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Gallery Leads in Race for Hollywood

14 Jan, 2005 By: Erik Gruenwedel

In the hotly contested bidding process for No. 2 rental chain Hollywood Entertainment Corp., No. 3 Movie Gallery this week appeared to gain the upper hand.

A special committee of Hollywood's board of directors agreed to Gallery's $13.25 per share, $850 million cash offer plus assumption of $350 million in debt.

The agreement also calls for Gallery to receive a $27 million break-up fee should Hollywood decide to accept another offer.

Combining the two video rental chains — the deal is expected to be finalized in the second quarter — would create an empire of more than 4,000 stores, including more than 700 Game Crazy outlets, with annual revenue approaching $2.5 billion.

Market leader Blockbuster Inc. has about 9,000 stores worldwide with 2003 annual revenue of $5.9 billion.

Dothan, Ala.-based Movie Gallery's acquisition of Hollywood, which must be approved by Hollywood shareholders and pass federal antitrust muster, would retain subsidiary Hollywood's corporate name and much of the infrastructure and staff in Wilsonville, Ore., according to Movie Gallery president and CEO Joe Malugen.

“We believe this combination with Hollywood presents an outstanding opportunity to enhance value for shareholders, create new career opportunities for employees and associates of both companies and expand our presence to better serve customers and the communities in which we operate,” Malugen said.

What, if any, role Hollywood founder and CEO Mark Wattles plays in the new corporate structure isn't known. Neither company is talking.

In a separate move, Wattles last week became principal shareholder and chairman of video game retailer Ultimate Electronics.

Blockbuster's Dogged Pursuit
Despite Movie Gallery's frontrunner status to acquire Hollywood, analysts contend the deal is far from certain considering Blockbuster's dogged pursuit of its perennial rival. Indeed, the Federal Trade Commission is continuing to review information regarding Big Blue's offer.

“I think Blockbuster [will make] another bid,” said Marla Backer, media analyst with Research Associates/Soleil Securities in New York. “I don't think anyone, including Movie Gallery, thinks this is a done deal.”

Blockbuster has made no secret of its willingness to bid higher, and investors took note, as evidenced by Hollywood's $14.03 share price Thursday.

Blockbuster and Hollywood have at times engaged in an acrimonious chess match.

Under a confidentiality agreement, Blockbuster had requested access to Hollywood's books — a request Hollywood reportedly was reluctant to accept unless Blockbuster agreed to a “standstill requirement.” Under such a requirement, Blockbuster would be prohibited, among other things, from circumventing Hollywood's board and making a direct “hostile” offer to shareholders.

Blockbuster has refused to sign such an agreement and additionally said it would deduct any break-up fee to a third party from its offer.

“What Blockbuster exposes itself to (with a standstill) is the risk that Hollywood's board will act capriciously and say, ‘yes, you offered more money, but we think there are serious antitrust issues. Therefore, we reject your offer, and we recommend shareholders go with Gallery, which we have a definitive agreement with,” said Michael Pachter, media analyst with Wedbush Morgan Securities in Los Angeles. “If that were to happen, Blockbuster couldn't do anything about it, because they have signed a legally binding document saying they wouldn't make a hostile offer.”

Pachter said Hollywood's agreement to the $27 million break-up fee created a wealth transfer from its shareholders to Movie Gallery shareholders.

Analysts doubt the fee would preclude Blockbuster from submitting a higher bid.Pachter wondered why such an agreement was necessary in an open bidding process. He believes Hollywood approached Blockbuster prior to Jan. 7 with Gallery's offer and asked if they would top it, as evidenced by Blockbuster's public urging against any break-up fees.

“They wouldn't have said that if they didn't know another deal was imminent,” Pachter said. “[Hollywood shareholders] are not going to vote for this deal. No chance.”

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