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Blockbuster Shareholder Sues Over Planned Spinoff

22 Mar, 2004 By: Holly J. Wagner

Just hours after executives of Blockbuster Video and its parent company, Viacom Inc., announced a plan to spin off the No. 1 video rental chain as a separate business, a shareholder sued the companies to block an expected stock swap to facilitate the transaction, according to the rental chain's annual report filed with the Securities and Exchange Commission.

Investor Howard Vogel filed a lawsuit Feb. 10 in the Newcastle County Chancery Court in Delaware naming as defendants Blockbuster directors John Muething, Jackie Clegg and Linda Griego; Blockbuster CEO John Antioco; Blockbuster; Viacom; and Blockbuster directors who are also directors and/or officers of Viacom.

Vogel alleges that a stock swap that Viacom is expected to announce to close out its 81 percent ownership in Blockbuster would be a breach of fiduciary duty to minority stockholders and that the defendants engaged in unfair dealing and coercive conduct. The complaint asks the court to certify a class and to block the transaction, which Viacom CEO Sumner Redstone recently told investors should take place in mid-July.

But details of the swap offer have yet to be finalized, prompting Blockbuster executives to brand the case premature in an annual report filed with the Securities and Exchange Commission.

“As of yet, no definitive transaction has been identified by Blockbuster, and Blockbuster believes the plaintiff's position is without merit,” the report states. “Plaintiff has confirmed that Blockbuster and the other defendants are not required to respond to the pending complaint. Should it become necessary, Blockbuster intends to vigorously defend [against] the litigation.”

The chain also acknowledged that a payout to Viacom shareholders in the spinoff could cut into its bottom line. “In the event of an eventual split-off, we anticipate that the board of directors may consider issuing a special dividend... [I]f this dividend were declared, it could result in increased outstanding debt and increased interest expense going forward.”

Among other disclosures in the chain's 2003 annual report:

  • The U.S. Supreme Court will not hear an appeal of a lawsuit that independent dealers brought against the chain alleging unfair practices related to pre-1997 revenue-sharing deals with studios. Blockbuster won a dismissal, and the indies have exhausted their judicial remedies.

  • Blockbuster will exit Norway at the end of the month, although the chain has just two stores there. It will also exit Hong Kong and Ecuador as the chain and franchisees abroad struggle to compete against piracy.

  • Used-disc sales rose 33.1 percent at the chain in 2002 to create a 175 percent increase in revenue from previously viewed titles, partly because used DVDs sell at a higher price than VHS. The spike contributed to a 29.7 percent increase in same-store rental revenue that year. Used-product sales slipped by 7.2 percent in 2003.

  • The report also noted that “we may need to turn our inventory of previously rented product more quickly in the future to make room in our stores for additional DVDs or new initiatives. Therefore, we cannot assure you that in the future we will be able to sell, on average, our previously rented product at or above the expected price.”

  • The chain has in-store movie rental subscriptions in 25 percent of its U.S. stores. Plans this year call for expanding the program nationwide and online, but that may be costly, as subscriptions carry no late fees during the term of the subscription. In addition, “we may test other alternatives to our standard rental model to respond to competitive alternatives that do not have extended viewing fees.” The company also expects to make a substantial investment in information technology to support the online rollout and other customer service initiatives. “We expect to increase our capital expenditures over our current level during 2004 and 2005, to support various revenue and profitability growth initiatives, as well as systems and infrastructure improvements.” The budget is about $250 million to $280 million.

  • Blockbuster paid $8.2 million to settle a lease obligation with Wherehouse that was incurred in the sale of 380 Blockbuster Music stores to Wherehouse; the chain may still have to pay more.

  • The chain's existing credit facility expires in July and will have to be renegotiated. Negotiations will include awareness of Viacom's spinoff plans that could result in less-favorable terms.

  • Blockbuster expects future rental strength to come from catalog — “titles that are not classics or current box office hits.” But that may not be enough to bring fourth-quarter revenue back to its heyday. “Our performance during the holiday selling season ... indicated that same-store revenue for our core rental business would be more unfavorable than we previously anticipated. ... [T]he strength of rental revenue in the fourth quarter had been and will continue to be negatively affected, to some degree, by consumers purchasing DVDs during the holiday season.”

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