Blockbuster And The Nobility Of Bankruptcy (BBI)

Carl Icahn apparently signaled yesterday that he would not fight for control of Blockbuster Inc. (NYSE:BBI), where he has already gained board seats and a measure of control. No wonder. What is there left to fight for?

Blockbuster's smaller competitor, Movie Gallery Inc. (NASD:MOVI) has already spent several months staring into the abyss. In the last year, that stock has dropped from over $34 to about $2.50 and management spends most of its time firing people and renegotiating bank debt.

Blockbuster is in a tight spot. Very tight. With Movielink announcing is now offering the option to download and store first-run movies over broadband and Netflix Inc. (NASD:NFLX) and Wal-Mart Stores, Inc. (NYSE:WMT) renting movies though the mail, the movie rental store business is going the way of the Dodo bird.

Blockbuster's own stock has managed to dive from a 52-week high of $10.65 to $3.80. Going back two years, the stock traded closer to $17.

Blockbuster has taken on great loads of debt to do things like pay a special dividend. According to the Value Line Investment Survey report on February 10 (www.valueline.com), free cashflow in the last quarter only totaled $18.9 million, which is not much for a company that does over $6 billion in sales. Blockbuster has also shown a net loss each of the last five years.

Blockbuster has $1.158 billion in debt. One of the interesting nuggets in the company 10-K is a description of what happens if cash flow is not adequate to service debt. The end-game is especially exciting. "Our failure to comply with these (debt) covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our debts, which we may be unable to repay." The company has already had to get waivers from one of its lenders. And Blockbuster does not leave the investor hanging. Things could get worse. "Any of these scenarios could adversely impact our liquidity and results of operations or force us to file for protection under the U.S. Bankruptcy Code".

The company has 1.2 million online subscribers who order DVDs online and in this arena they have a chance to compete with the likes of Netflix, although this is a cutthroat business. The company also has over 5,700 stores in the U.S. and over 3,300 stores overseas, and that is the heart of the problem. For starters, Blockbuster has a $150 million letter of credit that benefits its former parent, Viacom (NYSE:VIA), for liabilities on real estate leases. Beyond this, the company has leases that have five to ten year terms for most of its stores. The total obligations on operating leases over the next five years is approximately $1.975 billion.

Revenue at Blockbuster declined 11% in Q4 O5 to $1.53 billion. The new broadband download model at Movielink and Amazon's (NASD:AMZN) proposals to offer downloadable movies, coupled with pressure from NetFlix and others in the online DVD business are only going to pressure the Blockbuster top-line further.

Bankruptcy is a noble option for restructuring leases and debt. Ask the airlines. Someone at Blockbuster has to be thinking about it, or else how did it make it into the 10K?

BBI 1-yr Chart

Douglas A. McIntyre is the former Editor-in-Chief and Publisher of Financial World Magazine. He was also the president of Switchboard.com when it was the 10th most visited website on the internet, according to MediaMetrix. He has been chief executive of FutureSource, LLC and On2 Technologies, Inc. and has served on the boards of TheStreet.com and Edgar Online. He does not own securities in companies he writes about. He can be reached at [e-mail]