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UPDATE: Big Blue Makes an Offer for Hollywood

11 Nov, 2004 By: Holly J. Wagner

Blockbuster Inc. is making a play for ailing Hollywood Entertainment Corp., offering $11.50 per share in a potential deal that bested the $10.25 that a group of investors was planning to pay in a deal to take Hollywood private.

Hollywood has been on the block since an effort to go private at $14 a share failed in October and was superseded with the $10.25-per-share offer.

The Blockbuster press release said the offer had “not yet resulted in a substantive discussion regarding the terms of a potential transaction,” but the proposal represented a 12 percent premium over the $10.25 price the investors, led by Leonard Green & Partners, planned to pay.

Following the announcement, Hollywood stock closed at $10.93, and Blockbuster stock was at $8.20, a more than 11 percent hike for both. But Standard and Poor's said it might lower its ratings on Blockbuster and/or change its rating on Hollywood in the wake of the announcement. S&P has a corporate credit rating of “BB,” the second-highest junk rating, on Blockbuster and a “B-plus” rating, the fourth-highest junk rating, on Hollywood.

The combined companies' U.S. video revenue market share in 2003 was 20 percent, according to Video Store Magazine Market Research. Their share of the U.S. rental market was 46 percent, and their share of the U.S. game rental market was 54 percent.

“It's a hugely accretive deal, meaning they get more earnings [quickly] by buying Hollywood then they could ever hope to by building their own stores,” said Michael Pachter, analyst with Wedbush Morgan Securities. “Antitrust issues aside — let's just pretend they don't do something like raise prices to $5 a rental — there are numerous synergies between the two. They compete head-to-head in a lot of markets, which means they have to advertise, and if they are all under the same umbrella you save money.”

The companies reportedly tried to forge a franchise agreement in 1999 that would have seen Hollywood stores operating under the Blockbuster shingle. Although neither chain would comment on those reports at the time, the Federal Trade Commission made inquiries into a potential merger, according to contemporary published reports.

Hollywood studio executives were mum about the potential deal announced last week.

A source at a competitor suggested Blockbuster's announcement of interest falls short of an actual offer and speculated that it could be designed to weaken a soon-to-be-private Hollywood.

“If you are going to deem it an offer, you have to assume it is a genuine offer and not just to drive up the cost for the current acquirer, which would limit the flexibility of Hollywood,” said Movie Gallery SVP of Investor Relations Tom Johnson. “It might not even materialize in the way of a formal offer, if Blockbuster gets in there and does some due diligence. It depends on what kind of access to materials they are going to give them, whether they open the kimono wide, or say, ‘you're a competitor, and we are only going to let you see a little bit.'

“If it were to materialize to go to the Justice Department, we personally believe that the antitrust issues of a Blockbuster-Hollywood combination would be serious impediments to timely closing the deal,” he added.

Analyst Dennis McAlpine of McAlpine & Associates agreed.

“It's an expression of interest, not a formal offer. Blockbuster is saying ‘we want to look at the books, and there are a lot of material things that could change and we might walk away from it,’ he said. “I think Blockbuster had to push now before Hollywood went private.”

Netflix also rang in with doubts about the viability of a possible merger. “We look at this as one money-losing business buying another. The financials on the business side don't really look that good,” a Netflix spokeswoman said. “If they did do it, it would make the whole online rental business stronger. The loser would be the stores.”

The in-store rental market has been shrinking steadily since the rollout of DVD. Sellthrough pressure from discounters, mass merchants and even grocers, plus the emergence of online rentals, has 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. Blockbuster cited these trends in its announcement.

A merger with Hollywood would add 1,900 stores in 47 states and the District of Columbia, plus 600 Game Crazy stores and would more than double Blockbuster's presence in the U.S. game market.

“We believe this proposed transaction better positions Blockbuster to compete in the rapidly changing home entertainment marketplace,” said John Antioco, Blockbuster chairman and CEO. “In addition to providing Hollywood Entertainment shareholders with a substantial premium for their shares, the proposed transaction would give us more ways to serve more customers by taking advantage of both companies' combined store distribution capabilities and brand portfolios.”

Senior reporter Erik Gruenwedel also contributed to this story.

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