With Icahn, Netflix management is in fight for existence

Is Carl Icahn, the billionaire investor, the Netflix savior? Ask the people who followed his investment in the Blockbuster video chain.

Doomed. The Blockbuster video chain was on the road to a comeback when Carl Icahn replaced the CEO with a man who bet on brick and mortar instead of digital. Blockbuster filed for bankruptcy in 2010. Greg Sandoval/CNET

Netflix management faces perhaps the biggest threat to its existence in the form of Carl Icahn, the famed corporate raider.

Icahn acquired a little under 10 percent of Netflix's shares last week and made noise about how sees a way to profit from the potential sale of the Web's top video rental service -- a company that has struggled mightily in the past 15 months with a customer-alienating price increase and missed projections .

In a financial career that has spanned more than 30 years, Icahn has developed a reputation for being someone who can unlock value at troubled companies by weeding out weak managers and do-nothing directors. He has styled himself as an investor advocate. Critics say he advocates for one investor: Carl Icahn.

Icahn did not respond to a request for comment.

Netflix CEO Reed Hastings James Martin/CNET

At companies in which he has invested, such as RJR Nabisco, Texaco, Lionsgate, Western Union, Take-Two Interactive, Yahoo, and Blockbuster, his appearance is typically followed by management shakeups, proxy fights and very often quick profits for him and his allies. In the 1980s, he made a fortune breaking up companies and selling off the pieces.

If Icahn follows form, he will accuse Netflix's board and CEO Reed Hastings of being poor stewards and paint himself as the savior. He will push for his own handpicked directors and a new management team. If he wins, it could mean big changes to the service. But Netflix investors should review Icahn's record carefully. Icahn's talent for unearthing hidden profits in the media sector has been lackluster.

Reed v. Carl
Michael Pachter, an analyst with Wedbush Securities who has followed Netflix for years, said there's a fundamental difference between Hastings and Icahn.

"Reed Hastings has a long-term strategy for where he wants to take Netflix," Pachter said. "It's a multiyear plan. He wants to deliver a return but he's willing to sacrifice profits, maybe forever, in order to expand the company's footprint. Reed wants to build what he believes will be a special service. And Carl, well Carl is trying to make a buck."

Maybe that's why Netflix began bolting the door against Icahn yesterday. Netflix implemented a shareholder rights plan , a strategy commonly referred to as a poison pill and is designed to make a hostile takeover very expensive. Icahn blasted Netflix's defensive strategy, saying it and other unspecified moves were reflective of "poor corporate governance."

Nobody has to ask what he is referring to by "poor governance." Who doesn't know about Netflix's two-year-long string of glittering earnings followed by a haphazard price increase and an ill-timed attempt to spin off the company's DVD operations that alienated consumers? Those goofs cost the company 75 percent of its value.

Current and former Netflix employees told CNET this year that leading up to the missteps, Hastings had become arrogant and stopped listening to longtime members of his management team. When they left, he replaced them with less-experienced executives. One has to wonder if that's why the company can't meet its own projections anymore . Netflix acknowledged last month that it will likely fall short of adding the 7 million subscribers during 2012 it had predicted earlier in the year.

That Icahn is circling shouldn't come as a surprise. He takes control of companies where investors are angry, ready for change, willing to listen to a new idea. If it comes to a proxy fight, how many investors would back Hastings?

Icahn and Blockbuster
Here's the answer to that question: maybe those investors who happened to follow Icahn into Blockbuster.

For Icahn, says Pachter, "Blockbuster was a disaster."

The Blockbuster video chain was once synonymous with home video entertainment and Icahn jumped in when the company was considering a big acquisition. When the deal didn't happen, the billionaire declared war on management He took control of three board seats and saw to it that John Antioco, Blockbuster's chairman and CEO, was stripped of his chairmanship.

Read a Q&A with John Antioco, the former Blockbuster CEO, who offers Netflix CEO Reed Hastings advice on dealing with Carl Icahn.

In 2007, Antioco finally had enough of Icahn's badgering and resigned, according to the new book "Netflixed: The Epix Battle for America's Eyeballs." The problem, wrote author Gina Keating, was that Blockbuster was in a pitched battle with Netflix in the DVD-by-mail market. Blockbuster, which had gotten off to a late start in digital, had finally found a winning formula with a subscription service that combined home delivery with in-store rentals.

But Antioco's successor, Jim Keyes, scrapped the program. He began throwing the company's resources back into Blockbuster brick-and-mortar stores. The result was Netflix thrived while Blockbuster went bankrupt.

"We were clearly, in my mind, heading to profitability," Antioco told CNET yesterday. "The online business would have been cash flow positive. Why the board and Carl went along with [Keyes plan] was perplexing to me. Carl was legitimately a convert to our [digital plan] at the end."

Asked if Icahn is knowledgeable about tech, Antioco said:
No. I don't claim to be a digital whiz and Carl knows less than me.

According to Keating, during Icahn's run on Blockbuster's board, the 76-year old relied heavily on the opinion of his son, a move that raised eyebrows at Blockbuster.

"Board members, who were cowed by Icahn's temper and billions, said nothing," Keating noted in her book, "when he allowed his twenty-six-year-old aspiring filmmaker son, Brett, to sit in on board meetings and offer his unsolicited opinions on business plans presented by Blockbuster's management team."

At Yahoo, Icahn pushed hard for the sale of the company to Microsoft in 2008. When that deal failed to come off, he received three board seats and vowed to create change. What he didn't do was create much value. Icahn sold his shares in 2010.

Who is best to lead?
What it comes down to is whether Icahn is a better person to determine Netflix's future than Hastings. Netflix is trying to thread itself into the complex pattern of home-entertainment distribution, which includes cable, premium TV, broadcast TV and film. Much of the company's success has depended on recommendation algorithms and data crunching, something that even Hastings' toughest critics acknowledge he's a genius at.

Netflix has struggled to acquire newer titles for its streaming library, but since Netflix helped create the streaming market, who knows about these licensing deals better than Hastings and Ted Sarandos, Netflix's content chief?

"Reed Hastings is executing on his vision and doing a good job at that," said Pachter. "I don't agree with that vision but I know that Netflix without Reed and Ted is not the same company."

Pachter believes Icahn has listened to bad analysis about Netflix's value. He and a lot of other analysts have said they don't believe there's a potential buyer out there: not Google, Microsoft or Apple. If that's the case, then Pachter believes Icahn is out of his element.

"If this were some chemical or pharmaceutical company," Pachter said, "and there's massive synergies created by combining it with another company and Carl has his great insights how the two would work, then I get that. But I think he's fooled himself into thinking there's value here that he can unlock."

 

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