Blockbuster Could Collapse in 2010

The corporate graveyard is littered with companies that were either unable to adapt to structural changes within an industry, or were - in the saddest of situations - unaware that these changes were even happening.

Blockbuster Inc. (BBI) currently suffers from a combination of those two factors, a predicament exacerbated by the emergence of aggressive competition to its core video rental business. This competition has intensified to the point that Blockbuster could be forced into either bankruptcy or irrelevancy within the next 12 to 18 months.

Most of us have stepped inside one of Blockbuster's brick and mortar video rental locations; at one time, getting in the car and heading to Blockbuster was actually an exciting event. Then Netflix (NFLX) came along, offering customers video rentals by mail, immediately siphoning sales from Blockbuster.

Presently, subscription based video-by-mail services account for 36% of all videos rented by consumers, compared with a 45% share for rentals purchased at physical store locations. Blockbuster has also attempted to offer a Netflix-like service, however, it has clearly been unable to compete in this arena. The company's total revenue was nearly $700MM less in 2008 than in 2003; a sign that it has been woefully incapable of replacing lost brick and mortar sales with online and mail alternatives.

As a comparison, Netflix logged 2008 revenue that was over $1B more than it recorded in 2003.

Recently, video rental kiosks have made an enormous splash by offering cheap $1/day rentals, in prime locations (Wal-Mart (WMT), grocery stores). DVDs rented at these kiosk locations now account for 19% of all video rental activity.

More importantly however, is the marketing research firm NPD Group's prediction that, in the year 2010, 30% of all video rental transactions will take place at kiosks! A market share shift of that magnitude, in such a short period of time, will likely destroy Blockbusters brick and mortar sales. The company appears to understand the dying nature of a DVD rental physical storefront, and has plans to charge headfirst into the kiosk rental business. Blockbuster only has 500 such machines right now, but expects to roll out 7000 in the year 2010 alone.

Alas, this effort may be a textbook example of "too little, too late"; the leading player in the kiosk game - Redbox - already has machines in over 15,000 locations. The traditional real-estate cliche - location, location, location - has distinct parallels in kiosk site selection; a kiosk must be located in a venue that is convenient for the consumer. With a 14,500 machine disadvantage, it's likely that Blockbuster will struggle to compete with Redbox in the battle to place kiosks in the most convenient spots.

Over the next year, the largest threat to the kiosk distribution model will be licensing disputes with change-averse Hollywood studios. As far as Blockbuster is concerned however, the question of whether or not studios will succeed in stymieing kiosk sales is effectively the difference between a bad or worse outcome for the company; they will either continue to make a push into the market - from an extremely disadvantaged position - or their only chance of survival will be squashed by the studios.

This rapid shift in the video rental business is occurring at a horrible time for Blockbuster. The company's revenues are on pace to decline $1B, or almost 20%, in 2009 compared to 2008.

Assuming that NPD Group's projections regarding kiosk market share are correct, Blockbuster's second half numbers will deteriorate even further from already depressed current levels. I wouldn't be surprised if the company logs less than $4B in revenue for 2009, a greater than 33% decline in annual revenue since 2004's $6B year. Unfortunately for Blockbuster, that isn't even the bad news; the company has $415MM worth of debt obligations due between now and the end of 2010.

So how does a company with less than $100MM in cash, rapidly declining sales, and gruesomely negative cash flow meet such an obligation? Well, Blockbuster's strategy is to do the only thing they can: slash G&A as rapidly and as deeply as possible, and sell assets like there's no tomorrow (because there might not be). This was a borderline-achievable goal prior to the rapid ascent of kiosk rentals; under present conditions however, it may be impossible.

Simply put, sales may be declining faster than Blockbuster's ability to preserve cash via cost cuts and asset sales.

Many people still visit Blockbuster's physical locations, and may be disheartened in the event the company is unable to meet it's looming debt obligations. My movie viewing habits will not be disrupted though; I've been streaming Netflix video content, on-demand, through my XBox for several months now.

Disclosure: no positions

Comments

[Roger Knights:]

Commercial real estate will take a hit when all those storefronts hit the market.

Sep 08 05:59 AM

[JODATI:]

You boys with netflix stock have to say anything to drive BBI's stock price down...for what reason?...I noticed whoever wrote this article couldn't even put their name on it. Get a grip and make sure you really know what you're talking about....like netflix for example....4 years ago they had 6 million members and BBI had 4...now Netflix has 10million and BBI has 1 million....but read between the lines....the "movies by mail" business universe only grew 10% in 4 years and didn't take over the rental industry....looks like the studios will take care of the kiosks if they want any kind of return...too bad Sony, Paramount and Disney are in such terrible financial straits that they have to prostitute themselves out for 17¢ a rent........Blockbuster will be around for quite a while...maybe with less stores but they'll be here...don't underestimate Jim Keyes.

Sep 08 10:37 AM

[Coordinador:]

Did you take account that BBI reduced the size of its letters of credit for Viacom Inc (VIAb.N) by about two-thirds, or $50 million. In my opinion it means that it has a very strong cash and it is very reckless to insinuet could collapse in 2010. Perhaps I have to assume that is a finding interested.

Sep 08 01:26 PM

[Dark corner:]

You need to do your research before writing such piece of crap. Rapidly declining sales? Actually the decline has stabilized. BBI is now focus on growing revenue.
Less than 100mm in cash? More like greater than 100mm in cash.
'gruesomely negative cash flow'? Now I know you're really exaggerating for some purpose and financial gain. This article is close to slander and I wish you would put your name on this article so BBI can sue your ass.
I am happy for you that you have been streaming movies to your xbox for the last couple of months now. As for me, I still like being able to go to the rental store. Besides, you can also stream movies at blockbuster, and get your movies through the mail, and get it through kiosks. I do like having lots of choices.

Sep 08 01:28 PM

[Coordinador:]

I agree with te last 2 comments. I would like to know what is the mind of the journalist

Sep 08 01:53 PM

[Davis Freeberg:]

These comments are just plain funny. Decline has stabilized, I'm still laughing about that one. Considering that last qtr showed a 30% decline, I'm not exactly sure that stable is the word that I'd used to describe it. As far as the 50 million goes, this was only reduced because they reduced their lease obligations by $50 million to, so it shouldn't help Blockbuster at all. Not sure what Jodati is talking about from a 10% growth rate, but his math is clearly suspect. In 2004, Netflix had 2.1 million subs and Blockbuster hadn't even launched their online program yet. By my math this means that we've seen 500% growth in the DVD by mail category, not the 10% that Jodati seems to calculate.

As far as it being "reckless" to insinuate that Blockbuster won't make it past 2010, I'd say it's reckless to insinuate that they will. Until someone can tell me how Blockbuster plans on raising $500 million between now and then, I don't see how bankruptcy is avoidable. It'd be one to refinance debt, but at 40+% interest rates how the heck are they going to do that? Not sure that Netflix shareholders have anything to do with Blockbuster's stock price, but I will point out that Mark Wattles started selling his stake 2 weeks ago, which would certainly depress prices. Wattles also got out of Movie Gallery right before they went bankrupt, so this may be something to consider. Since he has 9% of Blockbuster's debt outstanding, it might give you a clue at how the smart money is investing in the company.

Sep 08 02:49 PM

[Carneades:]

Actually, nothing has stabilized for Blockbuster. The underlying point of the article is that kiosk's share of the rental market is about to explode in the next year from 19% to 30%. The most extreme estimates put at most 20% of that growth as additive; that is, 80% of kiosk "growth" will be to brick and mortar's detriment. Also, where are you getting the >$100MM cash figure? My numbers come from the most recent SEC filing, perhaps you should try that source out.

Slander? I assume you meant to use the word "libel", as this is a written form of communication. More importantly though, my article is 1) true , and 2) not malicious. I've already disclosed - as part of SA's policy - that I maintain no financial position in any of the companies mentioned. I imagine that the only purpose behind providing my real name would be so that you could engage in ad hominem attacks; but wait, you already have my bio, so what would your purpose be?

I'm glad you commented though, as it underscores my point about the many people who still enjoy a good old trip to the store. The problem is, Blockbuster's liabilities can not be sustained via it's attrition-plagued base of brick and mortar renters.

Sep 08 04:29 PM

[JODATI:]

may be from 2004...but not from 2006 which was 3 years ago not 4..my mistake...as far as using Wattles as an indicator if Blockbuster is going bankrupt...that's funny!


On Sep 08 02:49 PM Davis Freeberg wrote:

> These comments are just plain funny. Decline has stabilized, I'm
> still laughing about that one. Considering that last qtr showed
> a 30% decline, I'm not exactly sure that stable is the word that
> I'd used to describe it. As far as the 50 million goes, this was
> only reduced because they reduced their lease obligations by $50
> million to, so it shouldn't help Blockbuster at all. Not sure what
> Jodati is talking about from a 10% growth rate, but his math is clearly
> suspect. In 2004, Netflix had 2.1 million subs and Blockbuster hadn't
> even launched their online program yet. By my math this means that
> we've seen 500% growth in the DVD by mail category, not the 10% that
> Jodati seems to calculate.
>
> As far as it being "reckless" to insinuate that Blockbuster won't
> make it past 2010, I'd say it's reckless to insinuate that they will.
> Until someone can tell me how Blockbuster plans on raising $500 million
> between now and then, I don't see how bankruptcy is avoidable. It'd
> be one to refinance debt, but at 40+% interest rates how the heck
> are they going to do that? Not sure that Netflix shareholders have
> anything to do with Blockbuster's stock price, but I will point out
> that Mark Wattles started selling his stake 2 weeks ago, which would
> certainly depress prices. Wattles also got out of Movie Gallery
> right before they went bankrupt, so this may be something to consider.
> Since he has 9% of Blockbuster's debt outstanding, it might give
> you a clue at how the smart money is investing in the company.

Sep 08 05:19 PM

[montymel:]

probably an ex blockbuster employee who is disgruntled wrote this article. need to get your facts straight...

Sep 08 08:27 PM

[Konst:]

Blockbuster is nice. I am a shareholder and I hope the market cap goes up to match annual revenue, not unreasonable. I hope they resolve the financing issues as well as fully adapt to the new landscape of how entertainment is delivered, just like they did when consumers switched from VHS to DVD. Of course, in this climate, streaming, including to mobile devices, will become more and more important. At the moment the stock is cheap, if the company survives it will probably be a multibagger. I hold bbi.b, which is trading at 1/2 the price of A shares, while giving you the same equity and an extra proxy vote. I think good CEOs make a difference, so Jim Keyes and team, I am counting on you.

Sep 08 11:51 PM

[Ranma:]

These sort of hand waving arguments belong at The Motley Fool

Sep 09 02:18 AM

[Coney:]

Blockbuster is in an industry in flux, with so many unresolved factors that long-term predictions of outcomes for each company involved in the industry can't be determined with any certainty.

While the information in your article was generally accurate, Blockbuster on 8/13/09 projected 2009 Year Free Cash Flow of $148m.(with 193.6m. shares that equals $0.76/sh FCF). Blockbuster's CFO Tom Casey said at that time that the company was on track to reduce Debt by $200m. in 2009. This is in no way a "gruesomely negative cashflow" as you state in your article.

Blockbuster as a result of the recession made the decision to reduce expenditures on shelf inventory of DVD's, concentrating on cashflow rather than revenues. Blockbuster prior to the recession had greatly improved the in-stock availability of DVD'S and that had driven increases in same-store sales. The result of the decision to concentrate on cashflow was a loss in revenues that was accompanied, as planned, by a large increase in Free Cash Flow. In Q2 2009 the FCF was $108.7m., up $192.8m. from the Q2 2008 FCF of a negative $84.1m.

When companies expand their operations, it creates need for additional financing, and the opposite is true for companies in declining industries and/or with declining sales, creating "cash-cows" if the decline is handled appropriately.

Blockbuster is a cash-cow at the present time and examination of how they are handling the slowing of sales is informative. In Q2 2009, while Same-Store sales were down 17.8%, Inventory in Q2 2009 was reduced 30.9% and Accounts Payable was reduced 42.9%. Increasing inventory and accounts payable while sales are falling is an ominous sign, but that is not occurring when you examine Blockbuster's financial reports.


I would like to see in your future articles include more information on Blockbuster's present performance, including specific financial information, along with your attempts to divine the company's future prospects.

Coney

Sep 09 11:13 AM

[Dark corner:]

dfdf

Sep 09 03:04 PM

[Dark corner:]

sorry, didn't mean to come out so strong earlier but I just hate reading an article that comes out so biased and wrong. I think Coney hit it on the mark with a more thorough comment.
You now commented that the article is more about the growth of kiosks but you conveniently fail to mention that bbi has an alliance with NCR to capture this market. In fact, bbi's business model is convenience and choices for their customer. A bbi customer can rent at the store, get it through mail, kiosk and streaming. I think this business model will work and membership at bbi should be growing again. It shouldn't be a problem for Keyes to present this to banks and investors when he has to renegotiate loans.

Sep 09 03:25 PM

[Carneades:]

Alright guys, I will quote straight from the Company's most recent 10Q (pg 11):
"However, we expect cash on hand, cash from operations, and anticipated external liquidity generating events, such as divestitures of certain non-core international assets and the reduction of amounts committed under one or more outstanding letters of credit, will be sufficient to fund out anticipated cash requirements for working capital purposes including rental library purchases as well as commitments and payments of principal and interest on borrowings for at least the next twelve months. This expectation is subject to a number of assumptions, many of which are outside our control. Such assumptions include, among others, that we achieve our projected financial results for the remainder of 2009 and 2010, we compete the divestiture of certain of our international assets, we reduce our obligations under letters of credit or other external liquidity generating events and that there is no significant contraction in our trade terms"

What that little excerpt tells me is that the next twelve months will be an extremely uncertain time for the Company. What I doubt Blockbuster is counting on is that kiosk market share will jump from 19 to 30% in the next year.

Sep 09 03:44 PM

[Dialectical...:]

Four or five of these commenter have 3 or fewer comments on SA, and it appears this article accounts for all of those comments. I'm not saying these are all the same person, but it is odd that so many people would feel compelled to comment for the first time about an article that is simply stating the obvious. BBI is in a world of hurt. They have been saddled by debt for a long while and have not been able to make serious strides to pay down debt and turn the corner on cash flow. Not that they haven't tried. I am not short BBI and I don't care if they go bankrupt or not... it just appears that's where they are headed.

If it becomes a turn around story then a lot of shorts will get squeezed and some die hard faithful might make some good money. But I won't be one of them.

Sep 10 03:19 AM

[JHorton:]

Jodati sounds like a child who disagrees just so he can get the attention. Last Qtr showed a 30% decline. BB cannnot expect to make up this ground in this economy in the 4th Qtr. I have family member who works for company and they are told to mention Hollywood is to blame for decline. Really? BB still relies on "Penny wise, pound foolish" theory. The decline of the brick and mortar giant is nearing end. I don't see 12 - 18 mos. but within 36 mos.


On Sep 08 02:49 PM Davis Freeberg wrote:

> These comments are just plain funny. Decline has stabilized, I'm
> still laughing about that one. Considering that last qtr showed a
> 30% decline, I'm not exactly sure that stable is the word that I'd
> used to describe it. As far as the 50 million goes, this was only
> reduced because they reduced their lease obligations by $50 million
> to, so it shouldn't help Blockbuster at all. Not sure what Jodati
> is talking about from a 10% growth rate, but his math is clearly
> suspect. In 2004, Netflix had 2.1 million subs and Blockbuster hadn't
> even launched their online program yet. By my math this means that
> we've seen 500% growth in the DVD by mail category, not the 10% that
> Jodati seems to calculate.
>
> As far as it being "reckless" to insinuate that Blockbuster won't
> make it past 2010, I'd say it's reckless to insinuate that they will.
> Until someone can tell me how Blockbuster plans on raising $500 million
> between now and then, I don't see how bankruptcy is avoidable. It'd
> be one to refinance debt, but at 40+% interest rates how the heck
> are they going to do that? Not sure that Netflix shareholders have
> anything to do with Blockbuster's stock price, but I will point out
> that Mark Wattles started selling his stake 2 weeks ago, which would
> certainly depress prices. Wattles also got out of Movie Gallery right
> before they went bankrupt, so this may be something to consider.
> Since he has 9% of Blockbuster's debt outstanding, it might give
> you a clue at how the smart money is investing in the company.

Sep 10 05:27 PM

[ohjohnnyboy:]

as a blockbuster employee of fifteen years, all I have to say is this article is the same as every other article ever written since day one.
we were going to close when viacom bought us. we were going to close when viacom cut us loose. we were going to closing when we went public with our stock. radio shack in-stores. vhs to dvd. direct tv.
on-line subscription. no more late fees and so on and so on.
netflix is nice, but as I tell my customers who come in on Sundays and holidays when there is no mail service. "glad you're back. Every home does not have a computer or internet, not every market has a kiosk that only holds so many movies. don't bury the coffin until you have all the nails.

Sep 10 11:39 PM

[Abraham Wei...:]

Davis,
Your comment that Mark Wattles owns 9% of BBI's debt outstanding is factually inaccurate. Eric Savitz of Barron's mistakenly reported this in an article on March 16th, 2009 which is, I presume, your source. That said, it was a factual error when first written and should not be falsely passed along.


On Sep 08 02:49 PM Davis Freeberg wrote:

> These comments are just plain funny. Decline has stabilized, I'm
> still laughing about that one. Considering that last qtr showed a
> 30% decline, I'm not exactly sure that stable is the word that I'd
> used to describe it. As far as the 50 million goes, this was only
> reduced because they reduced their lease obligations by $50 million
> to, so it shouldn't help Blockbuster at all. Not sure what Jodati
> is talking about from a 10% growth rate, but his math is clearly
> suspect. In 2004, Netflix had 2.1 million subs and Blockbuster hadn't
> even launched their online program yet. By my math this means that
> we've seen 500% growth in the DVD by mail category, not the 10% that
> Jodati seems to calculate.
>
> As far as it being "reckless" to insinuate that Blockbuster won't
> make it past 2010, I'd say it's reckless to insinuate that they will.
> Until someone can tell me how Blockbuster plans on raising $500 million
> between now and then, I don't see how bankruptcy is avoidable. It'd
> be one to refinance debt, but at 40+% interest rates how the heck
> are they going to do that? Not sure that Netflix shareholders have
> anything to do with Blockbuster's stock price, but I will point out
> that Mark Wattles started selling his stake 2 weeks ago, which would
> certainly depress prices. Wattles also got out of Movie Gallery right
> before they went bankrupt, so this may be something to consider.
> Since he has 9% of Blockbuster's debt outstanding, it might give
> you a clue at how the smart money is investing in the company.

Sep 11 12:23 AM

[Abraham Wei...:]

Carneades,
Since this 10Q was written, the credit markets (especially for distressed debt) have experienced the strongest and quickest turnaround in the past 20 years. BBI's ability to find alternative capital in this environment is markedly higher than it was at the time the 10Q was written. Just look at the number of high yield deals that were completed in the past month for company's that are in much worse financial shape than BBI.


On Sep 09 03:44 PM Carneades wrote:

> Alright guys, I will quote straight from the Company's most recent
> 10Q (pg 11):
> "However, we expect cash on hand, cash from operations, and anticipated
> external liquidity generating events, such as divestitures of certain
> non-core international assets and the reduction of amounts committed
> under one or more outstanding letters of credit, will be sufficient
> to fund out anticipated cash requirements for working capital purposes
> including rental library purchases as well as commitments and payments
> of principal and interest on borrowings for at least the next twelve
> months. This expectation is subject to a number of assumptions, many
> of which are outside our control. Such assumptions include, among
> others, that we achieve our projected financial results for the remainder
> of 2009 and 2010, we compete the divestiture of certain of our international
> assets, we reduce our obligations under letters of credit or other
> external liquidity generating events and that there is no significant
> contraction in our trade terms"
>
> What that little excerpt tells me is that the next twelve months
> will be an extremely uncertain time for the Company. What I doubt
> Blockbuster is counting on is that kiosk market share will jump from
> 19 to 30% in the next year.

Sep 11 12:28 AM

[afan:]

You are all so passionate about Blockbuster and its future. I am hoping that the company pulls through. I do love the option of paying an honest buck for a movie whenever I want, but I hate dealing with a computer all the time. Not to mention the fact that the only options are what's "hot" or "new release", I miss those trips to Blockbuster and renting those "oldies, but goodies"...small talk about a movie I may like in comparison....those moments are the heart of Blockbuster. Miss it already.

Sep 15 11:29 PM