Monday, April 14, 2008

Circuit City: The vultures swoop in

Circuit City (CC), the electronics retailer in dismal shape due to gross mismanagement received a take-over bid from Blockbuster (BBI), the video rental retailer that has an existing set of problems. Vultures have been eyeing the carcass of Circuit City for a good period of time; it should not be a surprise that another retailer has swooped in to take a peck.

In terms of business intent, a combination with Blockbuster may be one of the better proposed deals placed on the table. Certainly better than simply selling out to a private equity firm. In reality, many would look at Blockbuster as being more of a white knight than a vulture.

Highlights of the offer include $6 to $8 per share in cash, a total of up to $1.3 billion. It appears that the chronically mismanaged Circuit City has effectively ignored earlier private proposals, so Blockbuster took the step of making this bid public and engaging shareholders. The press releases indicate that Blockbuster is proposing to use a rights offering, a mechanism that allows existing shareholders to buy additional shares of a company, in order to complete the transaction. Rights offerings are rare in the United States and typically occur at a discounted price.

Blockbuster has emerged as a survivor in a movie rental industry that is undergoing sharp transition. Over the past couple of years, several competitors such as Movie Gallery and Hollywood Video filed for bankruptcy or have been shuttering stores. Competition from online firms, delivering rentals via mail, such as Netflix (NFLX) have stepped up the bar in the industry. Pay per view films offered by cable operators have also deeply cut into the rental business. Being strictly a corner store video rental business is no longer a viable business model.

Blockbuster touted the synergies of the proposed combination; pointing to the ability to cut costs, exploit the growing convergence of media content and electronic devices, and benefit from selling complementary products. Circuit City stores are typically larger than Blockbuster storefronts; one could expect to see “Blockbuster super-stores” that sell electronics and rents movies. However, even if the deal is completed the expectation is that is would take over 12 months to see viable traction with the combination. A large number of existing neighborhood Blockbuster stores would probably be shuttered; frustrating consumers who have to drive longer distances to the new “super stores”, many which are located in crowded malls.

Investors also appear to be skeptical as they drove Blockbuster stock down over 10% in trading on Monday. Many doubt that Blockbuster can cure the problems plaguing Circuit City without causing a tremendous distraction to the company’s primary business. The financing for the transaction is also in doubt and may be dilutive.

Circuit City, winner of the dumbest retail business move of 2007, is a poorly managed underperformer. Its closest competitor, Best Buy (BBY), has been dominating the electronics retail segment. In a continuing sad saga, Circuit City handed out sizeable bonuses for executives while cutting top-performing employees at stores because they were “over-paid”. In response both the sales and stock price tanked. The ills of Circuit City can only be resolved by the replacement of the current management team, and a complete re-focus on the consumer.

Circuit City stock rose nearly 30% on Monday when the news hit the wire. The bid by Blockbuster may be just the front end of a chain of bids for the company. Other players, who have been sitting on the sideline, now may be forced to show their hands and open their wallets. Setting the table for a possible bidding war, an event that would please many long-suffering Circuit City stockholders immensely.