In the wake of activist investor Carl Icahn's 9.98% stake in Netflix (NFLX), the company has adopted a two-tier "poison pill" scheme that deviates from the standard model. The brilliance of this approach is that it will deter Icahn from taking over the company, while ensuring mutual fund demand will not be capped by the same trigger level.
Despite the board's approach, it will not prevent the inevitable: The company's best strategy is to sell itself -- a belief Icahn holds as well. Under management's current strategy, the company's valuation continues to stagnate due to the decline in revenue growth and EBITDA margins. These margins show no signs of improving as subscriber forecasts continue to disappoint. This bleak prospect for the once invincible company will cause a continued slide in shareholder value, similar to the one seen over the past year, and a call for managerial change.
The causes of these problems are twofold. First, Netflix CEO Reed Hastings has been reluctant to step aside, citing that he vehemently believes he can turn the company around. The Silicon Valley giant has a reputation for being a pragmatic genius despite being the person who changed Nexflix's subscription agreement, causing the marketplace to revolt against the company.
Second, shareholders have been anxiously awaiting the company to make a bold move that will address its poor performance in the marketplace. When news of Icahn's large stake in the company became public, investors cheered as the stock price rose dramatically. The reason for this praise is that Netflix has a great brand in a great industry, yet its brilliant CEO is ruining its chances of capitalizing on potential subscribers at such a crucial moment in the industry. With the advent of smartphones and tablets as devices that are as commonly used as televisions and computers, subscribers have been able to access their content in more ways than ever before. Still, Netflix finds itself unable to improve its services to attract new subscribers.
This paradoxical and tenuous situation leaves an amalgamation of potential futures for the company -- all of which leave potential acquirers foaming at the mouth. The list of strategic buyers, however, is not nearly as long as the one for private equity firms. Over the past year, Google (GOOG) has made a play to enter the online movie space through YouTube. The company, which sees this product line as a potential strong revenue earner in the not-so-distant future, has been working to enter the space for some time. The acquisition of Netflix would be a bold move for both companies. However, it is not the only strategic buyer with a strong interest in Netflix.
The other potential acquirer is Amazon (AMZN). If Amazon, which already sells movies and television shows by the episode or season, acquired Netflix, it would seal its dominance in this space. This would in turn make all other platforms parochial relics, including Google and its YouTube platform.
Because of the potential upside one would gain from acquiring Netflix, the bidding war between these two companies would push out most private equity groups. However, the usual suspects -- Kohlberg Kravis Roberts (KKR), Blackrock (BLK), Carlyle (CG), and Apollo (APOL) -- will certainly emerge on the vanguard of the bidding war.
Providence Equity Partners, however -- which just sold off its 10% stake in Hulu, a competitor of Netflix, to NBC Universal, News Corporation (NWS), and Walt Disney Company (DIS) -- would likely not be willing to enter the bidding battle. The primary reason is that Hulu underperformed and the firm does not believe there is much demand for the service. I disagree. As cable providers continue to provide poor customer service and limited consumer subscription options at high prices, more consumers will look to alternative sources of movie and television consumption.
Of the private equity firms listed above, all have seen growth in the third quarter from their portfolio companies and are still sitting on capital raised from their investors. However, with Google and Amazon both competing for Netflix, their competition would drive the price so high that the debt repayment structure, even under the best terms, would take up too much of the profits for any private equity firm to deem the investment prudent.
Nevertheless, Netflix's shareholder prospects seem bright. It is a company with a solid brand in a growing market with well-established companies looking to acquire it. The company has shown an incredible ability to grow in the past, and despite poor decisions over the past year the company, under the right management team, has the ability to increase margins to a level that will drive the sell price higher. Moreover, the threat that Icahn would "burn and turn" the company has been removed -- unless he is feeling particularly bold. Netflix's future, despite its poor management recently, is bright.