Is There Hope for Blockbuster Yet?

 |  Includes: BBI, NFLX
by: Mark Riddix

The second largest movie chain in the United States has just gone out of business. Movie Gallery is the parent company of the Hollywood Video, Movie Gallery, and Game Crazy chains. The rental chain company just announced plans to close its 2415 stores and liquidate all of its assets. Movie Gallery buckled from declining revenue and increasing debt obligations. The company’s debts dwarfed its assets, leaving the movie rental chain with limited funds to service its debt. Movie Gallery had filed for Chapter 11 bankruptcy protection in February hoping to find a way to keep its doors open. Management tried everything from closing stores to cost cutting but nothing worked. None of this changed the fact that Movie Gallery’s business model was obsolete.

In previous posts I have written about the troubles at Blockbuster (BBI) but today there may a glimmer of hope for the nation’s largest movie chain. The liquidation of Movie Gallery could help boost top-line growth at Blockbuster. Blockbuster has a slightly better balance sheet than Movie Gallery. Blockbuster has an opportunity to pick up a share of the $1.4 billion in sales revenue that Movie Gallery is leaving behind. Obviously Netflix (NASDAQ:NFLX) and RedBox will get a large share of this market but there is room for Blockbuster to benefit as well. There will always be a niche of customers that prefer going to a store than renting from an impersonal machine.

There is also the 28 day advantage that Blockbuster has over Redbox and Netflix. Investors shouldn’t underestimate the effect that a 28 day delay could have on the earnings of Redbox and Netflix. According to the New York Post, 75% of DVD sales are made during the first four weeks. Movie shoppers tend to be an impatient bunch. They want to see a movie immediately after it is released. Blockbuster’s deal with the major studios gives them 4 weeks to capitalize on sales before competitors can cut into these rentals.

Blockbuster is trying to change its business model by selling movies through kiosks, mail, online, and traditional stores. Being the only major brick and mortar retail chain left in the industry will either be a competitive advantage or a major liability.

The best move for Blockbuster long term is to be acquired by another entity. It obviously makes no sense for Netflix or Coinstar (NASDAQ:CSTR) to buy Blockbuster. Neither company has the cash to acquire Blockbuster and Blockbuster doesn’t fit with their current business models. I think that a movie studio should take a look at acquiring Blockbuster. It would make sense for a 20th Century Fox or Universal to acquire the rental giant and use Blockbuster to deliver its movie content. Blockbuster’s distribution channel would be useful for major studios and its emerging digital delivery format would be beneficial.

The only problem with an acquisition by a studio is the massive debt load. Blockbuster is in a similar financial situation to Movie Gallery. Both companies have about the same amount of debt but Blockbuster has more cash. The bondholders are the biggest roadblock to any deal. Blockbuster has $630 million dollars worth of 11.75 percent notes due in 2014. Bondholders would have to be willing to take a substantial haircut for Blockbuster to ensure its long term survival.

While I still would not buy Blockbuster’s shares, I will be paying attention to the company’s earnings announcement on Thursday to hear what company management has to say about future prospects.