Blockbuster (BLOAQ)

There are rumors currently circulating the business world that Blockbuster Inc. (NYSE: BBI) is destined to file bankruptcy in the coming year, rumors that sent its shares plummeting 77% yesterday. And while shares were up over 100% this morning, that doesn’t mean that the rumor is any less true.

For that matter, don’t even call it a rumor. Call it a fact. Blockbuster might not go under this year. It could even trudge on for the next five years for all I know. But one way or the other, its days of glory are over… Just like the cassette tape and VHS of old, and even CDs and DVDs to a growing extent.

As evidenced by the examples above, technology is changing at a rapid pace. Everyday, there is some new advancement that puts yesterday’s innovation at a slight disadvantage by being a little bit faster… a little bit cheaper… a little bit smaller… a little bit more capable…

Despite the downturn, consumers still expect all of those perks, and with good reason since inventors, manufacturers and marketers are more than happy to meet those demands. To that extent, Blockbuster just can’t compete. Or at least it won’t compete, sticking steadfastly to the basic business model it began on.

Sure, it started stocking DVDs and phased out VHS altogether when the transition needed to be made. But what about Blu-Ray? And Netflix (Nasdaq: NFLX)?

The latter especially is a boon to Blockbuster. With every customer it adds, Blockbuster loses out just that much more. And the more the rental giant ignores its waning popularity - which it has literally staked itself on doing - the more it ensures bankruptcy as its only future.

This isn't the good news people might think it is. So, I was going through some old news and found this (I forgot to write about it the first time).

The news:

Blockbuster Inc. (BBI) has received a boost from its former rival Mark Wattles, who purchased a 5.7% stake in the movie rental chain and said he doesn't believe the Dallas-based company will file for bankruptcy any time soon.

Wattles, co-founder and former CEO of Hollywood Entertainment and currently the majority owner of the Ultimate Electronics chain, said in a Securities and Exchange Commission filing on Monday, March 16, that he acquired the shares for investment purposes because he believes Blockbuster "does not have a motive to reorganize under Chapter 11."

Anyone remember Wattles last investment? Yup, now defunct Circuit City.

Mr. Wattles, principal of Wattles Capital Management LLC and the founder of video-rental chain Hollywood Entertainment, took a 6.5% stake in Circuit City, which had at the time about $12 billion in annual sales. Circuit city was evenautally liquidated

Beofre Circuit city Mr. Wattles bought Ultimate Electronics out of bankruptcy, ran it back into bankruptcy, and the bought it out again in 2005. Today it has locations in 9 states and is private, so no word on how it is performing is easily available.

Before that Wattles was best known as the founder of Hollywood Entertainment Corp., which he sold to Movie Gallery Inc. for $1.2 billion in 2005. Good timing. The combined company? You guessed it, ended up in bankruptcy.

Now Blockbuster.

Blockbuster Inc. Chief Executive Jim Keyes recently an independent auditor's doubts about its ability to continue as a going concern shouldn't hamper its day-to-day operations at a time when so many other companies are having difficulty coping with the economic crisis. "Given the tightness of the credit markets these days, we are not going to be alone," he said on a conference call. Blockbuster has spent "a lot of time" explaining its liquidity position to movie studios and various suppliers, Keyes explained.

He also that the "single biggest driver" weakening U.S. DVD rentals in the last two months been lackluster new release titles. In last year's first quarter, new DVD titles included "Enchanted" and "I Am Legend," while debuting releases this year have been "good but not great" in comparison, Keyes said during a recent conference call. "The good news is that we're seeing unprecedented theatrical strength," he added, pointing out that current box office hits like "Watchmen," "Slumdog Millionaire" and "Paul Blart: Mall Cop" will be available on DVD in a few months, driving greater domestic DVD rentals.

What effect? Blockbuster swung to a fourth-quarter loss on a $435 million non-cash charge related to a decline in the value of its assets. The company also said three of its largest creditors have agreed to extend its revolving credit facility through Sept. 30, 2010, alleviating concerns about a debt payment that would have been due this August. The company said it lost $362.7 million, or $1.89 a share in the fourth quarter of 2008. In the same quarter a year earlier, it posted a profit of $38.1 million, or 20 cents a share. Excluding items, the company would have earned $80.4 million, or 40 cents a share, in the latest three months. Revenue fell to $1.38 billion from $1.57 billion, as the quarter included one less week than the fourth quarter of 2007.

It looked like Blockbuster (BBI) was going to be no exception. The stock, which had already been battered over the course of the last year, declined sharply today to 22 cents before trading was halted on news that the company had hired restructuring specialists Kirkland & Ellis to explore bankruptcy. According to this Forbes article titled Blockbuster Not Bust , the reports of Blockbuster's demise were a little premature and the company refuted claimed about filing for Chapter 11 bankruptcy. With over $854 million in debt on its balance sheet and only $35 million remaining on a $400 million line of credit, the company was hoping that Kirkland & Ellis would help it refinance some of its loans. The stock rebounded nearly 60% or 13 cents to 35 cents in after hour trading.

The picture for Blockbuster has been bleak for some time now but for a few brief moments it looked like new management at the company might be able to turn the company around. The company posted a 11% improvement in same store sales numbers, cut back on aggressive marketing for its online subscription service, acquired the movie download service Movielink for a fraction of the money spent by the large studios developing it, closed down unprofitable stores, inked a deal with Live Nation to sell concert tickets and even managed to post a profit earlier this fiscal year after several years of red ink.

However with their credit facility coming due in August 2009, the prospects for Blockbuster look grim right now. When I invested in Blockbuster back in mid 2007, I was aware of the fact that the company represented a risky turnaround situation and stated,

"Did I mention that turnaround situations are risky (just ask investors of Gateway (GTW) or Imax (IMAX) who are still waiting for a turnaround) and the company may just as easily go bankrupt. Blockbuster may be best suited for investors who have a healthy appetite for contrarian bets and/or have a diversified portfolio that is anchored by core holdings like Johnson & Johnson (JNJ) and Procter & Gamble (PG)."

It appears that my appetite for Blockbuster and my faith in new management were probably misplaced and I am now looking at a position that has lost most of its value even if it rebounds by a few cents tomorrow. In the third quarter conference call, Blockbuster's CEO Jim Keyes said,

"While the doubling in our trailing 12 month adjusted EBITDA over the last year puts us in a much, much stronger financial position, we still have nine months to pursue new financing options but we have to have a back up capital plan that if needed would allow us to self fund this business without the use of any additional outside capital."

Closing the position right now would generate very little capital and I am inclined to retain the stock at least until the fourth quarter results are announced on March 19, 2009. The fourth quarter is traditionally their strongest quarter and there is a possibility that they might still raise the capital they require to continue implementing a strategy that has seen revenue per visit increase 15.4%, net paid rental rate increase 17%, net total revenue per square foot increase 7.6%, gross profit per square foot increase 2.4% and total store revenues improve 16% year-to-date.

In March 2008, Blockbuster announced that for fiscal 2008, it expects to deliver adjusted EBITDA in the range of $290-$310 million, which corresponds to GAAP financial measures of operating income (EBIT) in the range of $113-$133 million and net income in the range of $5-$25 million. Even at the high end of the range that equates to EPS of only $.13 cents a share which means shares currently trade at 25 times the top end of estimates and 108 times the low end. Either way, too expensive.

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Blockbuster (BBI) said it made a $1 to $1.3 billion cash offer in a Feb. 17 letter to Circuit City (CC) Chief Executive Philip Schoonover. The proposed Circuit City (CC) and Blockbuster (BBI) merger is the equivalent to the merger of Sears and Kmart that created Sears Holdings (SHLD). While a nice exercise, it lacks one thing, legitimacy.

Here is were is falls apart and it does so before it actually get started really. Sears and Kmart did the same thing, retail. Specifically clothing, lawn and garden, electronics, auto and the rest of the big box general retailer gambit. The combination of the two created the nation's third largest retailer with sales of over $50 billion a year. The combination of BBI and CC will do nothing to increase the size of either in their prospective industries.

Blockbuster rents dvd's and Circuit City sells them it their stores. They also both.....well.....they don't do anything else in common. Other that the fact they both have dvd's in their stores, the two businesses have no similarities at all, other than poor management.

A Circuit City and RadioShack (RSH) merger would be a similar comparison to Sears / Kmart as those businesses are very similar. There would be, in that case, cost savings involved with the merger that could be realized and the two businesses would have selling synergies that could boost results. Also there is the little reality that RadioShack's Julian Day could out-manage CC's Phil Schoonver in a coma.

One also has to remember the Sears / Kmart merger has produced a 10 fold increase in shareholder value, does anyone out there actually think a Circuit City / Blockbuster one will produce even remotely similar results? Anyone? Does anyone actually think they will be even profitable considering the debt load necessary to pull off the deal?

They'll have to essentially dilute shareholders to the max and then raid the credit line CC set up in February to fund the deal since banks are not loaning money for deals that make sense much less one that means a struggling retailer barely making a profit buying one that isn't.

The larger issue is, what is Blockbuster trying to become? They have a valuable franchise in video if they would just realize the video store concept is officially dead. Adding more brick and mortar locations, diluting shareholders and maxing out the credit line to acquire another problem is a huge mistake.

Keyes said "The combination of Blockbuster and Circuit City will result in an $18 billion retail enterprise uniquely positioned for the convergence of media content and electronic devices. We would seek to differentiate products in both Blockbuster and Circuit City stores by offering exclusive content and content-enabled devices. Both companies would benefit from complementary products, marketing, management strengths, technology and distribution and the resulting synergies would significantly improve consolidated financial performance."

He has mentioned this vision before but it has yet to be rolled out in Blockbuster locations, why bet the farm on a wholly unproven concept? He talks about "differentiating products" in both locations. That is confusing because I was not aware of any similarities currently. Let's also be real honest here. Using the term "management's strengths" and either Blockbuster or Circuit City in the same sentence is laughable unless it is preceded by "lack of".

Now, were RadioShack to make a run a CC, that would make sense. Borders and Barnes & Noble does. This doesn't on any level.

Maybe Keyes is officially throwing on the towel in the war with Netflix (NFLX) and has decided to try a new direction?^[1]

1. ↑ ValuePlays Research

Ever hear the saying "throw some $#%t against the wall and see what sticks"? Thus seems to be Blockbuster's (BBI) current business plan.

The box top game is a race. The first out with an affordable offering wins. This isn't something I envision people swapping in and out of. The set-top they buy initially will be the one they use for quite some time. I am still mystified at the apparent blase' attitude by Blockbuster with this. From mail rentals, to online rental, and now the box set they have consistently been behind the competition. This is the right move to make, they just should have made it maybe in May 2007? ^[1]

After being late to the video by mail model, late to the box top set model, talking about turning their obsolete locations into Apple Stores (AAPL) like locations, and attempting a doomed from the start takeover of Circuit City (CC), Blockbuster is trying something else. Now Blockbuster is in talks about taking a stake in the new premium TV channel to be launched by Viacom with Lions Gate Entertainment (LGF) and Metro-Goldwyn-Mayer.

Ok. Haven't we all come to the conclusion blockbuster doesn't have the financial ability to complete the proposed Circuit city deal? How do they intend on doing this also? Have you ever seen a company run in so many seemingly disconnected directions at once? This smacks of desperation. Blockbuster could survive and even prosper and compete with Netflix (NFLX) if they would only acknowledge what everyone but them seemingly understands, they need to close their stores. Should that happen, the cash save could possibly finance one or some of the shotgun like business moves they are contemplating. They cannot, however, keep them and do the others. I guess the only thing left to do for them is to talk about a merger with Sprint (S)?

1. ↑ ValuePlays Research