There are two approaches to analyzing the news that Dish Network has bought Blockbuster, the ‘they must have a devious plan’ approach and the ‘what on earth is it doing’ approach.
We are leaning towards fall a form of the latter, in that we think Dish is at least speculating, rather than investing, and that this sits well with the personality of Charlie Ergen, the CEO and largest shareholder.
But it is tempting to fall into the former logic, especially given the recent investments Ergen has undertaken and special problems which Dish has. It is threatened on all fronts, not the least of which is OTT Video, but also it has rivals who are currently doing better than it is.
Dish lives in a world where it has no triple play to sell, where other rivals can sell triple play services, so it is always looking for a broadband partner, which is perhaps why it has bought 700 MHz spectrum and why it has also bought some Mobile Satellite Services spectrum in S-band and why it has debt holds on two other remaining lots of S-Band spectrum in the US. Dish also lives in a world where is has no major sales partner any longer and where its moves into HD were late and labored.
Someone that hasn’t followed Dish’s past might think it was planning to build out its spectrum, but the truth is that Ergen has a free hand to speculate with spectrum and hopes to sell off these spectrum chunks with golden handcuffs attached ‘ bringing his businesses (he also owns the majority of EchoStar) either a triple play to sell, or some satellite services business. He neither has the money to build out such a network, nor does his company have the confidence of the market to raise such monies.
The other conclusion someone might reach is that the 700 MHz spectrum Dish holds could be used with (or without) the MSS spectrum to create a one way delivery mechanism that reaches most of the US and that part of a Netflix class service could be launched using it or even a mobile movie channel, borrowing from the Blockbuster online assets. That’s a hell of a way to take Blockbuster online content and deliver it as a series of broadcasts to US homes, perhaps in conjunction with a cheaply produced, EchoStar designed, set top (or Tablet) which offers push VoD, download to view later. Add an Android Market app for viewing content on phones and tablets and it looks like a winning transformation. It’s this type of speculation that makes the Dish and the EchoStar price rise and fall on deals like this, but recently Dish is only in the market for opportunism, not for building US wide networks. It has already done that with its Dish Network and at best Dish, in our view, is most likely to provide the spectrum and also the guts of Blockbuster, back to someone else to operate, either together in a single deal or separately.
Don’t get us wrong, there are lots of ways that Dish COULD follow through and either actually pursue synergies with Blockbuster or at least pretend to pursue such synergies, before selling it on. Why couldn’t all Dish customers become online Blockbuster customers overnight and get the service integrated into its TV Everywhere strategy. There are cross marketing relationships in here such as Dish offering discounted rates to Blockbuster card carriers, and vice versa and cheaper online deals if you are already a Dish customer.
Remember the film licenses of Blockbuster come from its ownership of Movielink, the collective Studio’s defunct online movie service. Last year Movielink and CinemaNow were effectively mashed together when the new CinemaNow owner, Sonic Solutions, cut a deal with Blockbuster and said it would update the services, to keep up with similar systems from Amazon, Netflix and iTunes, mostly by adding new business models and more and more devices which can receive the services. They would also run on a common hardware and software platform. Since then Sonic has been acquired by Rovi.
And then there is inclusion as a service for Blockbuster into Google TV. Google TV announced with Netflix, but not Blockbuster’s online service, so why can’t Dish, which offers the only version of Google TV integrated into its pay TV service and which therefore has some sway at Google, also offer an app for Google TV which supported Blockbuster rentals, both online DVD rentals delivered by post or online game and movie rentals. It might even ask to replace the Netflix widget in the Google TV boxes it ships ‘ if it is shipping any volume as yet.
Google TV comes pre-loaded with Netflix, Twitter, CNBC, Pandora, Napster, NBA Game Time, Amazon Instant Video and Gallery and will soon have apps from Android Market.
Dish can replace the retail footprint it had at AT&T which sold Dish subscriptions, by dropping them all into the remaining 1,700 US Blockbuster stores, and it can offer any free advertising inventory to promote Blockbuster on (most of it belongs to the channels it carries, but it can offer push advertising to its DVRs and some other ads).
There are also synergies (we hate that word) for its placeshifting DVR the ViP922 range and the Blockbuster online licensed content. Dish may even be able to leverage better online content at better prices from content suppliers by grouping together all of its buying power with Blockbuster. Blockbuster might even become a Dish channel brand in its own right.
So to say there is no real reason to buy Blockbuster and that it’s not worth the $320 million that it has agreed to pay, is perhaps unfair of us, so we’re not saying that, our instincts say that it is worth ALL of that. But that this is a turnaround project, not a genuine purchase. Dish can, and has, through the purchase process, separated out the assets it wants. It can then get rid of any other items which it couldn’t avoid taking on, by a process of hard bargaining and hard decision making and expense. The remaining, probably currently profitable, lump of Blockbuster might then be remarketed with in-built relationships such as those we have pointed out, with Dish. Someone, perhaps a financial partner or one of the partners that it is talking to about spectrum, then buys a slimmed down Blockbuster, which does Dish a lot of good, but doesn’t risk its share price long term.
That’s the Faultline take, but it’s not to say that the company could not be integrated into Dish, just that if it can be done with minimum risk and only upside, that’s more Ergen’s way ‘ it’s called betting on a sure thing.
The reason for us thinking this is the low price paid. The stalking horse bid from the creditors was $290 million made a few weeks ago. We know that SK Telecom was one of the other bidders, and yet the bidding never got more than $30 million above the stalking horse bid and Dish has said that it will pay out in cash some $228 million, way less than the earlier bid. However this is an accounting number which is adjusted for the cash the business holds and for a movement in its inventory on the balance sheet, and every bidder would have got the same benefits, so the real price was $320 million.
The last days of the auction had seen SK Telecom out of the bidding, but still involved was billionaire investor Carl Icahn, who lost a fortune investing in Blockbuster and who was looking to get some of it back; and a group of debt holders, presumably those were just bidding up the deal to get the best deal for themselves. Had Ergen really wanted this business, he would have put in a substantially higher offer to ensure that he got it, which is why we think that the so called ‘synergies’ will all have to be thought up after the fact, rather than come as part and parcel of a wider strategy move at Dish.
Certainly Dish is aware that it is doing less well in traditional pay TV than ever, with Dish losing 156,000 customers last quarter compared to gains at DirecTV of 289 new US customers, so it needs a new plan, and it SHOULD have a fundamental new plan, and Ergen has publicly cited the need for such a change of direction and a way to accommodate Over The Top video content. It takes no brain surgeon to work out that copying Netflix won’t make a business as successful as Netflix, but it might take the edge of such EchoStar losses and the second business to market with a deal like Netflix will have a much better chance of success than the third and fourth players to market.
It will not be lost on Ergen that Hulu Plus has announced this week that it is on track to sign up 1 million customers, and that, until this announcement, had been considered a failure.
Dish also announced two weeks ago that it was one of several parties signed up for the new Adobe Pass technology which plays both Flash and HTML5 videos, which can play on devices running on Windows, Mac OS, Android, Apple’s iOS, Blackberry OS and Google TV.
The slimming process at Blockbuster has been more than a little significant, and while we have always characterized Blockbuster as a 9,000 store location business, the truth is that it has been closing stores left, right and center, with its international business built mostly around franchise agreements across 23 countries, with directly owned international operations in the UK, Canada, Denmark, Italy, and Mexico, all shrinking. It had already closed its Argentina operation.
The last court documents list there being 2,400 owned stories still open with 700 more due to close by mid-April, which brings us neatly down to the 1,700 store locations inherited by Dish, and cited in its announcement. That’s a long fall from what was once 5,000 US stores and 9,000 globally. Prior to bankruptcy US stores alone had fallen to 3,000. We suspect that the majority of those are the more profitable stores and that they are for the most part in the US. This number of stores is far more manageable than the bulkier 9,000 number (Blockbuster still cites 8,000 on its web site).
As we went to press the trading on the Dish stock has been downwards only, but the US markets have not been open long enough to see a real pattern. We think the markets are confused by the deal, but once Ergen’s real plan comes out into the open, you can be sure it will have a potential upside.