Blockbuster Offers Big Upside Potential

For the risk tolerant, Blockbuster (BBI) offers big upside potential.

The company is obviously facing increased competition in many forms. The most formidable is NetFlix (NFLX), which was the first to start doing the mail order thing with DVD's and has grown rapidly. Video on demand and other new technologies are also a threat to the traditional in-store video rental market.

Blockbuster has significant debt, which was inherited as a result of a special dividend paid prior to their total spin-off from Viacom (VIA). Blockbuster's cash flow has been under pressure in recent years due to a big investment in marketing their mail order business and other initiatives.

Blockbuster: risky but not without its potential rewards

However, the worst is clearly behind them. They have already outlayed their primary marketing dollars, and their working capital situation should go from being a cash drag to cash neutral at worst. As they close underperforming stores, customers are driven to alternative stores, which has been pushing up comp numbers. Their online business is approaching break even.

Blockbuster should generate nice cash flow going forward, which will be used to pay down their sizable debt. Overall, comparisons should be much more favorable going forward, and should Blockbuster sell their Gamestop division, debt repayment will be much accelerated.

BBI-NFLX 1-yr comparison chart:

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Comments

[Amit Chokshi_:]

Why do you figure the worst is behind them? I love a contrarian play as much as the next person but in BBI's case, do you think it's just an issue of reducing store count and streamlining working capital to milk the business for cash? That might have worked for Autozone and some other retailers where there's not really a technology wall against them but I think BBI and MOVI are value traps.

VOD is going to continue to grow, so as a viewer you can pay $2-$4 to get a movie into your home rather than go to BBI and pay the $5 and have to worry about returning it. I just think the business model is under too much pressure. Plus from just a simple valuation metric rundown, according to Yahoo Finance the stock is trading at 15.0x fwd earnings, 5.9x EV/EBITDA, and 1.3x book. In this market that seems fair to expensive for a company that's in the type of long-term trouble BBI is in.

How much upside do you think BBI offers in terms of share price?

2006 Oct 06 08:56 AM

[Bharper:]

This is definitely a riskier play. But in terms of being a declining business, I think it is more like a RBOC type of attrition than, say, Kodak film where the substituting technology will all but destroy the traditional business. Certainly there is competition in many forms, but there is definitely a place for the traditional rental market.

Blockbuster has been this levered before, and they were able to pay down their debt in a few years. They have cut total debt by about $270 million in the past year.

Also, book value is sort of depressed since they paid a $5/share dividend to Viacom. So this sucked $920 million out of equity.

I have a base target of $10. I think the co can generate free cash flow of at least a buck a share, and that is with the current debt load.

2006 Oct 09 08:13 PM