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Update: Movie Gallery Stock Drops Nearly 15 Percent

27 Sep, 2005 By: Holly J. Wagner

More bad news, including an analyst downgrade, drove Movie Gallery stock down nearly 15 percent from $12.82 at Monday's close to $10.95 in late trading Tuesday.

Gallery announced after Monday's market close that it would not pay a dividend for the third quarter this year and had announced Friday that it was taking on more debt to buy out former Hollywood Video CEO Mark Wattles under a clause in the contract to buy the rest of the chain. Under the terms of the Hollywood Video chain acquisition, Wattles had the right to require that Movie Gallery buy the 20 stores he personally owns and operates.

"The board believes that it is more prudent at this time to focus on debt reduction and the working capital needs of the business. We will continue to reevaluate the company's dividend policy and hope to reinstate a regular quarterly cash distribution as soon as conditions permit," chairman and CEO Joe Malugen said Monday. "Despite the industry challenges that we are facing, we believe Movie Gallery is successfully executing on its strategic plans, and we remain confident that our core movie rental business is well-positioned for continued growth and success."

Although Wedbush Morgan Securities analyst Michael Pachter maintained his buy rating and $24 price target for shares of Movie Gallery, other analysts were not so kind.

Bear Stearns reinitiated coverage on Movie Gallery Monday, and analyst R. Glen Reid put a $7 target price on Gallery shares. The chain is behind the times and blaming a weak release slate for deeper problems in the rental industry, he contended.

Malugen has long been a vocal opponent of subscription models, but Reid said online rentals, sellthrough DVD and video-on-demand are eroding the brick-and-mortar rental market. He forecast Gallery's earnings per share for the year at 87 cents, well behind the analyst consensus of $2.28.

The chain amended its $870 million credit facility to allow another $50 million of borrowing and increased its revolving letter-of-credit sublimit from $30 million to $40 million without increasing the overall revolving credit line. The amendment also relaxes the required ratio levels under the financial covenants in the credit facility.

To win the amendments, Movie Gallery agreed to pay an extra one-quarter percent in interest to lenders that consented to the new terms. The company also agreed to other prepayment protections for the lenders.

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