Carl’s Icahn’s Netflix Position Made of Cheapy Options: a Not-So-Serious Man

Convinced that Carl Icahn means to force the sale of Netflix (NFLX), investors have bid up shares of the DVD-by-mail and content-streaming company by more than 20%. However, as the majority of the 9.98% stake purchased by the billionaire investor’s hedge fund, Icahn Capital, was in call options – not stock – it’s likely Icahn’s angle isn’t that of activist reformer but, instead, that of a leveraged, quick profit-trader.

On October 31, Icahn disclosed in a regulatory filing with the SEC a beneficial stake of 5.54 million shares in Netflix. He opined that “shares were undervalued due to the company’s dominant market position and international growth prospects.” Just because the company’s market capitalization is down more than 50% from where it was last year doesn’t necessarily imply a bargain valuation. A stock chart.

NFLX Total Return Price Chart

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Icahn argued, too, that the company “may hold significant strategic value for a variety of significantly larger companies that are engaging in more direct competition with one another.” This revelation is nothing new, too, as analysts have speculated for months that any large-cap tech company looking to expand the breadth of their online social media experience, including Amazon (AMZN), Apple (APPL), Comcast (CMCSA), Google (GOOG) or even Facebook (FB), could make a tender offer for Netflix.

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It’s doubtful a white knight will emerge, given the company’s deteriorating fundamentals. And, as proffered in a recent YChart article, there are questions as to whether or not the media company’s business model is still even relevant: Profit margins remain under pressure, as both subscription and content acquisition costs continue to soar. Furthermore, with domestic streaming membership not ramping up as quickly as expected, Netflix management recently lowered fourth-quarter guidance, with consensus estimates now predicting a loss of 11 cents per share.

NFLX Profit Margin Quarterly Chart

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Of late, Mr. Icahn’s ability to drive up value for all stockholders by acquiring material stakes in selected “undervalued” prey has yielded uneven results: Unlike his almost 60% gain (in about six months) on his $1.2 billion foray in El Paso last year, investors who’ve followed him into the likes of Chesapeake Energy (CHK), online health provider WebMD (WBMD), and trucking manufacturer Navistar (NAV) have watched their holdings underperform the S&P 500 Index.

CHK Total Return Price Chart

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In response to Icahn’s acquisition, Netflix announced on Monday that its board adopted a poison pill, which effectively blocks Icahn from expanding his stake (additional common shares would be issued, should any stockholder accumulate more than 10 percent – making it cost prohibitive for any corporate raider to gain ownership control).

Clorox (CLX), drug maker Forest Labs (FRX), and filmmaker Lions Gate (LGF) – Mr. Icahn has fought and lost dramatic board battles in recent years. If the shareholder rights plan adopted at Netflix wasn’t a loud enough “unwelcome” sign at the front door, Icahn will find, too, that time could work against him in a proxy battle with company insiders. Netflix has a staggered board of directors, with only three members up for election at the June 2013 annual meeting, including venture capitalist Timothy Haley (a 14-year director!). CEO Reed Hastings retains his seat on the board until 2014. It would take, at a minimum, two years for Icahn to win a Board fight.

Unlike past proxy battles, Icahn’s $168.9 million invested in Netflix is a highly leveraged bet. He controls his stake principally through in-the-money call options: Of 4.7 million shares “bought” in the past 60 days, almost 4.3 million (90%) were two-year call options (at $36.05 a share) purchased at premiums ranging from $18.94 to $24.78 per contract, which expire on September 4, 2014.

If Icahn is serious about turning Netflix’s performance around, he’ll have to spend millions more to convert his “beneficially”-owned stake into actual ownership. Or, he could unwind his option position and walk away with profits of between 28% and 42% -- if he hasn’t done so already.

David J. Phillips is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.



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