Wall Street Sour On Blockbuster’s Circuit City Bid

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As the content world moves toward all-digital distribution, Blockbuster has made a $1 billion-plus play to reinforce its bricks-and-mortar footprint with a hostile bid for Circuit City Stores.

The combined company would be the “ultimate distribution channel for digital content,” Blockbuster CEO Jim Keyes said on a conference call last week with investors.

Investors were evidently confused and displeased with the rationale for the merger, which would bring together two large and well-known retailers that have struggled recently. Blockbuster shares fell 10.2% the day the company announced the bid (April 14), closing at $2.81.

JPMorgan analyst Bart Crockett downgraded Blockbuster on the news, from overweight to neutral, calling the unsolicited bid for Circuit City “out of left field” and fraught with risk.

Even if Blockbuster pulls back on the offer, Crockett said in a note to investors, the company “has shown more appetite for risk than we like now.”

Keyes initiated the offer in a private letter dated Feb. 17 to Circuit City CEO Phil Schoonover, offering $6 to $8 per share in cash for Circuit City. That values Circuit City at between $1 billion and $1.35 billion.

Circuit City, in response to the bid, said “to date, Blockbuster has been unable to satisfy Circuit City and its advisers that Blockbuster’s proposal could be financed” and was “unwilling to provide Blockbuster with additional detailed due diligence information … until these questions are answered satisfactorily.”

Blockbuster said the deal is supported by the board as well as Carl Icahn, the company’s largest shareholder, who indicated he will help finance the deal himself if needed.


BLOCKBUSTER DEAL?
If it happens, the merger would combine two struggling retailers:


DEAL QUESTIONED

Ultimately, though, investor concerns may cause Blockbuster to abandon the proposed deal, Wedbush Morgan Securities analyst Michael Pachter said in a research note.

“We think that this proposed combination has the potential to derail Blockbuster from its mission,” he wrote.

The problem is that Blockbuster would be doubling down on the wrong business model, Seeking Alpha blogger Todd Sullivan wrote.

“The larger issue is, what is Blockbuster trying to become?” he wrote. “It has a valuable franchise in video; if the company 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.”

But Keyes, who joined Blockbuster in July after heading 7-Eleven, asserted that the deal really is driven by new media. He positioned the Circuit City bid as harnessing 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,” Keyes said in the letter to Schoonover.

Analysts contended that this is a dubious strategy. Apple has made a business of tying content to devices, but even with its cult-like following the iPod maker has been forced to cut holes in its walled garden and offer music without any content security attached.

Even if Keyes were able to deliver on this “converged” strategy, Pachter wrote, “we fail to see how Blockbuster has any competitive advantage in delivering content to these consumers.”

SET-TOP IN WORKS?

Meanwhile, Blockbuster has reportedly been quietly cooking up a set-top box to deliver direct-to-the-TV digital-video rentals, according to The Hollywood Reporter.

Netflix, which is Blockbuster’s chief rival at this point, has announced that it is working with LG Electronics to deliver a device that would play DVDs as well as downloaded content in the second half of 2008.

Blockbuster in August 2007 acquired Movielink, an online movie-rental and download company that was a joint venture of five movie studios: Metro-Goldwyn-Mayer Studios, Paramount Pictures, Sony Pictures Entertainment, Universal Pictures and Warner Bros. Studios.

With Movielink, Blockbuster has Internet distribution rights to a library of thousands of movies and TV shows from the five member studios and 30 other studios. Blockbuster said it would continue to operate Movielink as an independent service and eventually make the service available through Blockbuster.com.

At the time, Keyes said in a statement that the Movielink acquisition “with its associated digital content is the next logical step in our planned transformation of Blockbuster.”

But for the time being, taking over Circuit City is the movie-rental chain’s focus.

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