M+E Daily

By Paul Sweeting

When billionaire investor Carl Icahn bought up a big chunk of Blockbuster shares back in 2004 he was hoping for a quick profit from Blockbuster’s then-pending acquisition of rival Hollywood Video. Icahn, in fact, bought both ends of that deal as part of an arbitrage play pegged to shifts in the relative value of the two stocks.

When the Federal Trade Commission put the kibosh on the deal over antitrust concerns, however, Icahn lost his bet. In an effort to get at least some of his money back, he set his sights on squeezing cash out of Blockbuster. At the time, Blockbuster was investing heavily in Blockbuster Online in a bid to compete with Netflix and had moved to eliminate late fees — then a major chunk of Blockbuster’s revenue — in a bid to make renting more attractive in response to the widespread availability of sale-priced DVDs. Both initiatives cut severely into Blockbuster’s near-term cash flow.

Icahn decided Blockbuster should stop spending and keep the cash, which not only would boost the value of Icahn’s shares but could also be used to pay a dividend that would let Icahn get some of his cash back quickly. When then-CEO John Antioco resisted the shift in strategy, Icahn launched a proxy fight, took control of the board, ousted Antioco and brought in a new CEO, Jim Keyes, who cut spending and reimposed late fees.

In the end, the course-reversal didn’t work, and Blockbuster filed for bankruptcy two years later. Icahn now calls Blockbuster “the worst investment [he] ever made.”

Not so bad, apparently, that he isn’t willing to risk substantially the same approach to investing in Netflix, however. Icahn revealed in an SEC filing yesterday that he has accumulated a  9.9% stake in the streaming/DVD rental service, sending the shares up nearly 15% on the day (they have since give back a few points). In an interview with Bloomberg Television, Icahn made it clear he thinks the video streaming space is ripe for “consolidation” and he clearly hopes to be able to force Netflix into a sale. Icahn even mentioned several potential buyers, name-checking Microsoft, Google, Verizon and Amazon.

Netflix CEO Reed Hastings has repeatedly rejected the idea of selling the company, however, setting up a potential clash with Icahn. Should Hastings somehow manage to thwart a sale, though, we could well see a replay of what happened with Blockbuster seven years ago.

Like Blockbuster then, Netflix today is spending heavily on its international expansion plan in response to increased domestic competition. Also like Blockbuster, that spending is depressing Netflix’s near-term cash flow and earnings. In his interview with Bloomberg, Icahn also referred repeatedly to Netflix’s domestic cash flow, which he pegged at $2.5 billion per year, suggesting it wasn’t being properly valued by the market, in part because it is being obscured by the negative cash flow currently being produced by the international operations.

If Icahn can’t get his money out of Netflix via a sale, I don’t think he’ll hesitate to go after the cash it is currently spending overseas. Stop that spending and Netflix’s shares would likely rise. It would also make it easier for Netflix to borrow enough money to pay Icahn to go away, through some sort of Icahn-dictated special dividend — a tactic he has used before.

Either way, the shift in strategy could well leave Netflix worse off in the long run. But resisting that shift could leave Hastings worse off as well.

In 2011, Antioco wrote an article for the Harvard Business Review ($$) about his experience battling Icahn. Hastings might want to give it read.