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Institutional Action Heats Up Amid Hollywood Merger Bids

23 Dec, 2004 By: Holly J. Wagner

As Blockbuster Inc.'s general counsel groused that Hollywood Entertainment is stonewalling Blockbuster's merger efforts, institutional investors have been buying stakes in Hollywood and Movie Gallery, apparently gambling that the outcome of a bidding war will increase the value of both smaller chains' stock.

Blockbuster General Counsel Ed Stead, who is also substantially vested in the company, told Bloomberg that Hollywood's board is insisting on a “standstill” agreement that would bar Blockbuster from taking an offer directly to shareholders for three years. Analysts say a one-year agreement is standard.

“We're having some difficulty getting cooperation from the Hollywood board,” Stead told Bloomberg. “We are unwilling to sign a three year standstill agreement.”But as known players – including activist shareholder Carl Icahn, who owns 5.8 percent of Blockbuster's Class A stock, 5.07 percent of its Class B stock and 9.5 percent of Hollywood – duke it out in the press, investment funds are loading up on Hollywood and Movie Gallery.

Documents newly filed with the Securities and Exchange Commission indicate that a Cayman Islands-based British hedge fund, The Eureka (Euro) Fund Limited, bought 3,395,440 shares of Hollywood Dec. 15, making the fund Hollywood's second largest institutional investor with a stake of 5.6 percent. The largest institutional shareholder is Milwaukee, Wis.-based Artisan Partners. The InvestmentNews 2003 Databook lists the Eureka fund as the U.K.'s eighth-largest hedge fund, ranked by the value of assets under its management.

Yahoo! Finance shows Artisan Partners with a 6.8 percent stake in Hollywood – more than CEO Mark Wattles – and a 7.92 percent stake in Movie Gallery as of Sept. 30. Artisan's Small Cap Value Fund mutual fund also owns 2.05 percent stake in Movie Gallery and a 2.08 percent stake in Hollywood. But filings with the Securities and Exchange Commission show that Artisan bought up another 11.1 percent of Movie Gallery – 3,444,000 shares – Nov. 30, raising its stake to 19 percent.

Hollywood has been on the block since an effort to go private at $14 a share by an investor's group led by Wattles, failed in October and was superseded with a $10.25-per-share offer from the same group later. Blockbuster Video has offered $11.50 per share in a potential deal that bested the $10.25. Blockbuster valued its offer at $1 billion, including assuming $350 million of Hollywood's debt. Movie Gallery has not made its bid price public.

The Hollywood board's backing of the Oct. 13 proposal from Carso Holdings, the group of investors led by Wattles and backed by financial restructuring firm Leonard Green & Partners, have drawn protests from a Hollywood shareholder group.

Sellthrough pressure from discounters, mass merchants and even grocers, plus the emergence of online rentals, have forced all of the major rental chains to branch into games and used trading to shore up sagging rental revenue. Rentailers also face increasing competition from cable, satellite and Internet movie services.

A merger with Hollywood would add 1,900 stores in 47 states and the District of Columbia, plus 600 Game Crazy stores, to the winning bidder's business. An acquisition would more than double Blockbuster's presence in the U.S. game market from the 450 Game Rush and 50 freestanding Rhino Games locations that Blockbuster CEO John Antioco said the chain would have operating by the end of the year; while a Movie Gallery win would nearly double that chain's size and instantly give it a presence in the West, where it has few stores.

In a separate maneuver, Hollywood's Wattles has bought up a 9.8 percent share in failing Ultimate Electronics. Ultimate's stock plunged 54 percent Dec. 13 after the company reported it might be unable to make loan payments because of weak holiday sales. Wattles bought his stake in increments between Dec. 13 and Dec. 15.

“Mr. Wattles acquired the shares of the company's common stock…for investment purposes,” according to an SEC disclosure. The disclosure states that Wattles does not intend to increase his stake but may “discuss the company's business, operations, prospects, management or capital structure with management, shareholders, potential partners or investors” and “reserves the right to change his plans and intentions at any time.”

Thornton, Colo.-based Ultimate operates 65 stores in 14 states. In a quarterly report filed Dec. 16, the chain noted that most of its vendors had closed its credit lines and were demanding up-front payment. The filing warns that “potential loan covenant violations raise a substantial doubt about our ability to continue as a going concern.” While management is working on strategies, such a statement is widely read as a sign the company may go into bankruptcy.

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