Netflix (NAS: 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 (NAS: 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 (NAS: AMZN) , Microsoft (NAS: MSFT) , and Google (NAS: 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.
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.
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The article One More Sign Netflix Is Poison originally appeared on Fool.com.
Alyce Lomax has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Google, Microsoft, Netflix, and Staples. Motley Fool newsletter services recommend Amazon.com, Google, Microsoft, Netflix, and Staples. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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