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Eye of the Storm for Big Blue

18 Aug, 2005 By: Erik Gruenwedel

These are truly the dog days of summer for Blockbuster Inc. The top rental chain recently reported a quarterly loss of $57.2 million, saw its stock price sink to an all-time low and had its debt junk-rated.

The company, which reported $138 million in available cash as of June 30, spent $190 million during the first six months of fiscal 2005. It has more than $1.2 billion in long-term debt costing $17 million per quarter in interest. And the company has spent $850 million of a revolving credit facility.

The rising debt and $150 million drop in operating income reportedly forced Blockbuster into negotiations with its lenders to avoid default. Moody's Investors Service slashed Blockbuster's debt below investment grade to B3, or junk status.

Typically, the lowest debt rating a company can have and still raise financing is BB-, analysts say. When the debt goes into default, bondholders can assume control of the company and shareholders are left at the end of the line.

“This company is done,” said a venture capitalist, who asked his name not be used, after studying Blockbuster's 10Q filing with the Securities and Exchange Commission. “They don't have the ability to support this kind of debt, which means they have to raise some equity. They have to start issuing some more shares, and the stock price is below $7. And it is still going down. There is no way [they are] going to be around much longer.”

Online mystery
Media analyst Marla Backer, with New York-based Research Associates — Soleil Securities, agreed Blockbuster's debt isn't good but doesn't think it is insurmountable.

Backer said she is pleased Blockbuster increased its online subscription fee by $3 to rival Netflix at $17.99 and believes the company will be more cost-conscience going forward.

Blockbuster chairman and CEO John Antioco, in a statement to investors, said the company would not repeat the $100 million expenditure on assorted initiatives — notably subscription-based Blockbuster Online — that it did in the fourth quarter 2004.

The online service has 1 million subscribers and expects to reach 2 million members by the end of the first quarter 2006, according to filings. In addition to distribution centers across the country, Blockbuster fulfills online orders from 200 retail stores with plans to increase fulfillment from 1,000 stores by the end of the year.

Arvind Bhatia, analyst with Southwest Securities, said he would like to see more clarity on the online program, including details on subscriber acquisition costs, churn rate and subscriber additions.

“The lack of metrics regarding the online business makes it difficult for investors to evaluate its success,” Bhatia said in a research note.

Late fees albatross
A Blockbuster spokesperson confirmed the elimination of the one-out in-store subscription plan and said implementation of ala-carte rental price hikes by 50 cents was neither untrue nor official policy. Retail analyst Dennis McAlpine, with McAlpine Associates, said the rental hikes are not aimed at driving customers online as much as increasing revenue.

Fourth-quarter wishes
Antioco, like much of the movie industry, is pinning Blockbuster's turnaround on the fourth quarter.

Research Associates' Backer said a successful fourth quarter, including an uptick in rental activity, organically and not specific to Blockbuster, would be beneficial.

“It is a matter of time before we can really see whether that is in fact true,” Backer said. “But I don't think it is worth buying the shares on that possibility.”

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