Carl Icahn Takes on Lions Gate

MANHATTAN (CN) - Financier Carl Icahn claims Lions Gate Entertainment stonewalled his attempts to buy enough stock in the studio to elect a board member. Icahn says Lions Gate issued millions of new shares to a board member in a "sham transaction," diluting his own interests and entrenching management.

"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,'" according to Icahn's complaint in New York County Court.

Lions Gate, an independent film studio based in British Columbia, produces the Emmy award-winning drama, "Mad Men."

Icahn and eight affiliates - five of them bearing his name - claim they began buying shares in Lions Gate because they thought the company was in trouble and could be put on the right track.

"In 2009 and 2010, plaintiffs had growing concerns about the management of Lions Gate, including rapidly growing overhead expenses, increasing financial exposure to internally developed and risky theatrical releases, and the company's acquisition of high-priced distressed assets," according to the complaint.

"In short, plaintiffs believed that Lions Gate's management and board were pursuing a misguided and destructive business strategy that was diminishing shareholder value."

As Icahn's team increased its stake in the company from 18.6 percent to 37.9 percent - the largest block of shares in defendant Lions Gate - Lions Gate board members scrambled to preserve their seven-figure compensation packages, according to the complaint.

Icahn says board members warned shareholders away from his $7 tender offer, claiming that shares were worth more than $8.

Both parties agreed to a standstill in July, during which time Lions Gate was barred from issuing securities to board members or negotiating transactions involving more than 5 percent of outstanding common stock, Icahn claims.

"In blatant disregard of their agreement, Lions Gate, acting in concert with its individual directors, affiliated entities and other defendants, spent the standstill period scheming to insulate themselves from plaintiffs' anticipated proxy challenge and to entrench their own position by planning a collusive, multi-step transaction (the 'Sham Transaction') that would ultimately result in the issuance of over 16 million new shares of common stock to Rachesky, a friendly member of the board of directors, at a below-market and bargain price," according to the complaint (parentheses in original).

Icahn claims Mark Rachesky has a history of trying "to entrench his own position at the expense of a corporation's welfare," and that in 2008 a Delaware Chancery Court invalidated one such transaction in which he was involved.

"As an experienced and sophisticated investor who has been held to account for similar misconduct in the past, there is no question that Rachesky acted intentionally here, with full knowledge of the damage that his conduct would cause both to shareholders and to plaintiffs' contractual rights," according to the complaint.

Icahn claims that the studio also may have artificially depressed its stock price just before entering the deal.

"By agreement dated 'as of' July 20, 2010, the very day after the standstill period ended, defendants put their scheme into action," according to the complaint. "First, they refinanced and exchanged nearly $100 million in notes held by defendant John C. Kornitzer, a staunch and vocal board ally, into new notes that were immediately convertible into Lions Gate stock at a price that was below the then-current market price. Immediately after, Kornitzer sold the new notes to board member Mark H. Rachesky. Rachesky immediately exercised the notes' conversion option and, as a result, received over 16 million shares of new common stock at a price of $6.20 per share - substantially below both the $8.85 value estimate the board had announced only months before and the $6.50 being offered for shares at the time by plaintiffs."

Icahn says Kornitzer was just a "straw man" and Lions Gate mischaracterized the deal in a press release as a "deleveraging transaction."

"The sham transaction was funneled through Kornitzer, a putatively 'disinterested securities holder,' to hide its true nature and effect: the below-market issuance of a massive block of stock to a corporate insider in a related-party transaction," according to the complaint.

"Had the true purpose of this transaction been 'deleveraging,' as Lions Gate publicly claimed, Lions Gate was under a fiduciary obligation to issue the bare minimum number of shares necessary to retire [Lions Gate Entertainment Inc.'s] notes at the current market price. If the 'deleveraging' had been done at the board's stated $8.85 value, or at the conversion price of the notes before they were changed to lower their conversion price, or even at the market price of $6.50 on July 20, far fewer shares would have had to be issued. Instead, Lions Gate issued Rachesky 16,236,306 shares at a conversion price of $6.20 per share - a gratuitous windfall and far more than was needed for an arms-length fair market transaction. The sole purpose of this windfall was to further consolidate control in management-friendly hands."

Icahn says the transaction sent Rachesky's equity interest in Lions Gate up from 19.8 percent to 28.9 percent "literally overnight," while Icahn's combined holdings fell from 37.9 percent to approximately 33.5 percent.

"In other words, the incumbent directors were more entrenched than ever, while plaintiffs' efforts to replace the board with their own nominees through a proxy battle were rendered nearly impossible," according to the complaint.

Icahn and his affiliates sued Lions Gate Entertainment, a dozen corporate directors, and several affiliates associated with Rachesky and Kornitzer. They seek an injunction, rescission, and compensatory and punitive damages, alleging breach of contract and tortious interference. They are represented by Joseph DiBenedetto with Winston & Strawn.

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