Here's a look back at one of Carl Icahn's gigantic mistakes
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You can learn a lot from the successes of others. Sometimes you can learn even more from their failures – and, especially, from the failures of people who are otherwise extraordinarily successful.
Carl Icahn is an American investor and corporate raider whose current net worth of US$17.7 billion is proof of his investing skill. He is now 80 years old and ranks as the 43rd richest person in the world. (According to Bloomberg, he’s even considered a candidate to become U.S. Treasury secretary – the U.S. financial regulator and the person whose signature you see on U.S. dollar bills) if Donald Trump becomes the American president.
Some of Icahn’s notable wins include taking airline TWA private in 1988 (which earned him US$470 million), and making about US$180 million after he convinced eBay to spin off PayPal into a separate business. Just last week, Icahn announced that he had sold all 53 million of the Apple shares he and his company controlled. He says he made around US$2 billion on the investment.
But Icahn has made mistakes, of course. He’s said that the worst investment he ever made was the US$191 million he invested in Blockbuster beginning in late 2004. Before the days of streaming video and TV on demand, Blockbuster had a booming video rental business. A typical Saturday night in the suburbs of Anywhere, USA would often include a visit to the local Blockbuster to rent a few movies to watch on the VHS. As videotapes were replaced by the next technology, Blockbuster shifted to rent out DVDs, and also got into games.
In 2004, when Icahn began buying shares, Blockbuster was the world’s biggest video rental company. It had 9,000 outlets in over a dozen countries, a stock market value of US$5 billion, and annual revenues of US$5.9 billion.
But by the time Icahn got involved, Blockbuster was already in trouble. It was losing customers to companies like Netflix and Redbox. They were both newcomers, had no physical stores and offered the same popular movies but at a lower price.
Netflix, now an online entertainment giant itself, started in 1997, and at the time it was an online movie rental business using DVDs. In 1999, it started a subscription-based service where customers paid a monthly fee for unlimited DVD rentals that were mailed directly to their house. By 2003 it had over 1 million paying subscribers.
Redbox set up automated DVD kiosks (like a soda machine, but with DVDs instead of Coca-Cola) in stores and shopping centres. This was a cheap, easy way for people to rent movies, and by 2005 it was also taking business away from Blockbuster.
Investing in troubled companies is what Icahn does best. He is what’s called an “activist investor,” which means he buys enough shares of a company to be able to influence management decisions, through indirect pressure or by getting a seat on the company’s board of directors.
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His goal is to unlock value in the company, so that he and other investors can earn higher returns. Often just the announcement that Icahn is considering investing in a company is enough to make its share price jump, as investors anticipate activist magic.
Icahn believed that Blockbuster was a good candidate for his turnaround formula. So, in 2004 he started buying Blockbuster shares. According to the Wall Street Journal, he eventually owned over 14 million Blockbuster shares at an average share price of over US$8. He also owned US$38 million worth of convertible preferred shares that could have been converted into another 7.4 million common shares.
But this was one investment that wasn’t going to turn around. Icahn failed to see what was coming and the havoc the internet and online streaming would wreak on video stores. (How many video stores have you visited in the past five years?)
As late as 2007, Icahn told Time magazine that Blockbuster’s chain of stores was its greatest asset in the battle with Netflix. Company executives continued to defend their business model and even shelved an online rental service they had developed, even though it was the company’s best bet to compete with Netflix. They were frustrated that it lost money, and decided instead to focus on brick-and-mortar stores.
Icahn finally gave up in March 2010. He sold the majority of his Blockbuster shares at an average price of 26 cents per share. He was down around 98 percent. Blockbuster declared bankruptcy later the same year.
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Looking back, it’s easy to see that video stores were the horse and buggy of the digital age. Many industry experts saw it coming. But Carl Icahn did not. How did he fail so spectacularly?
As noted in our special report, investment pitfalls can trip up even the best investors. The human brain is hardwired to act in a certain way, and we have to train it to overcome these inborn tendencies.
Only Icahn knows exactly what he was thinking when he plunged ahead with Blockbuster. But it looks like his emotions might have gotten in the way in two ways.
Loss aversion is one of the results of our brain feeling actual pain when we lose money, or anything else of value. This tendency can cause us to hold onto an investment even when it has dropped in value and the prospects are bleak. We don’t want to sell it and lock in a loss – so we may hang onto it all the way to the bottom, hoping it will recover.
Confirmation bias is when we only look at, or believe, information that confirms what we were already thinking. So, if an investor thinks a stock is heading higher, he will only consider information that supports his viewpoint. And he may ignore anything that contradicts this belief.
Did either of these pitfalls affect Icahn? Well, billionaire or not, he is only human, so perhaps. He did hang onto his Blockbuster shares all the way to nearly the bottom. He also couldn’t see, or didn’t want to see, what was happening in the video rental industry.
How can you avoid these same pitfalls? Two ways:
- Replace it with cash. If you’re reluctant to sell an asset that’s gone down in value (whether it’s a flat or a stock or a beach house), imagine if the asset was replaced with cash overnight. In the morning, would you use that cash to buy the same investment? If not, it’s a sign that maybe you should sell and move on.
- Listen to others. It sounds obvious, but sometimes it’s easy to ignore opinions that differ from your own. That can be an expensive mistake, especially when it comes to investing.
Encouragingly, Icahn learned from his mistake. In 2012, he bought a 10 percent stake in Netflix. He held the shares until June 2015, when he sold them for a profit of US$1.9 billion. If Icahn’s experience with Blockbuster was training for investing in Netflix, it was (in relative terms) a valuable educational experience.
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