well, But not always.

    There were rumors about a possible takeover, and Hastings exit from the Microsoft board was a possible signal. In this case is Icahn simply an opportunist?

    Perhaps this shot across Netflix' bow will get the attention of management and they'll get really serious about cleaning up their act. On the other hand, Icahn's action may have simply dirtied the water and will interfere in the process of change at Netflix.

  • Report this Comment On November 13, 2012, at 5:01 PM, stan8331 wrote:

    Whether or not Icahn's stake in Netflix is good for shareholders depends on two related things, the same two factors that impact every potential buyout: investment time-frame and how bright you believe the company's future to be. Anyone who believes Netflix is becoming obsolete should definitely be cheering Icahn, because a buyout is the best thing that could happen for shareholders in that scenario. Likewise, if your investment has a short time-horizon, a buyout is the ideal way to reap maximum profit.

    If you are a long-term investor who believes in the company's international expansion strategy, a buyout could prematurely choke off potentially huge profits. In that case, anything that prevents a buyout is desirable, even if it originated in a sketchy manner. A majority of today's investors tend to have a focus on short-term profits that can be sharply at odds with those investing for the long-term. So, while this poison pill clearly disregarded shareholder rights, the interests of the average shareholder may not coincide with mine.

    I believe the best days of Netflix are still ahead of the company, but in a rapidly evolving technological landscape, that outcome is by no means certain. I would prefer the company not be sold but if it were sold at a significant increase from the current price, I would accept my profits and move on. The one disastrous scenario would be if the stock price were driven down much further in advance of a buyout. That could come to pass if Netflix really is on the road to obsolescence, but given what I know about the company, I'm willing to bet that's not the case.

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