There is news out this week saying that Blockbuster has hired a US law firm to look at its restructuring options. Most newspaper don’t quote a source for the story, referring to people close to the deal, but it was clearly announced in an SEC filing this week in a one liner saying that its fourth quarter and full year figures would come out on March 19 (very late) and that the company would use an analyst conference at that time to discuss the status of its efforts to refinance portions of its senior credit.
The credit it is talking about is due to mature in August and it is like a toxic time bomb on its books. We expect that it is deliberately giving off an aura of bankruptcy so that it has some clout in negotiations to replace or extend this credit line. The company says that it has hired the law firm of Kirkland & Ellis to advise it with respect to its ongoing financing and capital raising initiatives.
Interestingly it is not a financial adviser that might help it raise money, more a legal adviser that can tell all of its existing debt holders just what the law would allow to happen to their money if they push too hard and Chapter XI was the only way out. Kirkland & Ellis is understood to be a specialist in US bankruptcy laws.
Blockbuster is caught between an historical business that it has not worked hard enough to shed, and two new businesses at which it does not yet excel, online DVD rental and online film delivery.
All companies which have started up in online film rental have failed until very recently, with Netflix suddenly appearing to ‘crack’ the market. Its idea is a simple and obvious one ‘ let its existing online DVD ordering subscription customers have online delivered films for free. Even this alone had not worked until it added deals whereby a number of devices connected these free films straight to a TV set. These devices include PCs, Macs, Internet connected Blu-ray players, made by LG and Samsung, TiVo DVRs and the Netflix Player by Roku, and the Microsoft’s Xbox 360 due later this year as well as TVs from Vizio and LG.
Netflix has more than 10 million subscribers and had 2008 revenues of $1.36 billion and holds $297 million in the bank, and has no debt. Blockbuster at last count, which was back in October, has a falling online DVD rental business, slightly fewer stores, a decreasing in-store rental base all of which leads to revenues of $1.2 billion in the last reported quarter alone. So it is early 4 times the size of Netflix.
It is always hard to believe that a brand name which has stood the test of time for so long can fall by the wayside, but clearly the US public is telling each other to drop their Blockbuster membership and get a Netflix deal, and it will take time, time which Blockbuster doesn’t appear to have, to turn that around.
All of the consumer electronics companies want to do a deal with Netflix because they see it as the coming king of US video. Meanwhile Sonic Solutions recently partnered Blockbuster in its online service, a deal announced back at CES in January.
This was effectively a merger of the Blockbuster acquired Movielink with the Sonic acquired CinemaNow and the application of some new Sonic technology.
The two companies (Sonic and Blockbuster) now say they are collaborating with consumer electronics manufacturers, including Sonic’s existing CinemaNow providers, to expand the ecosystem of interoperable devices offering this new Blockbuster service. This ecosystem will include PCs, portable media players, Blu-ray Disc players, DVRs, set-top boxes, mobile phones and web-connected TV sets.
This is similar to what Netflix has done, except that files will be freely transferable between devices, including many portable devices. Netflix has little incentive to offer this feature right now, but could perhaps easily offer free transfers between Netflix affiliated devices at some point in the future.
The truth is Netflix can sweep aside the disparity in revenues between it and Blockbuster in a very short period of time, while Blockbuster management will spend all of its time dealing with its legacy ‘ 7,500 stores, an unwieldy international business and a feeling among its customers that it really is rooted in the retail, rather than the online world.
While Blockbuster flirts with bankruptcy, renegotiates debt, and perhaps sells off its international arm for not very much, Netflix is free to focus on getting its new model right.
The critical question to us is ‘If a Blockbuster store closes, does Blockbuster lose all the customers which use that store?’
The answer right now should be a very different answer from the one that would have been given 2 or 3 years ago, because of two things that Blockbuster has done ‘ firstly it has tried to keep up with Netflix in the online DVD rental business, and by now this should really be where its best business is coming from. Gone are the late fines for hanging on to a DVD for too long, gone (or they should be) are the arduous trips to the store in the rain, late at night to pore over DVDs which you’ve all seen before.
But the US public doesn’t see it that way. And while Blockbuster doesn’t break out its online DVD rental business, we know that by its own admission that instead of growing, it is falling. Rental revenue in its last reported quarter was down $63 million on the year ago quarter while merchandise sales were up $30 million. This perhaps shows a company that accepts that it cannot compete with the Netflix business model, and that it must continue to look for opportunities that come out of its 7,500 US stores hence the store sales.
Earlier in February Blockbuster launched a service to combine the benefits of online purchasing of games as well as movies, with what Blockbuster calls Total Access. Online customers rent video games, as well as movies and get them through the mail as part of their subscription plan.
The company says that it will have this program working nationally by the second half of this year, but surviving to the second half of this year is not something that new online business is going to achieve for Blockbuster. Given that it is burning $100 million a quarter operationally and has under $100 million in the bank, survival is now down entirely to banks and lawyers. And investors, worried either that the company will fail to achieve this or that they will do it at the expense of shareholders, currently have the company’s valuation in the basement, which is where it will stay until it is completely clear that Blockbuster has a way forward at least into 2010, by which time its new online initiatives may have time to work.
Today Blockbuster shares are trading at $0.22 which makes a company with a revenue run rate of around $5 billion worth just $35 million. As we have said before there are few White Knights out there in the current economy, but if someone were to buy Blockbuster, and force it away from a bricks and mortar past into an online future, they would set up the natural long term rival to Netflix. If that doesn’t happen then Netflix is going to have this entire market to itself.