In the past few months, shareholders have gotten especially active in pushing their corporate boards to act as they wish. Carl Icahn squeezed Motorola to a new Chairman and an eventual breakup plan. Electronic Arts has Take Two by the collar. Microsoft is chasing Yahoo. It used to be proxy fights and hostile takeovers were rare but now the rules are changing. The rough games are becoming common and they seem to be looming like a scripted sequel to Oliver Stone’s Wall Street. Is something in the water on Wall Street?
Today, just when it seemed more surprises were unlikely, up popped Blockbuster with a billion dollar Gordon Gecko maneuver of their own. Apparently, the struggling movie rental firm had been admiring similarly struggling retailer Circuit City for some time. They went so far as to send a formal inquiry and solicitation in February. Rejected, they’ve now taken their offer to the street. It isn’t officially hostile, yet, but the plan appears to be following the script being used by EA in their chase of Take Two: Start with a private talk, no private talk, then initiate a public talk. If public talk doesn’t work, then go hostile.
Many have been quick to chime in on the breaking news. Most don’t get the logic in a proposed deal. Om Malik at Giga Om colorfully wrote “It’s the kind of deal you can only justify if you’re coming off a major spring break bender.” A headline at Venture Beat read “Blockbuster Wants Circuit City: Sinking Boat wants more water.” Others have run with phrases like “Circuit buster” and “Blockbuster Short Circuits.”
The clear consensus is a state of confusion; even after Blockbuster CEO Jim Keyes addressed analysts in a conference call.
Is this the seven-eleven-ing of a weakened retailer? (Keyes turned around 7-11 before stepping to fix the Blockbuster). Is this an effort to take two weak businesses and somehow build a stronger whole? Is it a master stroke? Is it an ill conceived plan?
No deal is certain here, and if one does happen, retail analysts are probably going to a have a different view than media analysts. Regardless, initially all reviews seem to be skeptical and confused. Some may even be wondering if Blockbuster’s board has grown dazed and confused themselves.
There’s no denying it does look a little odd. Retail has been heavily segmented between specialist shops and big box sellers. Companies caught in the middle are hurting. In this market, Circuit City has not done a good job of defining itself. A simple trip to their stores reveals the troubles. In contrast to rival Best Buy, or a niche store like Apple’s boutiques, the lighting is dark. Floor plans don’t seem to navigate naturally. Staff doesn’t seem well trained. Generally, the stores are comparatively uninviting. It’s an altogether uninspired shopping experience – and that shows in their financial results.
Blockbuster, similarly, has been struggling too. Last year, they tried to compete with Netflix in online/mail order rentals only to find the heavy marketing spending wasn’t hurting them more than their competitor. Earlier this year, shares sank to an all time low of $2.66. Back in November, the company reported a net loss of $35m (20cents a share) on revenue of $1.24b for the 3rd quarter. That was down even lower than a loss of $24.7m (15c/share) for the same period last year. Factoring in a loss of the fiscal year, Blockbuster had lost money for the majority of the last decade.
The challenges of poor execution (Circuit City) mixed with a changing core business (Blockbuster), begs the question, in a Blockbuster world where Circuit City is part of their portfolio, how will things change to fix the flaws?
The idea that some rental shops become micro stores housing smaller mix of rental and retail of related electronics is clear enough, but is it really a competitive advantage? Will adding Blockbuster’s rental kiosks expand the big stores….like a Pizza Hut or Starbucks corner hidden in a Target? Ultimately, will earnings per square foot of retail space pick up to an industry leading level with this kind of a move? It doesn’t seem like that promise can be made or kept.
The big one is: how does a merger address the fundamental flaws in both businesses. This morning’s analyst call didn’t address that. Blockbuster, please explain. Where is the value proposition in taking two struggling chains, both dealing with competition and changing markets, and putting them together. How do they fix each other if neither seems to have the winning formula for retail success on their own right now?
Blockbuster says they’ll pay at least $6 a share (and possible as high as $8). With 168.4m Circuit City shares outstanding, that values the company at more than a billion. Last quarter, blockbuster had only about $184.6m in cash on the books. They’re willing to structure a stock based transaction, but more likely an offer will be cash based. That means debt, and a lot of it.
Early speculation hinted that debt load, especially in the current economic climate with banks pinched over credit issues, could be a fault line but that road block has been rebuffed. Wattles Capital Management, Circuit City’s largest shareholder (6.5%) reportedly spoke with Blockbuster’s largest shareholder (and board member) Carl Icahn this morning. Marketwatch reported Wattles said in an interview that “Carl [Icahn] was enthusiastic about the transaction and said he was willing to backstop the finance.” “There’s lots of capital to borrow from,” the interview continued.
The Marketwatch report also indicated Wattles, which is leading a proxy fight to try and replace Circuit City’s board, is reportedly in favor of the deal too.
That doesn’t answer the questions, however. Even if the money is there, the key question remains: should it be. CEO Jim Keyes told analysts in a conference call, “it is not inconceivable to imagine a Blockbuster kiosk in your local circuit city store or a Circuit City video game terminal residing next to the video game rental section in your neighborhood Blockbuster store.” Fine, if that’s the approach, but why buy a struggling company instead of partner? Why take the debt and the risk if there’s an easier way. It seems like this approach add more challenges than it can possibly fix.
To their credit, Blockbuster has shown a few signs of improving since Keyes joined the company last year. But moves like February’s effort to offer and promote serving feature downloads to mobile phones have called into question his grander strategy even as the company makes shrewder download moves at the same time.
[More on the mobile effort is here, but the simple version is: small screens, limited storage, short battery…and long form content? It doesn’t compute when matched against consumer behaviors].
Now there’s this potential quagmire. Keyes is characterizing it as a “game changing retail concept.” He said it “capitalizes on the growing convergence of media content and electronic devices.”
It’s clear a deal is motivated by that convergence but is it really capable of capitalizing? That’s the part that has a lot of head scratching. On the surface, it doesn’t make sense. If there’s genius in this plan, maybe it’s the kind that won’t reveal itself until its implemented. For now, it’s just confusing.
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