Jeremy Kay examines the intriguing merger talks at Lionsgate, and the role Carl Icahn plays in any potential deal.

In the latest twist surrounding the corporate ambitions of Lionsgate, unconfirmed reports emerged this week that the studio has met with MGM creditors to discuss a potential merger. Lionsgate has been actively pursuing MGM for a while and has held talks with the ailing studio’s management. Both parties declined to comment on this week’s development.

Summit Entertainment has also been associated with Lionsgate in the merger discussions, however that company’s co-heads Patrick Wachsberger and Rob Friedman declined to elaborate when questioned this week.

What makes the situation so intriguing is that any merger would have to be approved by Lionsgate’s largest shareholder Carl Icahn. The billionaire investor is a very public thorn in the Santa Monica-based studio’s side and recently increased his stake in the company to 38%.

As the owner of more than 33% of the company Icahn holds veto power over any possible merger or acquisition. Icahn and Lionsgate have waged bitter corporate warfare against each other for months and are currently observing a 10-day truce in which they have allowed each other to seek common ground on any possible merger.

A potential merger with MGM would bring Lionsgate a depth of catalogue that it and many other companies could only dream of possessing. James Bond and The Hobbit films - which are currently on ice - would be anybody’s jewels in the crown. Icahn, however, argued that Lionsgate should focus on its core strengths of film and television distribution and in March offered to buy Lionsgate at $6 a share, which he subsequently raised to $7 a share in April.

Icahn is against libraries, although he has intimated he might endorse an MGM acquisition if it makes sense. He has cited with plenty of justification that the flattening DVD sector and troubled television markets mean catalogues do not represent good investment opportunities. In fact it was Lionsgate’s initial interest in the stricken MGM library that prompted Icahn the shareholder to become Icahn the shareholder activist or, to dispense with euphemisms, corporate raider.

The businessman, who first came into Lionsgate stock in spring 2006 and took a larger position in late 2008, believes Lionsgate has stretched itself too far and overvalues acquisition targets. Take the TV Guide Network deal, for example, which cost the company $255m last year. Icahn believes they paid too much. He has also complained about the amount of money spent on overhead, claiming that stock is depressed as a result.

Icahn has also floated the idea of cleaning out the management suite and bringing in a new cadre of rulers. Lionsgate’s top-heavy structure has drawn comment in the past, with CEO Jon Feltheimer, vice-chairman Michael Burns, co-COOs Joe Drake and Steve Beeks and Mandate president Nathan Kahane each earning handsome compensation packages.

Icahn is believed to be preparing for a proxy battle for control of Lionsgate following the expiry on June 30 of his $7 a share tender offer. Headquartered in Vancouver and run from Santa Monica, California, Lionsgate is an attractive proposition and has spawned the Saw and Tyler Perry series, as well as small-screen hits including Mad Men and Weeds.

Icahn is betting that shareholders would welcome a changing of the guard, but Lionsgate management ridiculed the $7 a share offer, which effectively valued the company at $825m.

Icahn said shareholders including the billionaire Mark Cuban recently tendered 13.2% of their stock so that by mid-June he had amassed a 31.8% stake. Icahn’s ownership climbed to 37.9% on July 1 after he bought 4.6m shares on the open market. Observers say he may continue to acquire more stock on the open market as he prepares for a proxy war.

If the proxy war goes Icahn’s way, he would convince shareholders to use their proxy votes to instal new management amenable to a takeover.

This would allow Icahn to avoid paying a premium for ownership. He has said that if the proxy fight is unsuccessful, he will walk away.

Lionsgate executives are not so sure. That said, a well-placed source at the studio told Screen International recently: “We would be willing to consider some scenario in which he has board representation.”

“Lionsgate is really focused on running the business,” the  source added. “The best defence against a takeover bid is to maintain robust corporate performance and a strong stock price.” That does not sound so convincing after a film underperforms at the box office, like the Ashton Kutcher-Katherine Heigl action comedy Killers. The film reportedly cost $70m to make and by mid-July had managed a shade under $46m after six weekends in US theatres. Shareholders do not like to be disappointed.

It’s not all plain sailing for Icahn, who has come under fire from Lionsgate for his short-lived distribution venture Stratosphere Entertainment and for management of his prestige fund Icahn Enterprises. According to a letter from Lionsgate management to shareholders that went out last month, the value of Icahn Enterprises shares plunged 71% to $38.74 from a 2007 high of $134.

“If Mr Icahn cannot create value in his own funds,” the letter said, “how can he do so in an industry in which he has limited and unsuccessful experience?” Management went on to say that Icahn had no clear strategy for Lionsgate. Icahn and his associates had not returned a call to comment for this story at time of writing.

Lionsgate earned a reprieve in mid-June when it avoided a debt default on its $340m revolving credit line triggered by Icahn’s ownership of more than 20 of stock. Senior lenders amended the “change of control” provisions and raised the trigger threshold for an individual owner to 50%.

Icahn may not be at 50%, but as the biggest individual investor he has clout, even if Lionsgate chooses not to acknowledge this in so many words. At a time when Lionsgate is yet to schedule its shareholder AGM, the studio’s future hangs in the balance. Hollywood is watching closely.