Sunday, October 31, 2010

Carl Icahn vs. Lionsgate: A Breakdown

Over the past few weeks, relations have become particularly tense between Billionaire activist investor Carl Icahn and Vancouver-based film producer Lionsgate (LGF). Since early 2006, Icahn has been building his ownership stake in Lionsgate and has criticized the company for its "reckless" spending and leverage. He has repeatedly issued hostile bids in an attempt to buyout the struggling media company and to protect his investment. Yesterday, Icahn--who currently owns 33.5% of LGF--extended the deadline of his tender offer of $7.50 per share to November 12, 2010. Throughout the battle, the two parties have gone through standstills and attempts at cooperation--all of which have not only proved ephemeral, but have backfired on both. Icahn and LGF have issued rather vicious and sharp-worded litigation against one another in an attempt to influence the outcome of the proxy battle between the two.


On October 20, 2008, Icahn Capital filed its initial 13D statement with the SEC, revealing a 9.17% ownership stake in Lionsgate. In Item 4 of the filing, the firm stated its belief that the shares were "undervalued", along with its desire "to continue to have discussions with representatives of [LGF]". The shareholder activists' stake later reached 38%, but shortly thereafter was diluted to 33.5%. What happened was this: In June 2010, Lionsgate refinanced Kornitzer Capital Management's $100 million worth of debt into convertible notes redeemable at a price below the then-current market price. Kornitzer then sold the notes to Mark Rachesky, President of MHR Fund Management. The fund then exercised the notes at $6.20 per share. All told, the debt-to-equity swap increased Rackesky's ownership of LGF from 19% to 29%, while effectively diluting Icahn's from 38% to 33.5%. The situation is particularly fascinating in light of the fact that Rachesky was a former protege of Icahn. Many have incorrectly speculated that Rachesky would support Icahn's activist investment, but rather Rachesky has done just the opposite--support LGF's incumbent board of directors and management. As LGF's second largest shareholder (under Icahn), Rachesky will have considerable leverage in shaping the outcome of the proxy fight.


Unhappy with being diluted, Icahn did what--some may argue--he does best: sue the company. On July 26, 2010, he filed his complaint concerning Lionsgate's debt-to-equity swap and its breach in a 10-day standstill agreement to the Supreme Court of British Columbia and the New York Supreme Court, respectively.

In the lawsuit, Winston & Strawn, LLP (Icahn's legal counsel) writes, "This case involves an unlawful sham transaction by which an incumbent Board of Directors and their co-conspirators sought to further entrench their own positions and to protect their personal interests in compensation and perks at the sole expense of their company… and its shareholders". In case you are wondering, Winston & Strawn, LLP repeatedly refer to the debt-to-equity swap as "The Sham Transaction". They continue in Icahn-esque tone, "The Sham Transaction is the antithesis of responsible corporate governance; indeed it belongs more properly in the script for a new reality TV program, 'Mad Management'". Ultimately, Icahn is accusing Lionsgate for unlawful tortuous activity, violating stock exchange rules, violating laws, and violating federal securities law. He has asked the courts to reverse "The Sham Transaction" and to "sterilize" Rachesky's new shares--that is, take away their voting rights. As of now, no ruling has been made.


In April earlier this year, Canadian regulators rejected LGF's poison pill, which had a trigger of 20%. On July 1, 2010, Lionsgate launched a second shareholder rights plan, which would have gone into effect if a shareholder accumulated more than 38%. The board believed that the second poison pill would pass the legal hurdle, because it was established without the presence an active tender offer. Nevertheless, the British Columbia Securities Commission again rejected Lionsgate's poison pill.


Lo and behold, media company Metro-Goldwyn-Mayer Studios Inc. (MGM)--which is facing declining cash flow and high levels of debt--is being asked of its creditors to "discuss alternatives". The company was burdened with debt when it was taken private by a team of investors in 2005 for $2.85 billion--namely by, Sony Corporation, Comcast, Providence Equity Partners, TPG Capital, DLG Merchant Banking Partners, and Quadrangle Group. (Important Note: creditors were later disappointed with the highest buyout bid--$1.5 billion from the Warner Brothers--following the one in 2005.)

Believing that it can enhance the value of MGM's vast film library--which includes more than 4,000 titles--, on October 12, Lionsgate sought a merger with the media company. Under the LGF-MGM merger, Lionsgate would own 45% of the resulting-company; MGM creditors, 55%. Initially, Icahn was opposed to the merger; but, later supported it. In fact, Icahn supported it so much that he bought up 13% of MGM's $4 billion debt and then pressed other creditors to vote their shares his way--that is, in favor of the Lionsgate-MGM merger over the Spyglass alternative.


On October 28, Icahn got a taste of his own medicine, when Lionsgate sued him over tortious interference, "filing [of] materially false and misleading statements with the [SEC]", and "violat[ing] provisions of federal securities law". 

The company--hiring none other than the famous corporate law firm Wachtell, Lipton, Rosen & Katz--writes, "It turns out that Icahn has been misleading Lionsgate all along. While urging shareholders to support his takeover campaign… to ensure that Lionsgate did not pursue what he called a 'delusional' MGM transaction, Icahn was quietly amassing a huge portion in MGM debt with the undisclosed intention of reaping profits from both sides in an eventual merger." Notably, the case has some choice words to describe Icahn: a "corporate raider", "break[s] up companies", involved in a "double game". Fittingly, that day, Icahn extended his $7.50 tender offer, which is set to expire November 12, 2010, at 11:59 p.m (Vancouver time), unless otherwise amended.


Yesterday, October 29, MGM creditors officially voted on which alternative to pursue: either a merger with Lionsgate or bankruptcy reorganization. Ultimately, they "overwhelmingly" favored the latter due to its firmer financing arrangement. Under the accepted alternative, the company will file for Chapter 11 around (humorously) Halloween time. Spyglass Entertainment, operated by Gary Barber and Roger Birnbaum, will own 5% of the studio, as well as manage it; creditors will have their aggregate debt converted into 95% of the equity of the resulting company. Although MGM is seeking court approval on around December 2010--and thus there is time for reversal--Icahn, as of the present moment, is supporting the accepted merger, contingent upon concessions in deal terms and gaining a board seat on MGM.

Images extracted from (1) and (2).

Posted by David Schatz