Six Questions: Blockbuster Shareholder Gregory Meyer16 Apr, 2010 By: Erik Gruenwedel
Forget Carl Icahn — there’s a new activist investor intent on gaining a spot on the Dallas-based DVD rental company’s seven-member board.
Gregory Meyer, who holds a 645,000-share stake in Blockbuster and previously owned DVDXpress rental kiosks before selling to Coinstar — parent of Redbox — recently formally submitted a proxy notice to shareholders seeking to replace board member James Crystal.
Blockbuster CEO James Keyes promptly rebuffed him, citing stock ownership as insufficient grounds for warranting a board seat. Keyes cited Crystal’s “invaluable assistance” in Blockbuster’s recapitalization and transformation of its business model for his re-election.
The entire Blockbuster board is up for re-election at the annual shareholder meeting
May 26 June 24.
Undeterred, Meyer April 12 wrote a letter to shareholders admonishing Blockbuster management for not heeding a 2005 letter he sent to the board urging the company to seriously consider entering the kiosk business, among other initiatives. At the time Redbox had a few hundred kiosks in operation and would have thought twice about expanding operations (to more than 22,000 kiosks today) had Blockbuster entered the fray, according to Meyer.
The investor said it is debatable that continuity of the current board, whose limited stock ownership Meyer also criticizes, is in the best interest of shareholders given that it has presided over a 95% decrease in stock value over the past three years.
Home Media Magazine asked Meyer to explain what the current board lacks and how he would help change Blockbuster’s fortunes, among other issues.
HM: In your letter to Blockbuster shareholders, you state that the reason for joining the board is not just about the company’s perceived inaction toward a nascent rental kiosk market back in 2005. What is the Blockbuster board not doing? And what should the company do differently than its current multiplatform strategy involving in-store, by-mail, VOD and kiosk?
Meyer: Given the speed of innovation in the distribution of home entertainment, at least some members of the board should be acutely aware of the new technologies and business models that are emerging to determine which ones have the potential to succeed on a mass scale because these are the ones that can’t be ignored.
The past decade has seen the by-mail subscription model and the DVD rental kiosk gain mass acceptance for different reasons. In both instances, Blockbuster could have dominated these now billion-dollar channels had the company acted early enough and not been in denial. At a minimum, the current board needs to be vigilant enough to attempt to see what’s around the next corner and, ideally, to foster a culture that encourages innovation from within.
The multichannel strategy makes sense, as long as those channels aren’t set in stone and include emerging technologies and business models that resonate with consumers. Assuming the deal terms are fair, Blockbuster’s recent partnership with T-Mobile on their HTC HD2 smartphone demonstrates a step in the right direction, but this is an ongoing process.
HM: Should Blockbuster license or sell its by-mail and on-demand platforms to third parties similar to what it has done with NCR Corp. and Blockbuster Express kiosks?
Meyer: Given the right circumstances, it might make sense to consider the sale of certain assets. For example, if you look at the enterprise value of Netflix today, it is about $4.8 billion, which values each subscriber at more than $350. Applying this to Blockbuster’s most recent subscriber count of 1.6 million members would yield $560 million.
Now there are valid arguments for why Netflix deserves a higher multiple per subscriber due to its superior execution and growth rate, but that only goes so far. Blockbuster’s service offers some advantages as well that can’t be easily replicated by Netflix, such as the ability to combine the long-tail selection of the by-mail/streaming subscription model with the immediate gratification of trading in your DVD at the store for a brand new release. This is an extremely compelling value proposition for many customers that, if marketed properly, could give Blockbuster an edge and restore its relevance.
Blockbuster’s primary objective is to get back on solid footing financially, and if the sale of a particular platform allows that to happen then it should be considered.
HM: How does Blockbuster continue to evolve its brand when saddled with nearly $900 million in debt? How would you eliminate it in today’s economic environment? Is it even possible?
Meyer: Priority No. 1 should be to stabilize cash flows from the core business. The market is projecting decreasing store comps ad infinitum, which is probably too gloomy given the significant reduction in industry capacity over the past year as well as increased traffic resulting from the 28-day head-start that has just started to kick into gear. Add in cost savings from reduced store leases and overall SG&A reduction, and Blockbuster has the potential to post some healthy cash flow figures in the near future — although this largely depends on proper execution by management. Remember that during fiscal 2009, Blockbuster generated over $2.1 billion in gross profit, which is significantly greater than the revenue from either Netflix or Redbox.
Regarding debt reduction, the company has been talking about international asset sales for some time but we haven’t seen much since the sale of the Ireland assets last year. I believe there are some additional creative structures that can leverage Blockbuster’s less obvious assets to reduce its current debt load meaningfully. I have presented the firm’s financial and legal advisers with one such proposal, which I can’t comment on further due to its confidential nature. Then, of course, there is talk about a debt-for-equity swap, but this is not in the best interest of equity holders and should be viewed as a last resort, not a foregone conclusion.
HM: Despite Blockbuster being a brand synonymous with home entertainment and movie rentals, many pundits and analysts believe it to be anachronistic compared to Netflix and other alternatives. How do you convince them otherwise?
Meyer: On the plus side, the Blockbuster brand has near ubiquitous recognition, which is a huge asset. That said, a lot of what is associated with the brand stems from an earlier time when the company dominated the video rental sector and allowed itself to become complacent and take customers for granted.
Going forward, the Blockbuster brand has the potential to take on some very positive associations, such as the ability to get new-release DVDs on street date. I believe the brand can once again regain the power to excite customers who know they can count on Blockbuster to get the latest new-release movies as soon as they are released. Finally, the key is to extend this new, positive brand association into the digital and mobile distribution channels so that those customers who do prefer to acquire their content in digital form know that the latest new-release DVD rentals and retail downloads are available at Blockbuster On Demand.
HM: The studios appear to be throwing Blockbuster a lifeline by imposing 28-day new-release embargoes on Netflix and Redbox. How does Blockbuster take advantage of that window considering its limited resources?
Meyer: Blockbuster has spent tens of billions of dollars buying studio product over the past 25 years, so it is natural and healthy to see them acting in concert to support one of their best customers. It is essential that Blockbuster leverage this studio support to the fullest by clearly communicating its street date availability advantage to past, current and potential future customers via smart, efficient and creative marketing on-line and in-store. Better use of customer e-mail is certainly called for, as are low-cost viral marketing campaigns to get the word out. Blockbuster’s marketing for The Blind Side and Sherlock Holmes was a good start, but it’s not enough.
HM: Is there still a need for the video store, or should Blockbuster just focus on its alternative distribution channels?
Meyer: Over the past year, brick-and-mortar video rental stores in the United States generated substantially more revenue than by-mail subscription and kiosk operators combined, including Netflix and Redbox. So while the growth rate of these alternative distribution channels is highly positive and the growth rate of the traditional video store is not, it’s important to recognize that a lot of money still gets spent at the brick-and-mortar level and will for years to come.
The cash flow generated by Blockbuster’s top performing stores is significant and should remain significant for some time in light of the recent 28-day window as well as the elimination of many competitive physical stores, which have closed in the past 12 months. But a careful balance needs to be struck between maximizing current cash flow from the traditional model and investing in ways to transition customers into future distribution channels such as digital delivery via Blockbuster On Demand. This is not an easy task but by no means an impossible one either.